My Stocks Buying Guide

The reason why i started investing on my own is that, 

The fee currently charged by average mutual fund in Malaysia is quite high compared with the results they delivered. 

Mutual fund in Malaysia typically charged 6% entrance fee and 1.5% annual fee for asset under management. In return, their performance are hardly differ from the benchmark (KLCI) index. The few rationales why i think people still buying mutual funds are

i. They lack the time & energy to learn to buy stock

ii. Their investment size don't allow them to have the same diversification benefit as the mutual fund. 

I admit that full replication of KLCI index will indeed need a large investment size. However, a half-replication (ie, with stocks holding and weightage slightly deviate from KLCI) will generally cost less and little pre-requisite knowledge is required to replicate. If you are brave enough to venture into investment universe outside the thirty stocks listed in KLCI, you might be able to find a few rare gems which reward you substantially compared to KLCI. 

Hence, below are my few tips on how to profit in the stock market. If you do profit from following my advice, do treat me for a good meal in one of the fine restaurant. 

Tips 1. Avoid Company where controlling shareholder (with close to 50%) is the CEO / Chairman of the company.They usually paid ecessively huge remuneration package to themselves, and award themselves with big employee share option scheme (ESOS). 

Tips 2. Be careful when the company is diluting the interest of existing party. Either via selling cheaper than Net Asset Value per share (NAV) to other party through private placement, or through ESOS with exercise price lower than NAV.

Tips 3. Focus on return on invested capital instead of revenue
Screening out those management who talk only about expansion instead of profitability

Tips 4. Avoid company with huge fluctuation of income

Tips 5. Avoid company with huge capital expenditure
Huge fixed cost => Easily lead to overcapacity and cut throat competition. One of the reason why i am not particularly fond of manufacturing company is that, they need to keep investing to keep earning the same amount of profit.

Tips 6. Adopt buy and hold strategy. Learn to be patient.
Sell the stocks only if
i. The long term prospect is bleak
ii. You realize the stock you bought is not worthy
iii. The stock price rose to a point where you feel greatly over-priced.

The Pros and Cons of buying a life insurance

Most people are more familiar with the pros, 

i. Your family get a sum if you accidentally die prematurely or

ii. You get a sum when you faced terminally ill deceases or critical deceases

iii. It can be used by rich to transfer wealth in countries levy inheritance taxes

Etc Etc. 

Few people are familiar with the cons, 

i. Basically for some, they never recoup back the premium they paid to be insured against the risk

ii. It is not an efficient form of investment, especially for life insurance came with an investment plan, there always be a clause stating that, actual investment return depending on the fund managers performance.

iii. If you can keep paying the premium, you keep enjoying the benefit. But once you failed to make payment once, you forgo everything you accumulate in the past. 

iv. It literally follow the contract wording when came to decide the payout. And, most of the people who buy the life insurance, actually don't know the difference between type of diseases cover, or structure of payments. 

Last but a few, 

i. In malaysia where no inheritance taxes are levied, it matters less if you can used the life insurance to transfer the wealth. (although we do have tax exemption for life insurance, the amount exempted is combined with EPF contribution, which means when EPF contributions exceed RM6,000 per year, you receive no tax exemption for amount pay for life insurance.)

ii. If your family don't need you to leave a bequest, then you have no need to buy a life insurance. 

iii. Some big corporations do provide group life insurance, you can check whether you need to go for beyond. 

Writing one Investment Policy Statement (First Trial)

The Investment Policy Statement (IPS) , define one return and risk objective, while listing down all the relevant constraints (time horizon, taxation, liquidity requirement, legal, and other unique requirement). This will subsequently determine what portfolio can be invested into in the Strategic Asset Allocation (SAA).

Few assumptions:

i. Malaysia Inflation Rate to be 2.5% per year. (last 10 years average, 2.38% see calculation here.)

ii. Salary to be rise at 5% per year. 

iii. required living expense per month to live comfortably = RM 2,000 in current ringgit. 

iv. Malaysia income tax rate unchanged. 

v. EPF average return to be 5% per year. 

vi. Life expectancy to be 85 years. 

vii. Will retire at 60 years, as current statutory minimum retirement age. 

