Don’t Fall for One-Year Investment Return
Say you come across a person or an article indicating a particular investment has made a 10% return in the past year. Let’s try to be a bit more dramatic and say 40% return. I bet this will catch anybody’s attention. Our mind goes “This is a sure win. Everyone is investing in it and I do not want to miss this golden opportunity”. Bang!!! Just like that, we invest in it.
After a year, instead of seeing a 40% return, the investment return is -10% and we start asking the following questions. “How is this possible? What happened to the so-called 40% return observed last year? Why did I fall for this? Am I a scam victim?” Well, it’s too late. We should have questioned the investment and its return before investing, not after it.
Now, let’s try to understand what really happened. Below is a simple table indicating Stock A price on two different dates, one year apart.
|Stock ABC Price
|20th Feb 2017
|20th Feb 2018
Say Investor A purchased stock ABC on 20th Feb 2017 at RM1.00. After a year, the stock price grows to RM1.40. That is a 40% increase in stock price and Investor A made a 40% one-year return.
On 20th Feb 2018, Investor B (sadly, this is most of us) notices only the 40% one-year return and purchased the stock price at RM1.40, hoping it will generate another 40% return for the coming year. Look at it closely and you will realize, Investor B purchased the same stock but at a rate 40% far more expensive than Investor A did.
By right, on 20th Feb 2018, Investor B should have asked the following questions:
Why did the stock price increase by 40% in a year?
Can the stock price grow or drop below RM1.40 moving forward?
If I were to purchase the stock now, am I purchasing at the fair value or at a premium (expensive) or at a discount (cheap)?
There are more questions to be asked but the key point I would like to highlight is to never ever make any investment decision just by looking at a one-year return. Don’t be fooled by it. The way I look at it, if positive one-year return, it simply means I am purchasing a stock at a higher price. If negative one-year return, then I am purchasing it at a discount. It’s always nice to buy anything at a discount but even then, when it comes to the stock market, we still need to question why the stock price fell in the first place and if it can grow further in the future.
Note: The same applies to Unit Trust fund performance too. Don’t fall for a one-year investment return.
A part-time Malaysian blogger writing his thoughts online. Interest in both personal finance and economics, mainly the behavior aspect of them. I consider myself Poyo since I do not have any significant credentials in both fields, so readers beware. Thanks for reading.