Category: The Data-Driven Investor

As a 24-year-old, who’d just started investing, I was excited.

I wanted to put my hard-earned money to work.

I wanted to make money while I slept.

I wanted to invest as much as I could.

But…

I didn’t really know what I was doing.

I was jumping between individual stocks.

Buying ETFs.

And trying to build a ‘diversified’ portfolio.

But without knowing it, I was concentrating my risk.

I was not as nearly as diversified as I thought.

How could this be?

I owned several different stocks.

A few different ETFs.

But, my naive 24-year-old brain was missing something about my investments .

I had a big overlap problem

I bought some blue chip stocks.

Then I bought a financial sector ETF.

Then an index tracking ETF.

But what I didn’t realize is that some of the same stocks were in all three of these.

The index tracker was top heavy with banks.

The financial sector ETF had those same banks in it.

And I had also bought those banks again individually.

Did I really want to be so exposed to the banking sector?

Absolutely not!

But this is a common situation I have found when talking with passive investors.

Often, they don’t actually know what is inside the ETF they have bought.

By the time you buy a bunch of them thinking you are diversifying…

You end up like I did.

So how does an investor avoid this?

Know your ETF

When buying an ETF, do your research and find the list of stocks that are inside it.

From here it becomes pretty obvious if you are going to have an overlap problem or not.

For example, if you own a lot of Apple shares and the ETF you want to buy has a position in Apple as well, you need to decide if that is what you want.

And depending on your strategy, you may be perfectly happy with that.

But the point is, you need to know that this overlap exists.

Build your knowledge, build your portfolio

Back when I started investing I clearly didn’t have enough knowledge.

And look what happened.

I ended up concentrating my risk into a few stocks by mistake.

Losing money because that particular sector didn’t move much.

All the while, thinking I was diversified across the market.

Even though I harp on about strategies a lot…

This issue can still crop up even with the best of strategies.

The key here is building your investment knowledge.

Be aware of what you are buying.

Things on the surface can look great.

But diversifying is not always as easy as just buying ETFs.

Knowledge pays the best dividends,

Navarre

The Data-Driven Investor

There is an element to investing that people try to ignore.

It’s not fun.

It’s not sexy.

And it involves you losing a chunk of your hard earned investment gains.

Of course, I’m talking about tax.

I’m yet to meet a person who loves this aspect of investing.

Except maybe my accountant.

Yet, this is an area that you can not ignore.

I personally have ended up paying the government much more than was legally required.

Why? Because I didn’t like thinking about tax.

I didn’t want to know.

I didn’t optimize my investments for tax outcomes.

And, I paid for my wilful ignorance. 

If you’re investing, here’s what you must understand about taxation. 

Play a game of pass the parcel

In many countries, you have to pay capital gains tax when selling a stock.

This is a portion of the profit you make from the sale.

This is calculated by using the cost base of the holding and subtracting the gain by the cost base.

E.g. You buy some shares for $1000 (cost base) and sell them for $1500, you have made a $500 gain.

But what happens when you have bought the same stock multiple times (parcels), then sell some of it?

You get to choose a CGT strategy for calculating the gain/loss.

This can have a significant effect on what the end gain works out to be.

Let’s look at an example:

• I buy 100 shares of Stock ABC for $3 = $300
• I buy 100 shares of Stock ABC for $5 = $500
• I buy 100 shares of Stock ABC for $6 = $600

So all up I own 300 shares of stock ABC.

What happens if I sell 100 shares for $5 a share for a total of $500?

I could use the FIFO (first in, first out) strategy — I  sell the first shares I bought.

So that makes the cost base $300 and the sale $500 — a $200 gain.

I could use the LIFO (last in, first out) strategy — I sell the last shares I bought. 

This makes a cost base of $600 and the sale of $500— a $-100 loss.

There are other strategies, too. 

But you can see from this simple example how you can go from owing tax, to owning nothing.

And if all the CGT strategy options still result in a gain, there’s still moves you can make to mitigate. 

Turn a loss into a tax gain

When you pay capital gains tax, you pay it as a total of your entire portfolio.

Which means if you make a gain on one stock, you can cancel it out with a loss from another.

This is  tax loss harvesting.

Tax loss harvesting is a strategy that involves selling stocks at a loss to offset a capital gains tax liability, thereby optimizing your after-tax returns.

This concept is powerful enough to potentially kill an investment tax obligation. 

Tax Knowledge Pays Dividends

Even with just this basic investment tax knowledge, you can potentially save a lot of money.

