The future is unknowable

A COLLEAGUE shared that after completing his studies in the UK, he worked there for a while, and then made a brief stop in Australia, before settling in Singapore. He's a Singaporean now and he reckoned that he has done much better financially and professionally than his classmates who had decided to stay on in London. At that time, it wasn't clear if he had made the right decision to come back to Asia. London had the buzz.

Today, London is under a huge cloud of uncertainty. The currency has depreciated significantly. "Who would have predicted Brexit?" That's why he said he is very wary of macro forecasts.

I also know of someone who after graduating with a medical degree in Singapore decided to break his bond to go back to Malaysia in the early 1990s. The rationale was that Malaysia has a bigger market. Since then, Singapore and Malaysia have taken quite different growth trajectories. The ringgit has tanked while the Singapore dollar has gone from strength to strength. According to World Bank numbers, the GDP per capita of Malaysia in 2018 was US$11,239. That's not much higher than China's US$9,771. Meanwhile, Singapore's GDP per capita last year was at US$65,582.

As an illustration of how much Malaysia has lagged economically, my colleague shared that his friend has a piece of land in the northern part of Malaysia which a Chinese company recently wanted to lease. The company wanted to build a factory. The friend asked what will the factory manufacture? "Tissue paper," came the answer. Apparently it is now cheaper to manufacture tissue paper in Malaysia than in China!

My life path

As for my own life path, after finishing STPM - the equivalent of A-levels - in Penang, I applied to universities in Malaysia, Taiwan, Singapore and the US. Singapore was my first choice and it helped that I managed to get a scholarship which paid for my school fees. There's no question that my life would turn out vastly different - for better or worse - if I had gone to say, Taiwan or to University of Malaya.

The point of the ramblings above is that the future is unknowable. In a world where we have to make important decisions given an uncertain future, how best should we navigate?

To me, a sensible way is to take the probabilistic approach. Based on the past, what are the probabilities of the various outcomes coming to pass? Short of being able to foretell the future, our best guide is still history. As the saying goes: History does not repeat itself, but it rhymes. Perhaps factor in changes in conditions and tweak the probabilities accordingly.

History is more reliable if it has gone through many iterations and show similar results most of the time. For example, after going through tens of thousands of stocks, you discerned that stocks with characteristics A, B and C tend to yield positive returns and those with characteristics X, Y and Z generally have negative returns. When the next stock with characteristics A, B and C comes along, you have a fairly good idea of how it is going to behave.

Macro events are generally less predictable because there are fewer of them, and each situation is different, with many variables coming into play.

In addition to the probabilities of outcomes, another important factor to consider is the outcomes themselves. Is the outcome going to be so disastrous that one will have a difficult time recovering from it? Or is it going to be so wonderful that you are willing to risk a lot of what you have now or what you might have in the meantime while you work and wait for the realisation of the wonderful outcome? Take for example, a daredevil stunt person who is trying to make it big. In some cases, there is no recovery from failure. Contrast that with an aspiring actor who failed at an audition. There is always another audition. However, the chances of attaining super stardom are quite slim compared to, say, a bid to earn a decent living as a dentist. This is why most parents prefer their kids to train for readily available jobs.

It's the same for investments. If the bet is small, the consequence to one's financial health will be negligible. Spending $5 or $10 occasionally on a lottery ticket is by and large, harmless. It gives you a chance, however slim, of striking it rich. However, it will be foolhardy to risk a huge portion of one's net worth on a low probability outcome or an outcome whose probability distribution one has no inkling of.

An ex-colleague reached out to me recently. I haven't heard from him possibly for 10 plus years, and he's been retired for that length of time, if not longer. His question to me was: "Someone suggested trying Bitcoin. . . as I know nothing about it, I thought I should consult a guru." I said I don't know anything about Bitcoin, just that it's volatile. He said he's not a risk taker, hence the caution. My response was: "If you are not a risk taker, you should not even consider this. How do you even value it? If you buy something you can't value, it's speculation."

He agreed and revealed that his friend said he made $1.1 million from trading Bitcoin last year. But when he asked his friend how much he invested, he said "a few hundred thousand". I said if the friend is rich, the few hundred thousand dollars are just loose change to him. He can do what he wants. My ex-colleague said his friend has a luxurious villa and five other properties and runs a business. In contrast, he said losing a few hundred thousand dollars would ruin him totally. Exactly my point.

If one were to put a huge chunk of one's net worth in something, it has to be something that historically has a fairly predictable outcome and with almost zero chance of falling to zero. For example, shares in a basket of financially sound companies with pretty long track records, which are still delivering products or services that are relevant, are unlikely to go to zero if one were to purchase them at decent prices.

Unfathomable world

But the thing is, stocks prices in addition to their own fundamentals are affected in the short term by the macro environment and general investor sentiment. Hence many investors like to ask us for our views on the markets and some fret about headline news. Our standard response is: "We don't know." One of the greatest investors of all time, the portfolio manager of Fidelity's Magellan Fund, Peter Lynch said he did not spend 15 minutes a year trying to forecast the economy. He said he believed that more money was lost worrying about or preparing for recessions than was lost in the recessions themselves. Trying to surf the market according to the flow of macro data added no value but did hurt performance.

The takeaway is: If your investing timeframe is long-term based, you should largely ignore the daily news. Here's the historical probability: Stocks have gone up on average about 70 per cent of the years since World War II. If Brexit, the outcome of trade wars, globalisation or deglobalisation, recessions or bear markets cannot be accurately forecast, then staying invested has a 70 per cent probability of being rewarded.

Unless one doesn't trust whatever history we have so far. Just like a turkey shouldn't trust the person who feeds it every day as its best friend. In which case, all bets are off. Even money may be of no use in that unfathomable world.