Fool's Gold

Simple maths.

Qns 1: Johnny invested $100 and lost 50% of his capital in his first year. On the second year, he made a 50% gain. How much does Johnny end up with at the end of the second year?

I bet none of you got this one wrong. The answer is, of course, $75.

If you insist that I got my calculations wrong, then you will be the favourite customer of your investing manager, taking good care of your retirement funds.

How about another one?

Qns 2: Johnny invested $100 and averaged a 0% gain in 2 years. How much capital will be left in his investment account?

If you have an answer for this question, you are a genius because there is no definite answer for this question. A straightforward 0% gain over 2 years will see Johnny keeping his 100 bucks intact. The devil is in the details - and the key word is 'averaged.' The question did not provide sufficient information on what constitute the 2-year average. It could be a pure no movement 0% stagnation, or something of a scenario in Qns 1 - losing 50% on year 1 and gaining 50% on the remaining capital gives a 0% average gain for 2 years. 

So should Johnny realise his investment, he will be left with $75 in his pocket despite averaging a net gain of 0%.

So when a specific fund told the stakeholders they averaged a 20+% gain over x years, I didn't give a shit. Maybe you shouldn't too. Show me the accounts and I'll do my maths myself. Losing $50 out of $185 billions makes that a broken investment. For those who are more familiar with the principles of gambling, losing $50 out of $100 in the first game is no big deal because if you win the second game, you'll get back to $100 where you started off. It is much harder to do a comeback on a huge investment loss. In investment, your money is put into a product, a brand or even an idea. The first mistake any investor can make is to failing to cut their losses on a bad call. Anyone who allows a $50 billion loss is sleeping on the job because the extent of the damage on the capital was so serious because it makes a comeback a mammoth task. 

That's the dilemma of an investor over a gambler. A gambler starts the next game fresh but the investor must decide if he or she should painfully cut a loss or risk holding on to a rotten investment who may never recover to its past glory, never mind outperforming its peak. Should you need to realise your losses of $50 our of $185 at a 27% loss, you'll need to make a 50% gain of your remaining capital to return to where you started off with. How many years would that take, considering another loss on the horizon is always possible because the same gambler on identity crisis is still pretending to be Warren Buffet. 

So what happens if people are waiting to use that money?

The craziest thing I've heard of is that a fund manager has the authority to dictate when their investors are getting their money back. Just imagine your insurance agent, or financial planner whatever they like to be called, gives you a call on stormy night, 

"Mr X, I would like to inform you that endowment plan that you have been painstakingly servicing for the past 10 years is not going to be matured in 20 years' time as agreed. It shall be extended by 10 more years because the company reckons you are going to live longer. The payout may be adjusted on yearly basis within our discretion. There are also plans to retain a portion (say more than 50%) of it after maturity for your own good, in case you spend it on charismatic foreign women."

Your reaction should never be anything lesser than, "Lan jiao, understand!" and rightfully so.

No comments:

Post a Comment