“The Stock Market is Not Safe”

A common refrain for not investing in the stock market could be this: “The stock market is not safe”.

Some may go on to point out that stocks in Singapore often seem to be in a big decline of some sorts. Offshore services provider Ezra Holdings Limited  (SGX: 5DN) and commodities trader Noble Group Ltd  (SGX: N21) are both examples of shares that have suffered significant losses over the past 12 months.

But, are all stocks really unsafe? Yes they can be. But only if you make it so.

Playing poker without looking at the cards

Friend: “Hey, I just bought [Company X]”

Me: “Wow, what does the company do?”

Friend (laughs nervously): “Erm, I don’t know. I heard it might go up.”

As investors, we have the choice of looking under the covers of a ticker symbol to find out more about the business that we are buying. Thing is, if we chose not to study the business behind the ticker, then we may well put ourselves at risk.

Investing without knowing how a stock’s business is like wouldn’t be too different from the act of driving a car without looking at the road. In driving, we can take safety precautions. But the safety precautions become a moot point if we choose to drive a car blindfolded.

Similarly, there are precautions that can be taken when we invest. We can choose to diversify. We can choose to use money which we will not need in the next five years. We can choose stocks with strong businesses. We can also choose stocks that aren’t over-priced in relation to the growth potential of their businesses. All these may help us reduce the risks of facing losses when we invest.

But if we chose not to study the business behind the ticker or buy and sell at the whims of the stock market – then we may well leave our fate to the short-term gyrations of the stock market; “investing” in this way then becomes not too different from gambling.

Patience for the long term

In the 26 years examined below (1988 to August 2013), the Straits Times Index (SGX: ^STI) has enjoyed yearly positive returns of 50% or more and has also endured painful declines of more than 40%. It would appear that there is some danger of losses in this case.

Annual return distribution for Straits Times Index (without dividends) from 1988 to 2013

Source: S&P Capital IQ

But as my colleague Ser Jing has shown before, Investing with a short time horizon can turn out to be no better than a coin flip. Ser Jing sums it up with this point:

“If I measure returns (unadjusted for dividends and inflation; though it’s likely that both effects will cancel each other out over the long-term) at the start of every month from 1988 to August 2013, there has never been a rolling 20-year period where long-term investors (i.e. investors who bought and held for 20 years) have made losses.

Trigger-happy investors who have a holding period of just one year would see only a 59% chance of sitting on a gain.”

To aid ourselves in generating positive returns in the stock market, having a long term view and a lot of patience – and an insistence on buying businesses not stocks – will be good.

Foolish takeaway

Like learning how to ride a bicycle, there may be times when we may fall over. We might not always be right in our assessment of a business as well. But if we keep looking for the best businesses we can find, the returns for our efforts may eventually pay off.

The stock market doesn’t have to be a scary place if you take into consideration the points above.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.