Invest: Equity Selection or Exchange Traded Fund (ETF)?

Disclaimer: This is a personal, non-financial professional view and is not an investment recommendation. 

The invention of ETFs has made index investment (the notable all market fund in finance 101) possible and accessible to all. In recent years, many financial bloggers advocate investing in nothing but two or three ETFs plus one or two rental real estates. Is stock picking truly out of fashion and dangerous?

While there has been a nosedive in the market, all index funds like SPY ETF would return the S&P 500 average, 8.98% annually since inception. In comparison, picking the top shares like Amazon or Apple would achieve a >20% for the past ten years. Nevertheless, holding only SPY ETF is not a bad deal if you have sufficient income to grow the investment capital and no time to look at the market. 

On the other hand, the KLSE index has not performed that well and is near to the 2008 level currently. I think KLSE lack innovative technology-based corporations and our market is less efficient. If you buy the KLSE index today, the probability that it could generate a growth return in 10 years is not high.

In a low growth, less efficient market, the difference in picking a winning portfolio is quite remarkable. Therefore I think, if you insist on investing in KLSE, due to convenience or other reasons, active portfolio management is a must. Here’s a possible approach:

Building a portolio

How do we start building a portfolio? I use the approach of thinking a portfolio with three-segment: the foundational, the rotational, and the opportunistic.

By leveraging ETF, I ignore the foundational, and the rotational by investing in global markets ETF.

i. Foundational and Rotational: Invest in global markets ETF (at least 50%) – I do this with Stashaway but would prefer to invest directly in selected ETF if possible. 

ii. Opportunistic: Identify undervalued shares in KLSE for trade gains or dividend yield.

Why would I take the risk of equity? First, the dividend cash flow in ringgit. Second, limited direct access to ETF. 
At today’s speed of information, everyone has the opportunity to identify undervalued shares. The trade-off is the time required to make the right decision, and not losing your funds on one bad idea.

Making opportunistic work 

How to minimize time spent and maximize the chance of winning?

i. Screen winning equity: Find high Return of Equity, low Price/Earning shares. (KLSE screener is a good start)

iii. Study a specific industry or invest in an excellent analyst service. (Few hours a week)

iv. Diversity within a pool of 10 shares, assuming that you have a good portion of your funds in all index ETF.  

v. Set an exit strategy when you invest. Is there a stop-loss or target profit point? 

vi.  Do not chase high or trendy shares. A blue-chip could go down by 50% of your buying price (stomach ache), but a trendy share can go down 95% of what you pay for (devastating).

On timing and risk 

Choosing equity always comes with risk. Read the book titled “Good to Great” and see how much great companies stay great for longer. The Malaysian all-stars, like BAT, GENM is no longer as great because of so many factors. 

I love the idea of timing. However, research by JP Morgan (again, on S&P 500) shows how much harm timing can do to our long term returns. The average return  per annum of a 20 year S&P 500 portfolio is ~9+%. If you just miss the top 10 performing days, it becomes 6%, if you further miss another 10 days (the top 20 performing days), it becomes a mere 3%. So DO NOT time your entry in ETF investment. 

In my limited research, I find that timing is only useful for short-selling during a bear market or cashing out an overheated market. 

So, if you have RM1,000 today, would you invest in ETF or Equity? 

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