Why I'll buy 40 random stocks when the FTSE 100 hits 4000
There is an old joke about how to make a small fortune on the stockmarket (by giving a large one to a stockbroker). Having spent the best part of the last year researching and writing a book called Monkey with Pin, I think I might be able to rewrite this joke as:
How to make a small fortune on the stockmarket? Give it to a monkey to invest.
Let me tell you why. I am a private investor. I have been trading for over a decade, with a reasonable degree of success. However it struck me I never made as much as I thought I would.
Therefore when I heard someone saying that 85% of well-paid fund managers couldn't even beat the market, it set me on a quest to find out what are the average real returns for private investors like us.The result is a 250-page book with the answers based on facts and evidence and not on some of the marketing myths from the finance industry.
The average investor is probably missing 6% a year from their returns by the time you factor in all the costs, expenses, hidden charges, survivorship bias and our average investing skill level (which is negative).
The book is split into two parts: the first examines the evidence and the second what you can do about it, and how better understanding the system can help you lose a lot less than 6% a year. It's free (and I really mean free) - just go to monkeywithapin.com to download or read it.
Examining all the facts caused me to change my investing approach, which I will share with you. One important thing first: you'll read in the book my conclusion that no one single investing system works all the time (I evaluate all the key ones).
Some systems are better than others some of the time. It also shows that the best system is one you devise yourself. The key elements are a risk-management strategy and that you write down a set of rules and religiously follow them, irrespective of what your emotions tell you.
I'm going to follow the "monkey strategy". It is premised on the evidence I found that the average chimp can normally beat even the best pros at stock picking. Unbelievable, but unfortunately true and backed up lots of evidence (see Chapter 3 of the book).
There at least two reasons.
By randomly throwing darts into stock listings in a newspaper, you are more likely to pick smaller companies than the average fund manager. These tend, over the long run, to have a better performance.
Secondly, the monkey is not influenced by media stories, charts, or PE ratios. It does not follow the herd and in consequence does not suffer the penalty for this.
There is a nice bit of analysis that shows on average a stock a private investor buys increased by 25% in the previous year. In the year after, it goes down 3%. We are just not that clever, are we?
The monkey strategy
But before you all rush off to the garage to find your old dartboard, let me tell you how I'm going to implement the monkey strategy. Firstly, being a statistician, I know this is only going to work if I can pick stocks to get a good random sample. For risk management I also need to ensure that no stock ideally exceeds 2-3% of my portfolio, which means about 40 stocks.
The exact number will depend to some extent on how much I want to invest. In the book I suggest the costs of trading (not just commissions, but stamp duty and bid/offer spread) can become excessive if you trade in amounts of less than £1,000.
The final thing I learnt in writing the book is how the price of an individual stock is determined by overall market sentiment. In fact, hardly any of the variance in the price of an average stock has anything to do with a company's profits or performance.
Therefore before you invest you need to first understand market sentiment and where it might be going. What surprised me is how those feelings follow long-term cycles (as well as being affected by the six to seven-year normal business cycle).
The market has, for the last century or so, followed a pattern of rising for around 16-18 years and then consolidating for 13-16 years. We are currently 13 years into a consolidation phase.
It therefore strikes me there are two scenarios that could happen now. One is that the market puts in a new low at some point in the next three years (i.e. FTSE 100 (UKX) below 4000) and that ends the consolidation phase.
The other (and in my view less likely scenario) is that we're already in our next secular bull market, in which case the FTSE is headed out of its trading range of 3500-7000 to 10000+.
I am going to wait to try out my "monkey strategy" until I know which of these two scenarios is going to happen. If the FTSE drops below 4000, as I think it may do one day, I'm going to do a Buffett and ensure I buy my portfolio when shares are really cheap.
If I'm wrong and we do break 7000 on the FTSE, I'm happy to buy then as I know that wall of cash out there (and money taken out of bonds) is going to pile in and drive my monkey shares even higher.
Conclusion: give your money to a monkey, not a fund manager, to invest.
You can read or download Pete's eBook for free at monkeywithapin.com.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.