There’s no excuse for not knowing how investment taxes work.

If I had known these tax basics when I started, I might have kept a lot more of my gains.

So before you do your next tax return, have a think about which CGT strategy you are using.

If you are an Australian tax resident and it starts getting hectic calculating cost bases and keeping track of parcels, remember we help with that.

Check out Navexa now.

As always, knowledge pays the best dividends.

Navarre

A lot of people talk about buying index tracking ETFs.

Finfluencers.

Gurus.

Friends.

Even Warren Buffett has promoted index tracking ETFs.

The idea behind this is that you get decent diversification relatively easily.

As we learn early in our investing careers, diversification is a good thing, right?

Right?

Well, it depends on how you define diversification.

Is it owning multiple stocks?

Is it owning multiple stocks across different industries?

Do these stocks need to be of equal value in your portfolio?

Do these stocks need to be from different countries?

There are many different ways to diversify.

Note: Absolutely none of what follows should be considered financial advice — merely a personal investigation into the numbers behind diversification. 

Don’t Underestimate Big Companies’ Dominance 

The ASX200 index covers the top 200 companies listed on the ASX.

And there are many ETFs out there that track this index.

Buying into one of these would give you broad diversification in terms of number of companies.

But how diverse is the ASX200 really?

With a little bit of digging, you will find that the top 10 stocks in the ASX200 makeup more than 50% of the index’s total market capitalization.

In other words, the ASX200 is very top heavy.

BHP is the number one stock in the index, with a market cap of ~$200 billion.

Compare that to the 200th stock in the index, with a market cap of $1 billion.

This means if BHP has a bad year, it can significantly impact the whole index.

So what does this look like in a real portfolio?

Meet The ASX10 Big Heavyweights

Let’s take a look at a theoretical portfolio made up of the top 10 ASX stocks in 2018.

Let’s call it the ASX10.

In the past five years, the ASX10 has outperformed the ASX200 index.

With capital gains and dividends included, the ASX10 achieved a return of 12.45% p.a. — outperforming the ASX200’s return of 9.81% p.a.

You can see from the chart that the movements were almost identical the whole way through.

But the ASX200 had 190 other companies influencing its overall performance.

So while you get diversification from an ASX200 index fund, is it the kind of diversification you want?

It Pays To Know What Comprises Index ETFs

To be clear, I’m not saying investors shouldn’t buy index funds. 

If it’s between doing nothing with their money or investing at all, then index funds might be a great idea.

They do, after all, track the performance of an index — most of which, over the long term, tend to go up. 

But for those of us who pay closer attention to what we’re investing our money in…

And those — like me — who unashamedly ‘nerd out’ on every detail of our investments…

It’s worth noting that there can sometimes be hidden costs — or rather opportunity costs — to simply buying an index fund versus investing in a particular cohort of companies. 

Diversity has become one of those pieces of financial jargon people perhaps automatically presume to be admirable. 

But, as I like to say, the numbers never lie. 

Always do your own research — this is not advice and always remember that past returns are never a guide for future performance.

Knowledge pays the best interest,

Navarre

The Data-Driven Investor

What makes you a good investor?

Is it because you make great decisions?

You have the most knowledge?

A killer strategy?

What if I told you that, even if you had all three of these, you may not be doing as well as investors who are…

Dead.

Dead investors can’t make any decisions.

They know nothing.

Strategy? Unlikely, six feet under. 

Let me explain. 

According to a mythical study by Fidelity widely referenced in the investing world, but never confirmed, the broker’s best performing client accounts belonged to people who had either died, or had forgotten they had an account.

So, what can we learn from the dead?

Trading is hazardous to your wealth

For those of us with a heartbeat, we tend to be less than perfect in our investing.

We:

• Are impatient
• Make emotional decisions
• Let ego dictate our moves

This means we trade more. 

100% more than the dead. 

With each trade, we lose money to trading fees.

We pay taxes on gains.

We realize losses.

Increased trading activity often contributes to poor investment performance.

Become an expert at feigning lifelessness

If the dead are good at one thing, it’s being patient.

You could say they are the ultimate passive investors.

When Warren Buffett says his ideal holding period is forever, then the dead are *cough* living that ideal. 

When you buy into an entire market, or sector of the market through ETFs — and then do nothing — you’re emulating a dead investor.

You sit back and get rich slowly.

This mythical Fidelity study proves — on a long enough timeline, at least — this strategy is highly effective.

Inaction can be a super power

Society has always praised people for taking action.