__________________________________________________________

The first thing to know, is to calculate how much you need to sustain the living standard for 25 years after retirement.

This can be done by summing the Present Value (PV) of all future expense at age 60. 

I figure i would need RM 4631 per month starting age 60 for minimum standard of living (equivalent to RM 2000 that current ringgit value and 2.5% inflation rate). 

This translate to RM 55568 for the first year, and total PV of next 25 years expense to be RM 1.05 million (assuming constant rate of return of 5% in EPF) 

Ie, i would need to have RM 1.05 million by the age of 60 to ensure enough saving for retirement. 

I figure if my current salary to keep rising at 5% per year and EPF rate of return to be 5% per year, i would have roughly RM2.2 million by age of 60. Which means, except regular EPF contribution, i do not need to save anything now from my current salary. 

_________________________________

Hence my IPS will be

Return Objective : after tax 5% per year (nominal) 

Risk Objective: 

Ability to take risk - High ( as i am currently still young , with stable income to sustain living）

Willingness to take risk - High

Constraints: 

Time Horizon - Long (more than 15 years)

Tax consideration - as Malaysia dont tax capital gain nor dividend income, there is less concern here. 

Liquidity requirement - Not applicable for the moment. ( or one month expense to sustain living until next salary banked in)

Legal - Not applicable for the moment. 

Unique requirement - Not applicable for the moment. 

________________________________

Things will get complicated when I need to save for marriage, save for first home, save for emergency medical fund when i get old, save for some desires in my life etc. This will be address later when i subsequently revised my IPS and setting saving goals. 

Learning from Mr. Money Mustache

The story of Mr. Money Mustache is not easily replicated in Malaysia.

He start with a Software Engineer job with salary $40,000 and eventually earn up to $120,000 per year.
He can keep his annual expense down to within $25,000, thanks to the buying power of US dollar.
He lived in a small town, where people can actually buy a 3 bedrooms house for less than $100,000.

In malaysia, it would be difficult for youths to earn up to RM120,000 per year at their earlier thirties.
Even if they can keep their expense down to within RM 25,000, this would mean no long distance travelling, for a family of three. Thanks to the low buying power of Malaysia Ringgit.
And everywhere, a 3 bedrooms house will certainly cost you more than RM 200,000.

The only advantages we have over US, is that we generally pay lower taxes (no capital gain tax especially).
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But the philosophy remain the same, if we want to retire earlier, achieve financial freedom and enjoy our life, living the way we want when we are not born as son/daughter of Robert Kuok.

Save at least 50% of your salary by
Cutting down unnecessary expense such as
i. Fancy Smartphone and Data plan
ii. Imported Car
iii. Dining out , whether in expensive restaurant or mamak stall.
iv. Clothings and other expensive staff

You can share house rent, utilities bills, internet, even car pooling with friends.

And then invest all your savings into blue chips equities or paying down your mortgage.
Invest regularly, hold the blue chip stocks, dont try to time the market.

You will be surprised how fast you can gain the most precious gifts in your life, the financial freedom.

This Forbes Interview is a good read for any of you who are interested to his story.
http://www.forbes.com/sites/laurashin/2013/10/03/how-mr-money-mustache-retired-at-age-30-and-how-you-can-too/

How stock is priced?

This post is intended to show the reader how stock is priced in stock market (or Bursa Saham in Malaysia). 

Basically, 

Stock price recorded is the price of last transaction in the market. 

In every transaction, there must be a willing buyer and a willing seller, else no transaction would happen. 

In other words, the stock price will be set, when there is at least one willing buyer and one willing seller to transact at that particular price. 

Everyday, participants for the stock market will give order to their brokers regarding how much, and at what price level they want to sell/buy a particular stock. As a results, a summary of buy/sell order will be listed on the trading screen as shown in figure below. In the left column you will see a summary of quantity bid at particular price level, in the right column you will see a summary of quantity offer at particular price level. 

