Financial Happenings Blog
Monday, July 01 2013
For many years I have followed the writings and podcasts of Paul Merriman, a financial adviser based in the USA. Recently Merriman has retired but continues to write and publish on financial advice particularly investment advice topics. In a recent article 10 do's and don'ts for retirement investors he looks at 5 key dos and 5 key dont's in retireement. Even though the comments are focussed on retirees in the US the broad concepts are just as relevent for us here in Australia. So here are the 10 items for your consideration:
Retirement do’s
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Do take advantage of “the only free lunch on Wall Street” by building a diversified portfolio of mutual funds (managed funds in Australia). This will reduce your risk and probably increase your returns.
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Do buy funds with the lowest possible expenses. The average equity fund charges more than 1.3% a year, yet you can get most of the asset classes you need in good funds for a full percentage point less than that. This is equally important for bond funds.
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Do buy index funds instead of actively managed ones. This will be a big help in achieving both of the prior “do’s” I mentioned.
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Do invest in equity asset classes with long histories of successful returns. Based on years of careful study by academics I trust, this means U.S. large-cap blend, U.S. large-cap value, U.S. small-cap, U.S. small-cap value, international large-cap blend, international large-cap value, international small-cap blend, international small-cap value, and emerging markets. And for tax-deferred accounts only, it means U.S. REITs. (In Australia the asset classes include Australian large-cap companies, Australian value style companies, Australian small-cap companies, International large/value/small cap companies, emerging markets and Australian and international REITs)
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Do invest in the most tax-efficient manner. Unless you have unusual circumstances, that means maximizing your IRA and 401(k) accounts and (when you’re living off your money in retirement) using up your taxable accounts first. (In the Australian context this is about effectively utilising superannuation and superannuation pension accounts)
Retirement don’ts
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Don’t pay a sales commission to buy or sell a mutual fund. The commission is money that’s gone forever from your nest egg, and it inevitably and permanently diminishes the return you will get. (In Australia you can no longer buy funds that have commissions attached but any existing managed funds may still maintain a commission structure.)
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Don’t buy funds in asset classes with low expected returns or high levels of risk relative to their expected returns. Among the most prominent examples of asset classes you should avoid are commodities, gold and technology stocks. In addition, I think you should steer clear of pure growth funds, whether they invest in large-cap, midcap or small-cap stocks — and this includes international funds as well as U.S. funds.
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No matter how much you are attracted to an active manager, don’t buy actively managed funds. This is really another way of stating my third point above. Actively managed funds are guaranteed to have higher expenses than index funds, and their returns aren’t likely to be as high as those of index funds.
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Don’t speculate with your portfolio, even a small part of it “for fun.” If you have a properly diversified portfolio along the lines that I recommend, your investments will include all the “great opportunities” you will ever need. Speculating and playing the market will almost surely reduce your long-term returns.
If you absolutely can’t resist trying your luck, then spend (notice I am not saying “invest”) a bit of money that you can afford to lose and buy a lottery ticket.
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Don’t get snookered into thinking you have found a guru or anybody else who knows what will happen to the market in the future beyond statements such as “Stocks will go up in the long run.” Many people claim to have that knowledge, but nobody does. The sooner you can accept this fact the sooner you will be in touch with reality.
When you are in touch with reality, you are likely to invest more intelligently and productively.
These are great insights from a man with many more years of experience than me and well worth consideration for you investment portfolio.
Regards,
Scott
Friday, May 10 2013
The Association of Superannuation Funds of Australia (ASFA) has just released new data regarding indicative costs in retirement relating to the period ending 31st of March 2013. The media release suggests that health and energy costs rose over the March quarter whilst food and leisure goods and services fell.
I believe the information provided by ASFA can be useful in 2 key ways:
- assisting clients to determine what their budget should be when reaching retirement
- providing a gauge of inflation for those preparing for or in retirement
The study includes indicative budgets for 4 groups as follows:
A single person with a modest lifestyle $22,641
A single person with a comfortable lifestyle $41,169
A couple with a modest lifestyle $32,603
A couple with a comfortable lifestyle $56,317
When using the breakdown of budgets provided care should be taken in seeing whether they fit your requirements.