It’s also one of the things I pride myself on.

But when it comes to investing, inaction is often more powerful.

Not making emotional decisions.

Not FOMOing in and out of positions because of the news.

These things sound simple to avoid.

But they’re easy to fall for.

Don’t get me wrong, complete inaction, is not good.

Afterall, you have to take action at some point to invest in anything.

But, making calm and calculated decisions is usually best.

We can learn a lot from Fidelity’s mythical dead (or just inactive) investors.

Reducing trading activity saves on fees, taxes and realized losses.

Time in the market, as the saying goes, generates more value than timing the market.

Knowledge pays the best interest,

Navarre

The Data-Driven Investor

‘My name is Maximus Decimus Meridius, commander of the Armies of the North, General of the Felix Legions and loyal servant to the true emperor, Marcus Aurelius. 

Citizen of a failing currency, Victim of a collapsing economy’.

That’s not how the protagonist in Ridley Scott’s 2001 blockbuster Gladiator announces himself to his arch-enemy. 

But, it could have been.

Allow me to give you a quick lesson in ancient history.

This puts the present-day ‘war on inflation’ that’s dominating the markets and financial newscycle into perspective. 

Then, I’ll show you how misquoting Russel Crowe connects with my personal investment philosophy. 

Inflation: We’ve Been Here Before

When it first entered circulation, the Roman Denarius coin contained about 4.5 grams of pure silver.

This enabled the vast empire’s citizens and organizations to do business, receive payment for goods and services, and store wealth for the future.

The coins had value because the silver in them was scarce.

So scarce, in fact, that as the years went by, Rome started to run out of silver with which to make its coins.

So they started minting more coins with less silver in them.

Over a century, the Denarius went from containing 75% pure silver to just 5%.

The government printed more and more of them with the same face value, but less and less of the precious metal that gave them value in the first place.

This created the illusion of more money in the system. But the reality was that Rome’s debasement of its currency transferred wealth away from citizens and resulted in them having to use more and more coins.

The other word for this is inflation.

Rome effectively robbed its citizens of their power to exchange and store wealth.

This drove hyperinflation, produced soaring tax rates, and created worthless money, plunging the empire towards its demise. 

The Dollar’s Diminishing Power

If ancient Rome was a lesson, it appears as though civilization hasn’t taken it on board. 

In the first decade of the 20th Century, the total amount of money in circulation in the U.S. was about $7 billion.

One dollar could buy you a pair of brand new patent leather shoes.

By the 1950s, there was $151 billion circulating.

A dollar couldn’t buy you a pair of patent leather shoes. It could buy a Mr. Potato Head toy.

Fast-forward to the 1980s and there were nearly $1.6 trillion dollars in the financial system.

The dollar could now get you just a single bottle of Heinz ketchup.

In the first decade of the new millennium, the money supply ballooned up to nearly $5 trillion.

Now, the dollar could only buy a Wendy’s hamburger.

By 2017, the money supply had grown to more than $13 trillion — almost five times what it was at the turn of the millennium.

And that single dollar that could buy you a brand new pair of patent leather shoes more than a century ago?

It now buys only a single song on iTunes.

See the pattern? More money does not equal more wealth. 

Why We Invest

I talk to friends and family about wealth as often as I can. 

(And yes, I watch Gladiator on a regular basis. Are you not entertained?!)

I believe open and frank conversations are key to building financial literacy. 

And I believe financial literacy is crucial for creating financial freedom. 

Historical facts like those above are central to why I invest — rather than simply leave my money in the bank. 

Yes, you could argue there’s more risk associated with owning things other than cash.

But, when you consider inflation’s long history of insidious wealth destruction, I’d argue it’s wise to understand the difference between money and actual wealth. 

Knowledge pays the best interest,

Navarre

The Data-Driven Investor

There are people who believe the earth is flat. 

There are others who believe we’re living in a computer simulation. 

Or that a hidden race of Lizard People are running society from the shadows. 

There’s a whole lot of different ways to make sense of the world we live in. 

The same goes for the financial markets. 

There are those who believe in the so-called ‘50% Principle’ — that any uptrend must correct by 50% before resuming its rise.

Others prefer ‘Odd Lot Theory’. 

This is the idea that when smaller investors sell out of something, it’s because they’re wrong, and it’s therefore a good time to buy.

I know of one allegedly very wealthy investor who believes every financial market on the planet — property, stocks, commodities, you name it — moves in a repeating cycle, in which prices rise for a certain number of years, then fall for a certain number of years.

