We have gone through all the investment methods available in the stock market, as well as witnessed the power of the Passive Investing strategy.
Since this is an extremely effective strategy for non-professionals, this is also the strategy that the author will focus on the most, so we will have a separate section to talk about this strategy. In this section, we will focus on Passive Investing and the issues surrounding this strategy and how to increase the profit rate of this strategy to the highest possible level.
1. Compound Effect
When talking about Passive Investing, it is impossible not to mention the Compound Effect . This is the trump card that can help long-term investors win big at the final stage of the investment journey.
Note that when we talk about long term, we are talking about 15 years, 20 years, 30 years or even longer, if we only use it for a few years, or worse, a few months, this strategy will not be really effective.
According to Darren Hardy, author of the book “The Compound Effect,” this effect is about how you can achieve huge results from the small, smart things you do every day, intentionally or unintentionally.
Compound Effect: reaping huge rewards from a series of small, smart choices. Steps feel insignificant, results are massive. – The Compound Effect – Darren Hardy
In economics or in the stock market, the cumulative effect is also known as ” compound interest “, or commonly known as “interest on interest”, or “interest on interest”. Simply put, the profit of the first investment period will be added to the original investment, then continue to be invested and that profit will be added to the existing investment, and so on continuously for many investment periods.
Surely everyone knows the classic problem ” number of rice grains on the chess board “. Roughly, the problem is described as follows: if each square on the chess board is placed with a number of rice grains so that the number of rice grains in the next square is always double the previous square, starting with 1 grain of rice in the first square, how many rice grains do we need to be able to fill 64 chess squares?
The result is known to everyone, it is a huge number, and even if the whole country of Vietnam grew rice for ten years, it still could not provide enough rice.
Figure 1: The classic problem “number of grains of rice on a chessboard”. @Internet
Or a more classic problem, that is the problem of A and B working together. Mr. A receives a salary of 1 million / month and will get a 10% increase each month, while Mr. B receives a fixed salary of 50 million / month and does not have any additional allowances. So how long will it take for Mr. A’s salary to catch up with Mr. B’s?
Figure 2: A and B’s salary problem. @HIEU.TV
As we can see in the picture, it took A 5 years, or 60 months, for his salary to catch up with B’s. But just 1 year later, A’s salary was much higher than B’s. And after only 10 years of working, B’s salary is now too small compared to A’s.
Here’s another example: “You have two options, A and B. Option A gives you $3 million instantly, while option B gives you 1 penny ($0.01) that doubles in value every day for 30 days. Would you choose A or B?” If you know the math, you’ll probably choose B, because after 30 days, in terms of total value, you’ll get an astonishing number like this:
Figure 3: The problem of choosing between A and B. @Faster to Master
By the 30th day, the total amount of money that option B helps you earn is more than 3 times the 3 million that option A gives you. However, if you pay close attention, it is only on the 29th day that the difference becomes really clear. That is, within 29 days, if you have enough confidence in your choice (ie option B), and overcome the social pressure when many people around you choose A, then you will enjoy extremely great results.
Through the above examples, we can easily see that the core elements of the compound effect are perseverance and belief . Basically, the compound effect will happen very slowly in the beginning, but at some point, it will grow terribly.
When applying the Passive Investing strategy, we will invest in the long term and use the compound effect as a strategic card for the entire investment campaign. Because we understand the compound effect, we must have perseverance and absolute faith in the strategy we have chosen.
Persistence is shown in the fact that we invest regularly every month, without missing a month, like saving money in a piggy bank. And try not to miss a month, do not let the investment chain be interrupted, that will cause the cumulative effect to be interrupted.
Our belief is demonstrated by our absolute trust in the Passive Investing strategy through both theoretical and practical evidence. We are not allowed to follow the crowd, and we are not allowed to let FOMO cause us to sell our long-term investments.
Always trust ETFs and Index Funds with the core factor “in the long term, the market will always grow” .
Another property of the compound effect is that it is also negative. The most obvious is inflation . That is, your monthly money will also be slowly drained by inflation according to the compound effect.
