Which is best: technical or fundamental investing?
It may seem a difficult choice… at first.
But I'm hoping after you've read this article, you'll know which one to choose.
What's the difference?
Technical investing goes hand-in-hand with other dangerous words such as 'trading' and 'resistance'. Technical 'analysts' think short term, and try to guess the direction a share price will move.
These 'technicians' or 'chartists', as they're known, care nothing for the company attached to its three-letter stock ticker code.
Although they come out swinging wildly with all types of crazy charting tools, sometimes drawing different coloured lines all over the place; the basic principle behind the theory is supply and demand.
As Investopedia explains: "technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components."
As you can imagine, trying to 'time' the market's 'emotions' is as ludicrous as it sounds.
Source: CMC Markets.
As part of a technical 'analysis', you may find all manner of different charts, such as the one used above.
Do Technical Strategies work?
I've been investing – as opposed to trading – (so far, successfully) for years because I'm yet to find a trading strategy which works.
But don't just take my word for it:
"Over 5,000 popular technical trading rules are not consistently profitable in the 49 country indices that comprise the Morgan Stanley Capital Index once data snooping is accounted for."
That's a quote I read in a research paper from Massey University's School of Economics and Finance.
In case you're wondering what 'data snooping' is, it's simply the inference someone chooses to make after looking at some data. In other words, the researchers tested only strategies, not people's reactions to the data.
As you can imagine, I believe technical investing is a farce – even if there is a correlation between share price movements and the volume of trades in a stock.
And don't be fooled by salesmen posing as financial advisers who spruik a convoluted track record as proof of the worth of a complex investing service.
As a great investor once told me:
"If you put enough monkeys on a typewriter, eventually one will write Shakespeare."
If it don't make money, it don't make sense
Fundamental investing is at the opposite end of the spectrum to technical investing.
It's a long term (three years absolute minimum), passive, investment philosophy – and the less emotion the better.
Also known as value investing, fundamental investing requires (yep, you guessed it) investors to research the company behind a three-letter stock code, assess what it's worth and wait for the market to appreciate its value.
Value investing is not about being right every time, but over time.
As the legendary money manager Peter Lynch famously said:
"In this business, if you're good, you're right six times out of ten. You're never going to be right nine times out of ten."
Investors thoroughly research a company, like Telstra Corporation Ltd (ASX: TLS), assess what they think the present and future value of the company is (in today's dollars), and compare it to the market price.
If there is a very wide margin of safety (i.e. the price 'gap' between what we believe a share is 'worth', and the market price), it may be a good investment.
Collecting a diversified portfolio of these proverbial bargains is a tested method for making money from the share market.
Just ask Warren Buffett and Charlie Munger.
As at December 2014, Buffett and Munger successfully delivered 1,826,163% in book value gains for shareholders of Berkshire Hathaway since 1965 – equivalent to 21.6% per year.
There are many local value investors who've also achieved respectable returns from value investing.
Platinum Asset Management Limited (ASX: PTM), WAM Capital Limited (ASX: WAM) and Magellan Financial Group Ltd (ASX: MFG) each have managed funds which have outperformed the market, after fees.
The bottom line is that if done right fundamental/value investing works.
This is not to say that every individual or firm who is capable of value investing should be trusted – far from it.
My personal preference
Regardless of whether you invest for yourself or through an advisor/broker, the important point here is to make sure they use a value investing strategy.
Further, if the advisor's strategy isn't working, and you feel you've given them enough excuses (I'd say no more than three years), either stop using their services and find someone else, or buy a low-cost index fund or ETF – a fund which simply tracks the market's performance over time.
I try to invest using fundamental investing principles.
But just in case I'm no good at it, I've bought the ishares Global Consumer Stables CDI 1:1 (ASX: IXI) ETF for my family's portfolio, recently purchased shares in the upcoming IPO of a global fund manager (for compliance reasons, I can't name it just yet), and am looking at buying into a fund run by one of the money managers named above.
What's your strategy?