In today’s newsletter, though, I want to introduce and compare two of the less far out — and more influential — theories about the market. 

100% Efficient? 100% Of The Time? 

Efficient Market Hypothesis (EMH) claims that the price of any investment reflects everything the market knows about it at any given time. 

In other words, the market ‘prices in’ all available information about an asset.

Because of this, it’s impossible to ‘beat the market’, as the market already knows everything you could know.

The market is, in this theory, all seeing and all knowing. 

EMH is more than a century old and is most often attached to American economist Eugene Fama.

It’s crucial to understand that in Fama’s EMH, he’s talking about whether one can beat the market without taking on any extra risk. 

Anyone who beats the market’s returns can only do so by taking on additional risk.

Many investors, of course, aren’t keen to do this — which is possibly why there’s been such an appetite for passive ETF investing in the past few years.

EMH believers believe in keeping investment costs low and not bothering trying to outperform the perfectly priced market. 

Opponents, on the other hand, believe you can. Even without taking on additional risk.

Why?

Because the market is NOT perfectly efficient. Prices do deviate from their fair, or intrinsic, values. 

Enter the next theory of how the markets work. 

The Market Is A Drunk Man. 

In 1828, Scottish botanist Robert Brown dropped grains of pollen in water.

He observed that, suspended in the water, the pollen moved in a rapid, and random, oscillatory motion. 

About 70 years later, French mathematician Jules Regnault found that the longer you held a stock, the more it deviated from the price you paid for it. 

These two experiments form the bases of Random Walk Theory. 

This theory posits that asset prices change at random. Past prices are of little use in predicting future ones. 

And, to make our lives even tougher as investors, the market being the efficient (in theory) animal that it is, prices in all available information to these ‘random walks’. 

Economist Burton Malkiel popularized this theory in 1973 with his book A Random Walk Down Wall Street.

He called stock price movements the ‘steps of a drunk man’.

Random, unpredictable, unreliable. 

Random Walk Theory is another view of the market that leads followers to believe that it is impossible to predict or outperform the market. 

At least, not without taking on any extra risk. 

What Do I Think?

I personally believe the market is not 100% efficient. 

I believe it is quite efficient, but there is always room for improvement.

As a value investor, I believe at any given time there are stocks that are over and under their ‘true’ value. 

As the legend Warren Buffett says, ‘in the short run, the market is a voting machine but in the long run it is a weighing machine’.

And as John Maynard Keynes said — the market doesn’t reward investors for being smarter than it…

It rewards them for taking risk. 

More on that in a future edition. 

Knowledge pays the best interest,

Navarre

The Data-Driven Investor

Are you freaking out about your investments right now?

Compulsively checking your phone…

Pacing the room…

Doom-scrolling endless headlines about bank collapses and inflation rates…

Even — God forbid — considering selling all your investments and waiting for things to calm down?

If that’s you, chances are you don’t have something that separates the great investors from the vast swathes of the mediocre (and worse). 

This thing is free and widely available. 

And yet, too few of us understand its importance and value. 

While the panicked and fearful don’t choose it, use it and benefit from it…

The calm and confident are reaping its rewards right now. 

I’m talking about strategy. 

Investment strategy helps you eliminate emotional decisions and gives you freedom from stress.

Well, relative freedom, shall we say — compared with those who buy and sell based on emotion, for example. 

Here are three problems you’ll solve by employing a clear investment strategy.

1. Emotional decisions = emotional reactions

Back when I started investing, I had no idea what I was doing.

I remember buying into investments, only to sell out of them within a couple of weeks.

(And paying trading fees both ways…)

I’d get ‘tips’ from colleagues at work, or ‘ideas’ from online forums.

Ultimately, I couldn’t hold on to anything long term. Because I would freak out and sell. Because I didn’t know why I’d bought in the first place, basically. Because I had no strategy guiding my decision making. 

But once I had a strategy, this completely changed.

Because now it wasn’t up to my emotions whether I should sell a stock or not. 

It was up to the strategy I had selected — and the criteria for decision-making that commits me to.

Did it meet the criteria for selling? Then I sell.

Otherwise, I’m holding on for the ride.

With my strategy, I don’t worry about such decisions.

I chose my strategy so it can guide my shorter-term decisions.

Choosing a strategy is another subject which I’ll dive into in a later newsletter.

2. Bad Moves, Made For Bad Reasons

The next thing that a strategy helps with is helping you choose the right investments.

It doesn’t matter when you buy or sell if the company you bought into is no good.

Think about these two questions.

