Getting Rich (4) The only reliable investment method for ordinary people

Author: Xiaolai Li, Serial editor: Mr. Y

Introduction

All investment returns came from the price difference between buying and selling. But prices, especially short-term prices, are the most difficulty thing in the world to predict. At any moment, the price trend can be nothing more than rising, falling, or flat, and the probability of the three is equal.

This means any attempt at "precise market timing" is no different from a gamble with only a 33% chance of winning. To win 10 times in a row at that “casino”? The odds are less than 1/60,000, and that's not even counting the transaction fees the "house" takes with every “bet”. Therefore, the more frequently you trade, the higher your total costs and the lower your chances of success.

In fact, no one can truly predict the short-term market price. There was once a popular joke that if someone could accurately predict whether any stock would go up or down at the close of trading, then he could start with $100 and become the richest man in a year simply by trading in the stock market. If you can't even get the "guessing" part right, how can you expect to profit consistently?

So, is it impossible to reduce our procurement costs facing the chaotic short-term volatility? In the short term, yes, it is impossible. But if we extend our timeline, an elegant solution emerges. As long as the asset we choose is in a long-term uptrend, there is a powerful strategy that can significantly lower our average purchase cost. This strategy is called “Regular Investing”.

The term "Regular Investing" (or Ding Tou in Chinese) originated from mutual funds, but today it's broadly used to describe the strategy of investing a fixed amount of money at regular intervals into any type of asset, like stocks, mutual funds or cryptocurrencies. This is also commonly known as Dollar-Cost Averaging (DCA).

Almost every novice investor has been pitched on the idea of DCA by the bank wealth advisors. The bank wealth advisors loved to package it as a kind of "foolproof" magic that guarantees a profit, as if all you have to do is start, then sit back and wait for the returns. I was once one of their audiences, and while I always felt something was off, I could never quite put my finger on it.

That is, until one day, a sentence from a book by Xiaolai Li hit me like a bolt of lightning, and everything became crystal clear. He said: "For a regular investing strategy to be useful, there is one indispensable prerequisite: that the chosen asset must have the fundamental characteristic of being in a long-term uptrend. If the asset's price is in a long-term decline, the more you invest, the more you lose."

That one simple sentence instantly supplied the missing piece of the logical puzzle from all those sales pitches. It just aligns with basic common sense! Only when this fundamental condition, that the asset is in a long-term uptrend, is met, can regular investing or DCA truly work its magic and consistently lower the purchase price of the investment target.

In this article, Xiaolai Li used data to prove the powerful effect of regular investing in "reducing your purchase costs". But I want to emphasize that the charm of this strategy also lies in the fact that it allows us to see the profit sooner and greatly free up our time and energy.

Imagine that, over an investment period of 5 to 10 years, your strategy will be simplified to the extreme: only buy, never sell. How do you buy? By investing a fixed amount at regular intervals. This is the essence of regular investing: using discipline to fight volatility and simplicity to conquer complexity.

Following this line of thought, I am wondering, if regular buying can average down costs, could regular selling also optimize returns?

The answer must be yes. Suppose that one day in the future you need to sell assets to get cash, instead of selling the corresponding shares of assets all at once, it would be better to choose to "sell in batches" over a period of time. In a volatile market, this approach would most likely enable you to sell fewer shares to get the same amount of cash.

However, this is just my personal inference. In his articles and books, Xiaolai Li rarely publicly advocates "selling".

But the logic for buying is undisputed: choose the right asset, then regular invest without second-guessing. This is the only reliable investment method for ordinary people.

Main Texts

The Strategy and Results

by Xiaolai Li, rewritten in English by John Gordon & Xiaolai Li ©2019

Regular investing is quite simple:

• Regularly invest a set amount in a particular investment over a long period of time.

For example, every week (regularly) for the next five to ten years (a long period of time) invest 200 USD (a set amount) in BOX (a particular investment). Of course, you could change BOX to any investment that is worth investing in and holding over a long period of time, such as shares in Apple, Maotai, Coca-Cola, or an S&P 500 Index Fund.

Is such a simple strategy really effective? The numbers don't lie.

Suppose you started investing in the S&P 500 on October 8th, 2007. Knowing what we know now, that seems to be the worst time to enter the market, because what immediately followed was the 2008 financial crisis, and it was that day that the stock market began to crash. So if you started investing $1,000 USD per week on that day...

