Speculating or Investing By Malcolm Good I read with great interest the results of a recent stock market ‘investment competition’. In particular, my eyes widened when I read that the winners had managed to make a fantastic 134% return on their initial investment, with the report noting that over the same period the FTSE 100 had actually lost 3.20% – wow - all very impressive stuff! So had the winning team cracked the secret to the stock market, had they found the holy grail of investing? Sadly, I doubt it. My concern was the time-scale of the competition which was held over an eight month period to June ’09. For my liking, far too short a time period for anyone to invest in the stock market, speculate: yes, invest: no. Not that there is anything wrong with speculating if that is what someone wants to do, although I suspect many people who follow that approach do not consider the potential risks that they are taking. As I delved into the results for each of the 48 competing teams I was not surprised to see a spread of returns. The chart below shows the % return for each team in the competition. While the winning team managed to provide a great return (that’s its line to the extreme left), two teams managed to pretty much lose the lot, with the last placed team retaining the princely sum of 74 pence from its original £1,500. However, it would be interesting to see if the leading teams could sustain their performance over an extended period. Indeed, I am always nervous when I see fund managers highlighting strong performance over six months or a year– why not over five, ten or 25 years, the length of time that many people invest savings for their retirement? I think the answer to that question is simply that it is very difficult, if not impossible, to find a manager who can consistently beat market returns over the longer-term (it sometimes appears to be the case that short-term gains or losses in the stock-market can be more down to chance than good guidance). Thus, due to the competitions short time scales and from picking a limited number of shares the teams were likely to increase greatly the volatility and associated risk of their returns. For me, a canny investor may try to diversify out individual stock risk by buying a wide range of shares and then hold them over the long-term. Indeed, much research shows that through diversifying widely by type of share and geographic location greater long-term returns may be achievable. Such an approach is sometimes referred to as ‘passive investing’ where index or tracker style funds can be used to replicate market movements. In addition, by holding and not trading shares, dealing and other costs associated with ‘active’ management are avoided as are the great difficulties in trying to time trades in the market. Traders often miss-judge market movements and lose potential value. However, I realise that setting up a competition where teams buy a fully diversified portfolio that matches their attitude to risk and then hold on to it for an extended number of years would make for a pretty boring competition. So, while I congratulate the winners and think that they should be justifiably pleased with their results, I wouldn’t be too disheartened if I was part of the last placed team as the results may have been more influenced by timing and chance than they perhaps realise. Malcolm Good is a Director of Melville Hutchison Financial Management and is the author of st Self-Help for the 21 Century.
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