Why Value Investing?

In this first post I will try to answer the question of why I picked value investing over other types of investment strategies. After all people have gotten rich investing in real estate, index funds, and some people even got rich under-performing the stock market. So why did I pick value investing?

For starters I recommend buying a house because you need a place to live, and the prices are only going up because you cannot manufacture more land. However, taking care of more properties is somewhat difficult and I realized that stocks give you more scope for investing. So buy a home, and maybe 1 rental property but after that you should invest in stocks.

Now why not index funds? And the answer to that is actually surprising. I recommend index funds like the S&P 500 to the majority of people. The reason I say this is that if you put away a small portion of your income say $5 per day from when you start working full-time, and you put it in an index fund averaging 10% compounded yearly, 40 years later (I'm assuming you retire in your 60s) you are a millionaire. Furthermore, your investments are averaging several hundred thousand dollars per year in profits. You can definitely retire on that. You may worry about inflation, and the idea that a few hundred thousand dollars is not a lot, but if your salary stays up, you can put more away and make a lot more. Also, use tax deferred accounts so you get the most out of your money. That way you only incur charges when you take money out of your account.

Now I have already recommended buying a house and index investing. So why value investing? Well, again with the house, you need a place to stay, so may as well own it, and having maybe one or two rental properties is a good idea. But then we need something that has scope to make more money with less effort to manage. Stocks take almost no effort to manage, you just need to vote on the issues such as who to elect to the board of directors. And for most people you should invest in index funds. However, there are a handful of people who can beat the market. Be honest when assessing yourself. More than 50% of investors under-perform the market. To assess yourself, do not look for how smart you are. If you are really, really smart I recommend becoming a doctor or doing things that will change the world. You'll make a lot of money still, and you would have been a much better person than an investor like me. However, even if you have average intelligence or less it should not deter you. However, you have to see if you can be unemotional about your investments. I recommend a stock simulator to see how you react. Do you panic and sell too early, or are you able to hold on? In the mean time just invest in index funds. You'll do fine. If in the simulator you see yourself beating the market over 5 years then consider picking individual stocks. And make sure it wasn't just 1 really good year, make sure year in and year out you tend to outperform and you have used the same methodology throughout. I did it for 7 years and got compounded rate of return of 40% per year so I decided I was good enough. What this does is lower your risk as you risk nothing to test whether or not you are one of the few who can do this.

Now if you can do this write down your methods. Make sure it is fundamental analysis because even with all the technical analysts out there, I have yet to hear of even one who has beaten the market consistently for 5 years. And of course the reason I picked value investing is that if I beat the market I can get to my financial goals faster. Now understand the compounded rate of 40% was quite a bit of luck. My target is always 12%-15%, but I never buy a stock that I do not think will return 20% or more so I have a bit of a margin of safety. This is in case I was wrong, I miscalculated something, or perhaps something unexpected happens down the road.

So this was my analysis on why I chose value investing. I expect future posts to be much shorter because it will be on specific subjects like the HP scandal. I look forward to any and all comments.