So it is very dangerous if you keep cash for a long time instead of investing it. And because of its negative nature, 1 dong you waste today can be 100 dong later.
For example, one year, you like a new phone (but you don’t really need it), the problem is that your shopping funds are not enough, and instead of waiting to have enough money to buy it, you sell part of your investment to buy it, which leads to the volatility of the compounding effect and bankrupts the entire Passive Investing strategy.
Figure 4: Illustration of negative compounding effect (negative compound interest)
2. When should I start investing?
2.1. In the long term, the market will always grow
Figure 5: Chart depicting the growth of the S&P index over the past 100 years. @macrotrends.net
The figure above is a chart depicting the growth of the S&P index over the past 100 years, starting from 1927. On the chart, we can see the gray areas, which are to mark economic crises, which are periods when the stock market goes down.
In the stock market, people call it a crash , this is a case where the market has large fluctuations leading to the prices of all stocks simultaneously plummeting. Another concept that is less known is correction , this is a case where the market self-regulates when stock prices increase to a certain threshold.
In the stock market, there will always be crashes and corrections that go together, along with their own characteristics. That is, in the stock market, and more broadly, the economy, crashes will occur cyclically. This is not entirely random, but it is the way the economy operates, stemming from fundamental issues such as purchasing power, labor productivity, how to regulate market growth, and many other factors.
That is why crises are not random but will occur cyclically, meaning that it is almost certain that a crisis will occur, and there will certainly be a recovery.
In fact, based on the chart, we can see that according to statistics, on average, there will be a crisis every 10 years. The most recent was in early 2020, when the whole market was in crisis due to Covid-19. Before that, we had the global economic crisis in late 2007, early 2008, and before that, the dot-com crisis in late 2000, early 2001.
Thus we can see that a market crisis is almost certain and on average a crisis will occur once every 10 years.
So the question is no longer “will there be a crisis?” but the real question is “when and how will the crisis happen?”.
When we look at the whole market, we can see that no matter how long the crisis lasts, no matter how terrible it is, the market will eventually recover and continue to grow higher than before.
Based on all the above properties, we can affirm with certainty that in the long term, the market will always grow . This is almost certain and no one can deny this property of the market. This affirmation is clearly not due to chance but due to the nature and general development of the macro economy.
2.2. So when should we buy and when should we sell?
2.2.1. Catch the bottom – sell the top
Looking at the chart, it is obvious that the best time to buy is when the market hits bottom and the best time to sell is when the market hits top. Any investor, whether professional or amateur, will have the same mentality.
But catching the bottom and selling at the top is just a dream, because in reality it is like looking at the lottery results and wishing that we had bought the right jackpot number. In fact, catching the bottom and selling at the top is even more difficult than winning the lottery.
If you want to win the lottery, you only need to be right twice, that is, buy the right number and buy the right station, but with Vietlott, you only need to be right once, buy the right number.
As for the stock market, you have to be right a total of three times, which is to choose the right stock code to buy, catch the right bottom and sell at the right top . In reality, no one has been able to do this yet , even the best experts in the stock market, the world’s leading stock investment legends have not yet been able to accurately calculate all three of these factors at the same time.
No matter how good they are, how advanced their formulas or techniques are, or even how modern their machines, tools, and artificial intelligence are, no one has been able to do this yet.
If we meet any “expert” who brags about that ability, they have some mysterious method that can predict the time of increase or decrease in the short term, predict where the bottom is, where the top is, then 99.99% of the time they are taking advantage of people who do not understand the stock market to do things that benefit them.
If somehow these people could identify the market, they would have gone from rich to extremely rich, why would they have the energy to do these brokerage, solicitation, and seduction jobs?
So, we can only predict when the stock market will crash periodically, but to know exactly when it will crash and how it will crash is almost impossible. And because we cannot predict exactly when the market will rise or fall, the best way is to give up the dream of timing the market .
The vast majority of the world’s best investors admit that they cannot predict exactly when the market will bottom out and when it will top out in the short term, so they all agree on the conclusion that timing the market is not advisable .