Hence, from the figure, 33 lots bid at RM. 3.56 means that the buyers collectively willing to buy 3300 shares of the stock (MNRB) at RM 3.56. Similarly, 64  lots offer at 3.58 means that the seller collectively willing to offer 6400 shares of the stock at RM 3.58. 

As nobody are bidding/offer at RM3.57, no new transaction will occur. A new transaction will occur, either if the seller accept a lower price (RM3.56), or the buyer willing to pay for higher price (RM.3.58). 

The implications are as below:

i. The price will likely go down when there are more sellers than buyers, and likely go up when there are more buyers than sellers. 

ii. How much the price will go down, depends on how much the seller willing to accept for the shares, during the economy crisis, as stock holders eager to cash in their stocks, thus a market "crash" (stock price fall sharply) is more likely. 

iii. How much the price will go up, depends on how much the buyer willing to pay for the shares, during bull's market, when everyone believe that one particular stock will rise to double or triple level of current price level, they will bid for the stock for higher price. Thus a sharp rise. 

iv. This means that, current stock price is not reflective on the actual value of the underlying company. Instead, what stock price reflect is the expectations of the stock market participant. 

v. And, the stock price level is actually determine by the participants which is less than 0.2% of the total shareholders only. ( for example, Bursa Saham Market Capitalization for year 2012 is 1466 billion, while the average daily trading value is 1.666 billion only. )

Hence, the advice to gain in stock market, dont follow the trend, especially if the trend is only  less than 0.2% of the market participants. 

EPF new basic savings - Its actually not that bad...

EPF announced new figure for basic saving requirement before withdrawal which will be effective next year.
A quick comparison, this is the old rate.

Below is the new rate,

The revised figure represent an 25%- 60% increase of the old rate. Some critics say that, the effective new rate is actually locking up the members capital, hence preventing them for realizing higher potential for the savings. One of the critique even says that, if Nobel Foundation was to act as EPF, they will ceased to be exist today. (See here) or picture below. 

But is it true to their claim? I'm afraid not. 

First , we can try to check the performance of Nobel Foundations. 

Their annual report can be viewed here, In 2012, they earned a total of SEK 30.456 million for total equity of SEK 2860.9, this represent a return of........1.1%! 

Incontrast, EPF declared a dividend of 6.15% for 2012, which is comparable to Amanah Saham National Berhad's  fund distribution between 6.00%- 6.70%. And their return is less volatile than some of ASNB's fund. For example, in year 2008 during World financial crisis, EPF declared distribution of 4.5% while Amanah Saham National Scheme Fund report a return of -34% (source, ASNB annual report 2012). 

We need to understand that, 

1. There is no free lunch in the world, higher return came with higher risk. Especially when we invest in equity. 

2. The main objective of EPF is to safeguard the member's saving for retirement. Growing the fund within the risk constraints, is their second objective. Hence, chasing higher return by taking much higher risk, is against their principal. 

3. With roughly 40% invested in equity, 20% invested in overseas (see here) , EPF holds a much balanced and diversified portfolio than any other unit trust in Malaysia can provide. In investment world, a balanced and diversified portfolio is much safer, while have a potential of earning return near equity level. 

4. And not to mention, EPF overhead expense is less than 0.2% of total assests, where most of the private unit trust in malaysia charged around 1.5% for assest management fees. 

5. Last but not least, even if the members can withdraw earlier, how many of them, have the skill of Warren Buffets to outrun the investment professional in the long term? How many of them , will actually loose their savings in stock market frenzy? 

As conclusion, 

The above measure is not that bad, after all. 

How to get rich(4)- Mr Market and Stock evaluation basis

If you are a stock (or share or securities) investor,  what do you hope tomorrow market direction to be?

Most investor will hope the market will go up forever, so that tomorrow (stock) price will be higher than today, and their net worth will increase everyday. In fact, if every market participant hopes that way, they are hoping for someone to always pay for the higher price. But one would wonder, if the musical chair somehow stops, who will end up with the stocks when market is turning tide?  And how do you know when the musical chair will end? 

