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This Counterintuitive Principle Is What Could Really Be The Key To Making Money

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The Motley Fool Singapore

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It’s easy to see why people get turned off by investing, or can’t be bothered to start in the first place. Fear of loss, a ton of complicated information that makes no sense to the average person, and a lack of a definitive way to start makes it a seemingly huge barrier to entry. But does it really have to be so complicated? The Motley Fool explains that in this case, keeping it simple could be your best bet at investing success:

Financial writer Garfield Drew wrote more than 40 years ago that “in fact, simplicity or singleness of approach is a greatly underestimated factor of market success.” I tend to believe that’s true.

It might just be me, but I think keeping things simple in investing can be a great way to invest. Here are three of my favourite stories about keeping things simple in investing.

 

The Great Investor With the Simple and Great Strategy

In 1980, a small Missouri, USA, publication called the Bulletin Journal ran a short profile of a money manager no one had really heard of called Edgerton Welch.

Welch was running the Citizens Bank & Trust Co.’s equity fund and the fund was the third best fund in the whole of the USA for the decade ended in that year with its annualised returns of 11.9%; by way of comparison, the S&P 500, a broad share market index in the USA, had returned just 1.5% per annum in that period.

With such great results, it might be easy to imagine Welch having some special insight or access to arcane market-related information and investing techniques. But, that couldn’t be further from the truth, as recounted by the Bulletin Journal:

“Citizens Bank’s secret, said Edgerton Welch, board chairman and chief executive officer, is the weekly Value Line Investment Survey. Welch, 72, said he ignores all the stocks except those that Value Line has ranked No.1 [the cheapest shares around in the market according to the service], which means they should have the highest performance during the next year.”

In other words, the shares that Welch really likes and would invest in are those highly-regarded by the value-investing-based (what else, given its name?) Value Line service.

But given his penchant for cheap shares, what’s really remarkable was how he was completely ignorant of who Benjamin Graham was (Graham was, not-so-incidentally, the intellectual father of value investing), as a Forbes journalist discovered when the magazine interview him in 1981.

Of course, that didn’t really matter to Welch’s investors, who benefitted from his simple and very effective investing strategy.

 

The Great Investment With the Simplest of Theses

The next story about simplicity comes from the really successful hedge fund manager Mohnish Pabrai. In 2003, an American tanker company called Frontline had collapsed in price after oil shipping rates and oil prices fell (the latter is a key determinant of the former). In fact, the situation was pretty dire: Frontline needed rates of US$18,000 per day to survive, but prevailing rates were at just US$5,000 per day.

Other investors might have focused on future changes in shipping rates and oil. But for Pabrai, his focus was on something else entirely – something really simple.

Based on Frontline’s balance sheet, the scrap metal value of the company’s entire fleet was worth more than the company’s market capitalisation at that time. In the worst case scenario – where Frontline has to scrap its entire fleet – the investment would still generate a positive return. In the best case scenario – where oil prices and shipping rates recover – the potential returns could be massive.

Turns out, according to my American colleague Morgan Housel, investors who adopted Pabrai’s simple line of reasoning could have made as much as 20 times their money in 2 years.

 

The Great Investment Portfolio With a Simple Strategy

Teh Hooi Ling, who used to be a renowned local financial journalist, wrote one of my favourite pieces of financial journalism in Singapore when she penned the article titled “In buying low PE stocks, beware of value trap”. In the article, published in The Straits Times in December 2012, she shared the performance of a portfolio built with a very simple investing strategy.

Based on annual data as of the end of March of every year since 1990, she ranked all the shares listed in Singapore according to their price-to-earnings (PE) ratios. She then split them into groups of equal numbers, with the first group made up of shares with the lowest PE ratios, and so on.

Next, she constructed a hypothetical portfolio that had starting capital of S$10,000 that was first “invested” in the shares with the lowest PEs in March 1990. After one year, which is the end of March 1991, she would liquidate the portfolio and take all the proceeds (capital gains and dividends) and reinvest it into the group of shares with the lowest PEs in that year.

She did that buying and selling every year all the way till March 2012 and ended with a portfolio value of S$199,847, representing a very impressive compounded annualised return of 14.6%. In comparison, the Straits Times Index (SGX: ^STI) had capital gains of only around 4% per year.

Teh’s strategy in the article was simple: Buy only the cheapest shares and rebalance them annually. And as it turns out, that had beaten the market by a huge margin.

 

Foolish Bottom Line

When I first came across them, the three stories I shared had given me plenty to think about when it comes to keeping things simple in investing. I hope they can provide some food for thought for you as well.

 

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