2.2.2. Time in the market >> Timing the market
So, we know that the market will definitely crash. So should we invest or not, or wait for the crisis to happen so we can buy at the cheapest price possible. Or a more worrying question is what if we invest now, and then a few months or a few years later, the market plummets?
Through the analysis above, we can understand that we only know for sure that the market will crash, but no one knows specifically when and how it will crash, so we almost cannot answer these questions.
Let’s look at an example: what would happen if we bought at the worst crash? We will analyze the worst case scenario that has ever happened in the history of world finance.
Figure 6: Chart depicting the worst crisis in the history of the stock market. @Hieu.tv
Let’s look at the year 1929, which was the start of one of the worst crises in the history of the stock market. People call it the Great Depression. This crisis happened in late 1929 and it was so big that even now, there are many studies that say it was one of the main causes of the world war.
Now, let’s imagine we’re living in this era. Let’s say we’ve accumulated $5 billion and we decide to buy an S&P 500 ETF in August 1929 (note: this is just an example because the concept of ETFs didn’t exist back then).
When we placed our order, the market went down for three years. During those three years, our assets slowly evaporated, until it bottomed out in June 1932. At this time, the 5 billion we spent, after three years, did not increase by a single cent, and its value was only 1 billion.
Figure 7: A chart depicting the market’s performance over the next 27 years. @Hieu.tv
The story does not end there, now we look more broadly and we will see that, for all our assets to return to the original level, we have to wait until May 1956. That means we spend money, after 27 long years, only to see our assets return to the original level, the time we started investing.
This is the worst possible scenario that we can face. Looking at this scenario, no one will dare to touch the stock market anymore. However, this scary scenario will be very unlikely to happen. This is a very rare event and according to calculations, such a crisis only happens once every hundred years.
If a similar great crisis occurs, it will lead to a series of other large and very serious problems, not just limited to the economic and financial fields, but also politics, war and many other aspects that can change the order of countries in the world.
At that time, even our lives will be threatened, let alone our property. So you can rest assured that it is not only you who are worried, the governments of other countries are much more worried than you, so they will try very, very hard to prevent a major crisis like this from happening.
It is also very difficult for us to be in the full force of a great depression from beginning to end. We must be very unlucky to be born and grow up at the exact time of such a great crisis. It is like being born and growing up in Europe at the exact time of the world war.
The vast majority of other crises will be shorter and less terrible. And that is the case when we sell at the bottom, if we still persist in holding on, we will not fall into such a big loss.
Because in the long term, the market will always grow , so if we are unlucky, we don’t need to worry too much, because that asset will still grow again in the long term, we can use it for our old age or save it for our children and grandchildren in the future.
And the above big loss case can only happen when we go all in with a lump sum of 5 billion to buy at once, then we do nothing but sit still and watch our assets gradually evaporate.
In reality, we rarely go all in like that. With the Passive Investing method, we will spread out the investment, buy many times instead of buying once, accumulate regularly every month like putting in a piggy bank, then we will limit the risk of having to go all in at the top, limit the loss and shorten the recovery time.
So we can conclude that as long as we enter the market early, no matter how bad the time is, we will definitely have a positive rate of return in the long run of several decades.
Please note that this conclusion is based on an analysis of a worst-case scenario, the worst case scenario that only happens once in a hundred years. If we had just chosen another scenario, another crisis, the outcome would have been much better. Even if we were unlucky enough to be born and raised during the Great Depression, if we knew how to do things right and believed in the market, we would have been fine in the long run.
This is much better than sitting around waiting and not daring to invest. That is why people always say “time in the market is always better than timing the market” .
If we sit and wait and the best possible scenario is that we enter right when the price drops, we may save a lot of money but this will create a bad habit for us, which is to wait for the market, to watch the market go up or down to enter and exit.
And in the long run, that habit is extremely dangerous, if the best case scenario is that you catch the bottom. But as mentioned above, no one knows where the bottom is, where the top is, so just sit and wait like that.