Thus, you should only hope the market go up forever, when you plan to sell, or stop buying in the future. 

An intelligent investor according to Benjamin Graham or Warren Buffet, which plan on keep buying in the future, will pray for the market to stay flat or even going down tomorrow, so that they can keep buying the stock at bargain price. In that case, they are not hoping to profit from capital gain, they are hoping to profit through underlying cash flow derived from the stock. 

How do you determined if the stock is underpriced? 

One simple way, is to find the implied rate of return using Present Value formula, 

P = D/ ( r - g) 

Where P is current price, 

D is amount of dividend, 

r is the implied rate of return,

g is the growth rate , equal to ROE * retention ratio

Retention ratio = amount of earning that is not pay out = (1 - D/E)

Using public bank as an example (stock code 1295) With Price = RM 15.64, Dividend per share of 48 sen, average ROE of 25.4%. and retention ratio of 0.52 for last year, 

g = .52 * 25.4% = 13.2%

r = D/P + g = 3.07 + 13.2 = 16.27%. 

Seem a good buy as implied rate of return is 16%! 

However , an investor should noted that, a large portion on the rate depends on the growth component, 

And it seemed that current earning growth for public bank have slowed to 10%. 

In other way, given the price is highly above its tangible asset (RM 4.83) , an investor can only recoup his principle from the dividend income. A dividend of 48 sen with 10% growth will repay the nominal principle in 15 years, which roughly translated into 6.6%  implied rate of return in 15 years. 

How to get rich(3) : Gamblers beware - on Technical Analysis and Forex

For past tips , please see here for how to use float, and here to understand the risk and return characteristic of investment products.

What is [ technical analysis] ?

Taking from wikipedia, 
" Technical analysis is a security analysis discipline used for forecasting the direction of prices through the study of past market data, primarily price and volume." 

In short, by trying to predict what the market will go next through current price and volume information, people are trying to [ act ahead ] of the market and taking profit from it.  Technical analysis is easy to learn, and can be apply to virtually any market which price and trading volume can be charted. There are so many experts that claim themself have been successful in technical analysis, that they can win big utilizing relatively small market daily price movement through the use of leverage. There is, however, one question that investors ask themself, if trading in currency exchange market using technical analysis is so successful, and everyone taking the same strategy, where is the winner's money came from? 

Unlike [ Stock Market ] ,  holding currency in a foreign exchange market will not generate cash flow over time. The only return you can get, is by buying low and selling high. But in foreign exchange market, every buyer must be matched by every seller. This mean that if one's is making money at this moment, someone else must be loosing money at corner somewhere around the world. One can easily related the trading in foreign exchange market as gambling in a casino. 

One would wonder, if the overall wealth of all the participant won't increase in a foreign exchange market, why would the brokerage firm like FOREX so keen on encouraging others to take part, and even providing free chips for them to start?  The answer is very obvious. Company like FOREX gain through the tiny amount of transaction fees they charged, hence the more you trade, the more they gain. 

What about those financial gurus that claimed to have [secret recipe] for successful trading? 

Well, think of all the gamblers in a casino each have different way in predicting whether the ball in a roulette game will fall on red or black square. Overtime , there must be someone that are lucky to predict accurately at 70/80% of the time. Now, the one who might be just lucky can sell whatever formula he have based on his past records. While the buyers seldom realized that, in a casino game, success can't be replicated. If there is one winner who success by trying the formula, there would be more people who end up loosing, and their failure will be attributed to their inability to master the trading formula...

How to get Rich (2) - Understand risk and return characteristic of different Investment Products

In the previous post , i introduced the idea of using float to generate return in excess of cost to get rich. Now , it is vital for us to know which type of investment products should we put our money in.

I would classified the investment products available to general public into four types, namely bonds(including fixed deposit with bank), equities (stocks), real estates and precious metals (gold) . The classification is based on
i) how certain you can get your money back (ie, preserved your capital)?
ii) what factors of growth inherited by the product?
iii) what determined the future value of the product?

