August 2011: Teaching Kids to Gamble

The best career choice I ever made was to present workshops on how to squeeze positive alpha (see the sumsbelow) from investing in listed equity shares. If you want to learn, teach. I have had a lot of fun developing ideas, I have made many friends in the process and have converted my puny nest-egg into a substantial retirement fund.

An exercise I encourage participants to undertake is to develop a paper portfolio whichwill generate positive alphas in the future without taking unnecessary risks. (Conventional wisdom says: “The higher the risk the higher the return”. In fact, studies show that the higher the risk, the higher the loss!) I monitor the performance of these portfolios and learn from the choices made. From this study I have identified five wealthcreation profiles:

1. Investor v Speculator: Investors focus on returns generated from their portfolios whereas speculators focus on the gains or losses made from selling shares. Speculators do not understand that the real wealth created from equities comes from dividends reinvested. For example, the Alsi index on 31 December 1974 was 279. On 31 December 2010 it was 32 119, i.e. a gain of 31 840. Had the index been calculated inclusive of dividends reinvested since 1974, it would have been 149 412. 31 840 of the total gain came from capital growth (21%) and 117 293 from reinvesting dividends (79%).

2. Small hitter v Big hitter: Big hitters do not believe in diversification.They believe that this approach dilutes future returns. However, most of those attending my workshops have day jobs and do not have the time to identify the next big thing so, to reduce risk, they diversify their holdings.

3. Passive v Active: Passive investors earn their returns from sitting on sound long-term investments whereas active investorstry to time the market. Most active market players realise after many years that you don’t make money from trying to time the market: you make it by sitting in the market.

4. Strategic v Random: Most portfolios I see in practice seem to be a random selection of shares with no thought given to diversifying across the various sectors of the market, allocation between resources, financials and industrials and how best to capture alpha.

5. Knowledgeable v Clueless: The professionals will tell you that you should not invest in anything you don’t understand. Market players should know what they are investing in or they should leave well alone.

If you draw a decision tree of the above choices you will arrive at 32 different possible choices. I encourage those doing my workshop to be knowledgeable, strategic, passive, small hitter investors (branch 1 of the decision tree). I rate Mr. Warren Buffett as a knowledgeable, strategic, passive, big hitter investor (branch 9). The most dangerous choice is a clueless, random, active, big hitter speculator (branch 32).

This brings me to the purpose of this article. I recently made a presentation on investing to the pupils at a high school in Pretoria. I found that many children were partaking in share competitions presented by various financial institutions. The apparent motive of this activity is to get kids interested in the JSE. The effect of these competitions is to nurture children to become clueless, random, active, big hitter speculators. I spoke to some of the children and their parents. Both were frustrated trying to understand how to choose shares and when to sell them. Those who fluked good choices developed false confidence and those who made poor choices felt devastated. This activity is a lose/lose for the children. So why do the financial institutions embark on such projects? I leave this to your imagination. Is the next step to get casinos to teach children how to gamble?

Try this: I invested R10 000 45 years ago on the JSE. During this period it yielded 18% p.a.. What would I have had today had I done the job properly? Financial products yielded 10% p.a. during this period. What do you think this comes to? Had I been able to squeeze 2% p.a. out of the market (not impossible), what would it have come to? These calculationswill shock you into planning and taking action before it is too late. (R17,2m, R0,7m and R36,6m)