TIME IN THE MARKET >> TIMING THE MARKET
2.2.3. Dollar – Cost Averaging
As mentioned above, spreading out our investments, buying many times instead of buying all at once, is called Dollar-Cost Averaging . This is a method that many investors use, especially passive investors.
In the short term, the market is always volatile, we will never know when the stock market will go up or when it will go down.
Figure 8: Chart depicting the Dollar-Cost Averaging strategy. @Hieu.tv
Suppose we have 120 million, in 2008 (the year of the global economic and financial crisis), unfortunately we invested right at the peak of the market. After we bought in, the market plummeted. After a year, the value of our assets has evaporated by 50%, meaning our 120 million is now only about 60 million.
From that fact, people have come up with the strategy of averaging the purchase price to eliminate this risk. The way it works is very simple, instead of all in 120 million in the market, we will spread it into many small parts, dividing it evenly over a certain period of time. In the above example, suppose we divide 120 million into 12 parts and buy regularly within 12 months, every month we buy 10 million.
The advantage of this strategy is that suppose in the above example, if we were unlucky enough to buy at the top, when the stock was over 2000 VND , and for a year continuously, the market went down and the stock price was now less than 1000 VND , meaning it dropped by 50%.
When we apply this average purchase price strategy, there will be times when we buy at the top but there will also be times when we catch the bottom, meaning that by the end of the year, the average price we buy will be in the middle, around 1500 VND .
As a result, we would have limited our losses, and as the chart shows, just one year later, around 2010, the stock price would have gradually pulled back to the average price at which we bought it. If we had persisted in applying the strategy of averaging the purchase price throughout the period from 2009 to 2010, the value of our investment would have gradually recovered and become positive again.
But of course this strategy also has its drawbacks. The dollar-cost averaging strategy will work in a down market and will also work in an up market .
In case of a down market, this strategy will help the average purchase price to decrease, thereby helping us to lose less. But in case of an up market, this strategy will also make the average purchase price increase, thereby making us to gain less.
In essence, the dollar-cost averaging strategy will not help us eliminate 100% of the risk, it only helps us exchange one risk for another less dangerous risk. In this case, it will be less profit when the market goes up and less loss when the market goes down.
In the long term, the market will always grow , so the probability of the market going up will always be higher than the probability of the market going down. Specifically, when analyzing statistics over a long period of time, people calculate that in a period of 43 years, there were a total of 33 years when the market went up and a total of 10 years when the market went down, meaning we have a ratio of 77% / 23%, roughly rounded to 8 / 2.
However, in the writer’s personal opinion, the average purchase price strategy is still a very good strategy because:
- Suitable for people who do not have too much money at once, but every month, after deducting basic expenses, we can put a small amount into investment.
- Suitable for those who do not have time to monitor the market, monitor the electronic board but simply invest and accumulate monthly.
- We can’t know when the stock market will crash, and how long it will crash, so this may be the safest strategy, we’d rather make a small profit than lose a lot.
- By constantly putting money into the stock market, we will increase our chances of escaping the “thief” of inflation.
- Because it is difficult for us to predict how the stock market will develop in the short term, if we keep “timing the market”, our money will gradually be stolen by the “thief” of inflation, and if we keep sitting outside the market like this, we will miss many investment opportunities and miss the benefits of the cumulative effect.
So when should we buy? The answer is right now, right now.
“The best time to invest was yesterday, the next best time is today” – Chinese Proverb
3. Summary
Through all the factors analyzed above, I would like to summarize the main ideas that you should grasp when starting to invest with the Passive Investing strategy:
- In the long run, the market will always grow .
- Have faith in market growth and believe in the Compound Effect .
- Never sell your investment in the short term , to maximize the cumulative effect.
- Persistently invest and accumulate monthly using the Dollar-Cost Averaging method .
- Buy now, buy now , don’t hesitate.
- “Fire & Forget” , buy it and forget it, don’t pay attention to it, just accumulate it gradually and don’t care too much about it.
Thank you for reading my sharing, hopefully it has brought more or less useful value to you.
- Sky -