Lets examined them one by one.


i) How certain you can get your money back? 

The question can be further subdivided into whether you can get back your money in absolute term or relative term (inflation adjusted) .

Investment products denoted in a given currency like bonds and Fixed deposits are safe in "absolute term", which means you are almost certain to get the quoted return. This is good when using floats, where you can invest the float at bonds/FD that give you higher rate of return than its cost, thus taking the excess home. However, investment products that offer maximum protection in "absolute term" offer no protection against "inflation risk". The buying power of one dollar ten years later would certainly be less when price of goods keep soaring. Thus, this investment products are bad place for your own money. 

The rest of the investment products ( equities, real estates and precious metals）are less certain in getting back your money in absolute term, but have more protection against inflation risk. This is because the future price of these investment products are entirely determined by the supply and demand of future market. Thus, an ounce of gold, a house , or a share of equities should exchange the same amount of goods for now and the future, provided the supply and demand of the market remains the same. These are better place to put your own money. 

ii) What factors of growth inherited by the product? 

When growth occurs, you can get more money back following the passage of time. There are three main growth factors: Inflation, Population Growth, and  Market Share Growth  (due to good management).

Bonds and FD offer no growth factors at all.
Precious metals offer inflation growth, but as the supply (ie mining activities）usually growth together with the population, it they offer less population growth factor.
As the supply of real estates is limited, their value grow with population in addition to inflation.
Equities have the chances of additional market share growth, when good management team grabbing business from others while growing along with population and inflation.

iii) what determined the future value of the product?

For Bonds and FD, their future value is fixed. 

For precious metals, their future value is sole depends on market favor. As gold is almost useless to general public, they are bought in the buyer's hope that someone else, who also know that the product will be forever unproductive, will pay more for them in the future. 

For equities and real estates, their future value is not only determined by market favor, but also the underlying cash flow that they can generate for the investor. 

An history overview

Over the last 200 years in America, as this source has showed, the stocks (equities) outperform Bonds in long run, where both outperformed gold in inflation adjusted return. 

http://www.joshuakennon.com/stocks-vs-bonds-vs-gold-returns-for-the-past-200-years/

Looking at more recent data at another source, stock is again outperform the bonds and homes and gold,

http://lansner.ocregister.com/2011/09/11/home-price-gains-pale-vs-other-assets/122448/

However, it should be noted that market favor will changes the rate of return of particular investment products, when more people prefer stocks rather than bonds , there is a chance that investing in bonds can beat the stocks in short term or long term. (see here, and here) 

Source: Bianco Research

Conclusion

If you are using float, it is probably best to invest in bonds/FD that can give you certain excess of return. 

If you are using own money, which type of investment product you choose should be determined by the expected rate of return you can get at the time of buying, which is further determined by the Mr. Market。 

Out of all, the price of gold is mostly determined by the fear of the market of possible economic collapse, no wonder Warren Buffet who always hold an optimistic view on Corporate America, will dismissed it as a viable investment products. 

How to get Rich (1) - Use Float

What is Float? Float is simply the money currently parked with you but not owned by you.

You can use the float to buy things you like, like the iphone5, the car, or the house. 

But most importantly, you can use float to buy investment products that generate return with the passage of time. The investment products can range from Malaysia Government Securities (MGS), high quality corporate bonds, equities listed on Kuala Lumpur Stock Exchange (KLSE), foreign currencies, fixed deposits, properties or commodities (Gold). 

However, when someone parks their money with you, they usually demand interest rate for it. This is called the cost of float. Utilizes float to  buy investment products can generate positive return if the cost of float is smaller than the rate of return from the investment product. For example, like Rich Dad Author's Robert Kiyosaki taught us, when you borrow a loan to buy a house, you definitely gain when the rental income per month exceeds the loan payment that you need to settle. Thus, rich people like Tan Sri Syed Mokhtar likes to borrow money to finance his business empire, as long as he can generate adequate return to cover his loan payment. 

