2015 wasn’t a good year for the local market.

The STI started the year at 3370.59 and ended the year at 2882.73 for a drop of 14.47%. To make things simple, we might as well call it a 15% drop. That’s 3/4 of the way to a bear market. The IPO market was also terrible with just one listing on the mainboard. I haven’t checked but that must be a multi-year record low.

While I subscribe to the oft-quoted view that forecasts are useless, horrible and misguided, I just want to also point out that the chance that things will get better are higher after we’ve sat through a storm. The only problem will be figuring out if the storm has truly passed or we’re just getting some respite.

More importantly, how you set up your portfolio and your life also matters much. Take for example the following statistics.

The total investing returns on my portfolio was 0.65% for the year while my portfolio value increased by 9.7%.

How is that possible?

Well, let’s deal with the total investing returns first. Total investing returns is my measure of investment returns i.e. how much has $1 at the start of 2015 changed by the end of 2015. This positive 0.65% was helped by two factors- 1) diversification across stocks and asset classes; and 2) dividends.

Holding a portfolio of stocks and an ETF means that I wasn’t exposed to any one horrible pick. Of course, conservative picks based on strong fundamentals meant that the chance of picking a fundamentally shaky stock like Noble were mostly avoided but even in the event of such a pick, it didn’t go all south for my portfolio due to one stock. Secondly, I wasn’t 100% in stocks. Typically, I hold anywhere from 15-30% in cash which is a drag on performance but exactly where you want to be when markets go bad like this year.

Dividends also boosted the returns to the portfolio and adds cash to the hoard which is nice when prices are down. That way, when stocks are cheap, you have bullets to expend. Ok, so the 14.5% decline in the STI doesn’t account for dividend returns but remember that the dividend yield on the STI is typically anywhere from 2.5-4.5%. At the start of the year, it was probably closer to 2.5%. That means that anyone fully invested in the STI alone would still be subject to a drop of at least 10%.

Now, let’s deal with the second figure. 9.7% increase in the value of my portfolio? How is that even possible? Well, the answer is Savings. Every month, a portion of my salary gets added to my hoard. Since this is fresh cash, I don’t account for the increase in this cash in my investment returns otherwise my returns will start looking like Warren Buffett’s. But in reality, it does increase the total value of my warchest and thus net worth. Ultimately, it is this amount that will generate returns for me in order for me to have the freedom of not relying on full-time employment for survival.  So ladies and gentlemen, boys and girls, please cultivate a habit of saving money. It is important.

To drive home the point, consider the difference between the following numbers: 8.88% p.a. vs. 22%. p.a. To put those numbers in dollar terms, $10,000 compounded at 8.88% per year for five years gives you $15,301.73 while the same $10,000 compounded at 22% over the same period gives you $27,027. That is the difference between my pure investing returns and the increase in value of portfolio over the last five years*. Also, if you remember the Rule of 72, then what those rates of return also means is that the former will take you slightly over 8 years to double your wealth while the latter takes you only about 3 and 1/4 years for the same doubling to happen**. That’s a world of difference.

In sum, may 2016 be with you. (Star Wars: The Force Awakens rocked.)

 

*This illustrates the importance of stripping out any increase in cash due to inflows. Returns can be inflated due to inflows of cash especially when the total portfolio amount we’re considering is small relative to any cash inflows that might occur.

**Of course the returns from savings will eventually become minuscule as the portfolio increases unless you move from mid-level executive to CEO or owner of a successful business. In which case, you hardly need to worry about investing at all. Worry more about not blowing it all on stupid toys, keeping up with the Joneses, drugs, partying and alcohol.

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