Buy the stock because a friend told you it was a good idea?

Or…

Buy because you have a set process that you filter any investment through?

Which do you think will lead to the better outcome?

Having a strategy that helps determine what you buy is crucial.

That way, you can constantly improve your strategy, based on set criteria, rather than making it up as you go along.

3. To Be Underprepared Is To Risk Underperformance

Ultimately we all want good performance from our investments.

We want our money working hard for us while we sleep.

As with anything in life, not having a plan, is planning to fail.

Having a strategy helps keep you on the right path.

Even if that path turns out to be the wrong one, having a consistent strategy helps you figure that out fast.

Which means you can then pivot to one that works better for you.

This means you can achieve optimal performance as quickly as possible.

If you have no strategy, you may never figure this out.

To sum up…

Strategy & Success Go Hand In Hand

Choosing and committing to a clear investment strategy will:

• Reduce/remove stress
• Help eliminate emotional decision making
• Help you choose better investments
• Help improve your investment performance

Find a strategy that works for you.

There’s quite a few out there. You’ll know the one for you when you find it (and especially when you start seeing the results).

From there, you can rest easier about your investments, knowing you’re investing according to a plan.

Knowledge pays the best interest,

Navarre

The Data-Driven Investor

One of the first stocks I ever bought was a total disaster. Or so I thought.

After holding it for five years, the value had risen 0%.

I would have been better off loaning the money to a friend and asking them to pay me $1 in interest.

So I logged into my broker account to sell my shares.

Before I hit ‘sell’, I figured I’d work out how much money the shares had generated in dividend income.

To my utter amazement, the dividends had nearly paid me back my whole investment.

This changed my perception of the investment completely. 

What I thought had made me nothing has, in reality, returned 100% — just not in the capital gains I was looking for. 

This is the power of knowing all the factors of investment performance.

Unfortunately, most investors don’t have an easy way  to calculate things such as dividend performance.

This means they end up making poor decisions based on incorrect data.

And as a data-driven investor, this pains me.

Here are the four things you absolutely must understand about any investment.

1. Capital Gains

Obvious, right?

Most investors buy into an investment, hoping that the price will go up, resulting in a capital gain. 

This is one of the main metrics to track for any investment.

Like I said, obvious. But important.

2. Dividend Income

As you saw in my story about the stock I nearly (stupidly) sold, dividends can have a huge impact.

If I hadn’t calculated the investment income and factored it into my performance, I could’ve sold this holding and ended up missing out on future profits.

Not only that, dividend income — in Australia at least — carries tax implications. These are difficult to manage if you’re not property tracking your investment income. 

3. Currency gain & loss

This one is crucial when investing in foreign stocks.

Currency exchange rate fluctuations can massively impact investments.

See the USD/AUD currency chart for the last 5 years.

Say you bought a $10,000 dollar investment in a US stock from Australia, in March 2020.

In December 2020, the exchange rate completely turned around in dramatic fashion.

Assuming the share price of the stock hadn’t changed at all.

You would have made a 32% loss, on the currency movement alone.

Sometimes this shift is against you and other times it can make you a lot of money.

But if you don’t measure it, you’re not going to know, either way.

4. Time

What do you mean time?

Well let me ask you, would you rather make a 100% gain in one year…

Or a 100% gain over five years?

Basically anyone I know would choose the first option. So would you, right?

Look at this scenario.

You buy ‘Stock A’ for $1 and in the first year it goes up to $2.

Happy with the 100% gain, you keep a hold of this stock for another year.

But in that year, the price stays at $2.

So now instead of a 100% return, you now have an annualized return of 50%.

You can see if this plays out across a few more years staying at $2, it quickly eats away at your performance.

Which is why it is crucial to factor in time when you analyze your investment performance . This is what we mean when we talk about ‘annualization’. 

These Are The Four Pillars of Investment Performance

Capital gains. Income. Currency gains. Time. 

These are what I call the four pillars of investment performance. 

Any investor who’s serious about building wealth long term should, in my humble opinion, understand and track these factors. 

Remember how I nearly sold a stock that had doubled my money?

These are the sorts of poor decisions investors might make if they don’t have all the information.

It’s very rare for anyone to fluke their way to success or wealth. 

For most people, a plan, a strategy and a certain amount of discipline is a much better path than trying to get rich quickly with a financial fluke. 

This is why I’m a data-driven investor. 

Because if you can’t measure it, you can’t improve it.

The data doesn’t lie, 

Navarre
The Data-Driven Investor