Sometimes, it is possible to obtain float without costs. Even more, some people will pay money for you to hold it. For example, when big insurance company has an underwriting profit in particular year, the policy holders are paying insurance company premium that exceeds the total claim of the others in that year. Thus, insurance company not only gain by paying less for the claim out of the premium receives, but it also gain by utilizing the cost-less float to generate additional returns. This is the secret of how the world's richest people, Warren Buffet building his wealth, as quite a number of subsidiaries under Berkshire Hathaway such as General Re (reinsurance business), GEICO(auto insurance are insurance company. 

We, as the ordinary people, wont have an insurance company at our disposal. So where do we get float? 

One of the cost-less float that we can get is something we are familiar in our life, the credit card. By utilizing the interest-free period that the credit card company grant us, a disciplined consumer can deposit the money for the bills on bank as long as he can to gain interests. If you have your own business, the money that you supposed to pay your supplier, would be the cost-less float you can used, as long as delaying payment wont incurred additional charges by the supplier. And again, like i mentioned earlier, if the rental income from particular properties exceeds the loan payment per month required by the banks, you should borrow money to buy as many properties as you can like the Rich Dad's Author. 

  

Top money tips 1: The myth of saving early

If everyone doing the same thing, you need to do more and better.

Taking an excerpt from kclau.com, top money tips preview,

" James started saving RM1000 at age 18. The brothers’ income is measly RM10,000 a year at that time. James decided to save 10% of his income. But Jeremy didn’t. Jeremy thought that RM1000 saving a year is really hard for him.  

10 years had passed by. James had never failed to set aside RM1000 every year for the past 10 years. He invested the money and got an average return of 10% per annum. Both the twin brothers were earning RM50,000 a year at age 28.  James thought he had saved enough. He stopped saving since age 28. But he still invests what he had put aside before that. Ironically, at the moment he stopped saving, his brother Jeremy started the commitment to save RM1000 a year. Jeremy was so determined that he never stopped saving a thousand ringgit every year until he reaches age 65.  

The brothers invest in the same portfolio and reap a return of average 10% per annum. Who do you think has more money at age 65? James only saved RM10,000 from age 18-27. Jeremy saved RM38,000 from age 28-65. Without doing the compounded calculation using Microsoft Excel, most people would have guessed that Jeremy would be richer. 

But the fact is that at age 65, James has RM645,617 but Jeremy only has RM403,536. James is richer than Jeremy by RM242,081! Both the brothers were doing quite well. The moral of the story is about deferring your spending. The earlier you can do it, the better it is. The earlier you can save, the less you need to sacrifice at later age. "


There is some truth to that, but there are certain assumptions in the scenario descripted that you need to be aware of.

The first assumption is that you can earned average 10% per annum every year. That rate of return is only achievable when capital are demanded and pursuited in the market. ( like the age where our parents start working) . With the development of global financial market, and increasingly more people saving for their retirement, the rate of return on safe and sound financial products have been inadequate in past decade.
Hence , lowering the rate of return to 7% per annum ( the best you can get with ASW2020), James and Jeremy will end up with RM 180,709 and RM 172,561 respectively, not much a difference.

The second assumption is that there is no inflation occuring at that period,  This is never the case in human economy history of using fiat money. Assuming, James and Jeremy will  save money which real term equivalent to RM1000 at their age 18. At 10% rate of return and  moderate inflation (3%), they will end up with RM 667,842 and RM 659,087 respectively.  At a lower rate of return(7%), Jeremy will end up with RM 336,130. While James are left with RM 203, 786.

The spreadsheet calculation can be see here.

The moral of the story is that, saving early , start investing early do give you substantial advantage to the others who don't. But if won't give you much advantage if you stop while other continue during the long term prospects.

The choice is largely depends on, how would you like to distribute the enjoyment of life brought by money, over your course of life. Some people might choose to sacrifice later, when their salary is higher, and hence less suffering in controlling consumption desire. But at some point, you will realised that, working to achieve a higher rate of return in capital, is much worthwhile than working hard to save for investment.