Twenty truths about the sharemarket
■Pick all the weeds and you are left with the flowers. Pick all the flowers and you get left with the weeds. Pick the weeds. A small weed is the best weed.
■If you want to achieve the same returns as the sharemarket, you also have to trade out of the losers and replenish with winners. Of course, the index will do that in a virtual world without fees. In other words, index returns are a bit of a fantasy and accumulation indices that compound dividends are even more fantastic. No wonder your fund manager underperforms. The index does not have to pay for an office.
■Bear markets start and bull markets end when the market says so, but it will only become obvious in hindsight and too late, and by then it will be so obvious you will look stupid for being late.
■If you have a mortgage, every dollar you lose goes on your debt and you pay interest on it, possibly for 20 years. On that basis, with interest rates at 5 per cent for the next 20 years (generous assumption), every dollar you lose actually costs you $2.50.
■Don't buy a portfolio, buy stocks, and one day your portfolio will miraculously reappear.
■You will make more money guessing what everyone doesn't know about a stock than you will ever make finding out what everyone knows about a stock. The unexpected moves share prices, not the consensus, so concentrate on the unexpected. That is where the money is.
■A diversified portfolio of 20 stocks you ignore is more risky than a portfolio with one stock you know everything about.
■You cannot do it the Warren Buffett Way or there would be a fund manager doing it, we would all be invested and we would all be billionaires. Quite simply, Buffett is free marketing for financial products, it is not reality.
■The market falls three times as fast as it rises because, as an academic behavioural finance paper once concluded, losses have three times the emotional impact of a gain. Fear is a bigger driver than confidence and "it takes five minutes to be fearful, but you can't get confident in five minutes". ■Sharemarkets rise slowly and fall quickly. You have to react quickly to losses. In a bull market, you have time. In a bear market, you don't.
■If you ever find yourself standing up and punching the air in delight, it means "sell".
■There is only one thing a falling share price tells you and it is not "BUY ME".
■In a bull market the core virtue is "participation". In a bear market the core virtue is "non-participation".
■In a bull market you are a sophisticated investor. In a bear market all professional financial advisers are idiots.
■Bear markets end when the headlines are terrible. Bull markets end when the headlines are euphoric.
■Murphy's law of the sharemarket: The average loss is inexplicably bigger than the average profit.
■Murphy's law of stockbroking: Errors always go precipitously against you.
■The only effortless way to get rich is to be born rich. The problem is you only get one shot at it and people seemingly far less capable than yourself always seem to succeed at it.
■Be nice to your children. They will be the first generation of future investors who have no recollection of the 2008 financial crisis and the next generation capable of a bout of irrational exuberance. It will be these delicate little cherubs who eventually pay top dollar for your assets. Nurture them.
■The best advice no one ever gave me: If faced with two equally attractive potential mating partners for life, marry the rich one.
Marcus Padley is the author of sharemarket newsletter Marcus Today.For a free trial, go to marcustoday.com.au.
Frequently Asked Questions about this Article…
Very important. The article says 50% of making money from the sharemarket is not picking the best stocks but avoiding the bad ones. In plain terms, removing losers from your holdings matters as much as finding winners — pick the weeds and you'll be left with the flowers.
The article warns that index returns can be a bit of a fantasy because the index trades in a virtual world without fees and it automatically replaces losers with winners. Fund managers face real costs, so matching index returns in practice is harder than it looks. That means understand fees and trading costs before assuming you can effortlessly replicate index performance.
According to the article, the core virtue in a bull market is 'participation' — staying invested to capture gains. In a bear market the core virtue is 'non-participation' — avoiding losses. The market also signals transitions only in hindsight, so be cautious about timing and focus on protecting capital in down markets.
Not necessarily. The article points out that a diversified portfolio of 20 stocks you ignore can be riskier than owning one stock you know everything about. Diversification helps only if you actively understand and monitor your holdings; blind diversification can create hidden risks.
Sharemarkets tend to rise slowly and fall quickly. The article cites behavioural finance research that losses have about three times the emotional impact of gains, so markets often drop faster than they climb. Practically, that means you should react quickly to losses and have plans to limit downside.
No — the article suggests caution. Bull markets often end when headlines are euphoric, and if you find yourself 'punching the air in delight' that's often a contrarian sell signal. Extreme optimism can mark market tops, so pause and reassess before buying more.
The article is clear that a falling share price tells you one thing — but it's not 'BUY ME'. A drop may reflect serious problems or changing fundamentals, so don't reflexively buy declines without understanding why the price fell.
If you have a mortgage, investment losses effectively increase your debt and the interest you pay on it. The article gives an example: with interest at 5% for 20 years (a generous assumption), every dollar you lose can end up costing you about $2.50 in total. That highlights the extra importance of avoiding losses when you carry long-term debt.
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