What would the result be? Back on October 8th, 2007, it would be really hard to say. But looking at it from today, more than a decade later, the answer is clear: the results were fantastic! We experienced a crash in the market from $1,561 to a low of $683, but we kept buying at that low price. Later, the market recovered, and by October of 2019 the S&P 500 had exceeded $2,960.

But this description is missing an important detail. The chart below shows the value of your total assets (the red line) and the value of your total investment (the blue line).

There is an extended period of time when your asset value drops below your total investments. But towards the end of 2009 the red line passes the blue line, and it almost never drops below it again, growing faster over time.

Note: The historical data in this chart is from Yahoo Finance (^GSPC), and the chart was created in Google Sheets; you can view the data and chart here.

The key point is that you entered the market at the worst time –- on October 8th, 2007, the S&P 500 was at $1,561, and it didn't return to this price until March 25th, 2013.

But if you take another look at the second chart, you'll see that the red line crosses the blue line for the first time in 2009. So while it took the S&P 500 286 weeks to return to its high, your strategy of regular investing began to see steadily positive returns after just 111 weeks. When you started to see positive returns, the S&P 500 was still 30% off its all-time high. When the S&P 500 finally returned to its high after 286 weeks, your strategy was already showing returns of 32.64%.

Let's take a look at an even more striking example. Suppose you started regularly investing in Bitcoin in December of 2017, when Bitcoin was at its all-time high of $19,800. Shortly afterwards, the price crashed, and it still hasn't returned to its all-time high. The chart below assumes you started regularly investing in Bitcoin on December 11th, 2017, and kept it up for 87 weeks.

Note: The historical data in this chart is from Yahoo Finance (Bitcoin USD), and the chart was created in Google Sheets; you can view the data and chart here.

Even though you entered the market at the worst time, your investment has still been profitable in USD terms, with the red line (your assets in USD terms) passing the blue line (your total investment in USD terms) on May 6th, 2019. If you invested $100 each week, by the 87th week you would have invested $8,700, but your Bitcoin would have been worth $16,417, for a gain of 88.71%. This is despite the fact that Bitcoin remained 62.85% of its all-time high, which was when you started investing.

This can seem really flabbergasting at first:

With regular investing, even if you start at what seems like the worst time, such as just before a market crash, your overall investment will become profitable before the market recovers.

Some fans of regular investing always emphasize a partially correct fact, which is that regular investing will effectively reduce your average cost. But the other side of the coin is that it also probably raises your average cost. It's obvious, isn't it? So these fans are using an incorrect reason to choose the correct strategy. But how long can an operating system with an error at the base level continue to run for?

The reason why regular investing is effective is that it matches up with the following reality of markets:

Bear markets are much longer than bull markets.

For example, over the last one thousand days, the blockchain markets have had less than 150 days of a true bull market. The same phenomenon is true no matter which price chart you are looking at, whether it be the S&P 500, Apple, Google, Amazon, Facebook, Tencent, or Alibaba. Bear markets are always very long, and bull markets are always very short. Bull markets are so short that we call them bubbles, like the dotcom bubble at the end of the last century.

Once you understand this key point, you will understand the following;

With regular investing, your profits essentially all come from the bear market!

Most investors don't understand this, and it is the core reason why their investments are destined to fail. They want to make money quickly in the ephemeral bull market. It's really quite depressing: most of the "investors" who enter the market during a bull market are destined to lose their shirts, because before they realize it, the short bull market has ended, and the long bear market has begun. Regular investors, on the other hand, are slowly accumulating throughout the bear market.

In fact, the strategy of regular investing is not only applicable to trading markets, it's useful in almost all important areas of life, whether it be study, work or family. "Lifelong learning" is essentially a regular investing strategy, isn't it? If you could draw a "price curve" for an individual's learning, it would look a lot like the S&P 500. Even though it increases substantially over time, it goes through long periods of flat growth or even drops. Often when you are investing time in learning something it feels like you would be better off not learning it. The "bear market" is long, isn't it? This explains why so few people are able to become true lifelong learners. The reason is the same: everyone wants to make money quickly in the bull market and then leave.

Jeff Bezos once asked Warren Buffett, "Your investment thesis is so simple... Why doesn't everyone just copy you?" Buffett's reply was quite striking:

Because nobody wants to get rich slow.

The most important part of Buffett's strategy is to hold for the long term. He has said that "Our favorite holding period is forever." At its core, the reason why regular investing works is that it is the ideal version of a long-term holding strategy. Most of the time, even Buffett doesn't just buy a target all at once; he enters his position over time. Those who follow the regular investing strategy also continue to buy at regular intervals over the long term, and hold the asset throughout the process.

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