In terms of inflation the latest data suggests there has been only slight changes with the two comfortable lifestyle budgets actually falling slightly. However the annual change was between 2.16% and 3.17% due to a large jump in costs in the September quarter of 2012.
This inflation data can be really useful for assisting with determining what level of total return will be required to meet the goal of making sure assets last long enough through retirement years.
Using this data you can add a required drawdown rate - say 5% - and add the level of fees you are paying - say 1.25% - to work out what you need your portfolio to be generating in total returns - 9.25% using the example data.
This can then be a really useful starting point to see what style of portfolio you require to reach that total return target. In particular how much risk needs to be incorporated into a portfolio. In particular, if you are targetting a 9.25% total return, you should be considering what style of portfolio has provided that return through history with the least amount of volatility (risk).
For anyone contemplating or in retirement taking a look at the ASFA Retirement Standard data could be a really valuable use of time and a great starting point for retirement planning.
Regards,
Scott
Wednesday, May 01 2013
A key issue when analysing whether you have enough invested to retire is how much you expect costs of living to increase by through your years of retirement.
This is a tough number to determine. Many economists have trouble enough identifying what it has been historically yet alone trying to predict what it might be for the next 20 or 40 years.
Using history as a gauge
Economists tend to start their analysis using the Consumer Price Index (CPI). In Australia the Australian Bureau of Statistics (ABS) has the responsibility of determining this index level every quarter using a pre-defined basket of goods. It calculates the cost of that basket of goods and compares this with previous levels to calculate how much prices have changed.
The database I looked at placed the CPI at a rate of 5.27% since October 1948. However this period was marked by extremely high inflation through the 70s, 80s & early 90s. (Inflation was close to 10% on average from the beginning of 1973 until the end of the 80s) Since then central banks and governments around the world have implemented inflation targeting as a core economic policy and through doing so have driven inflation down. (It has averaged 2.7% from the beginning of 1990 until the end of March 2013 in Australia.)
In Australia the Reserve Bank of Australia target rate of inflation is somewhere between 2 and 3% over the course of the economic cycle. Hopefully a firm lid can be kept on inflation so that it will not climb back to the levels experienced in the 70s and 80s.
What is current level of inflation?
The most recent reading of the Consumer Price index suggests that the cost of living rose by 2.5% for the 12 months to the end of March 2013.
Some commentators suggest that the basket of goods used by the Australian Bureau of Statistic might not provide an accurate reading of cost rises for retirees. I also look at 2 other measures to see how costs are faring for retirees:
1) The ASFA Retirement Standard
2) The Australian Bureau of Statistics Selected Living Cost Indexes
ASFA Retirement Standard
Every quarter the Association of Superannuation Funds of Australia (ASFA) commission a report conducted by Westpac to gauge the cost of living in retirement for singles or couples with a modest or comfortable lifestyle.
Figures to the end of December 2012 suggest that costs have risen by:
2.99% for a single person with a modest lifestyle
1.93% for a single person with a comfortable lifestyle
2.78% for a couple with a modest lifestyle
1.97% for a couple with a comfortable lifestyle
For me this suggests that cost s for those in retirement are rising basically in line with the official CPI figures and with in the Reserve Bank target.
The Australian Bureau of Statistics Selected Living Cost Indexes
The ABS has started to release living cost indexes on a quarterly basis for a number of broad groups. The latest data release for the period ending March 2013 suggests the annual increase in costs have been:
2.7% Pensioners & Beneficiaries
2.8% Age Pensioners
2.3% Self Funded Retirees
So again these numbers fall close to the broad CPI figure and with the Reserve Bank’s 2 to 3% target.
So what level of inflation should be used for predictive purposes?
My approach is to start with the current rates of inflation. If these levels are below the 3% Reserve Bank threshold (which they currently are) I would use 3% . If they are above the 3% threshold I would tend to use the current levels. i.e. I try to use the worse rate to hopefully build in a level of conservatism.
If you are an inflation bear, you might want to use a rate more like 5% on average.
If you can use a higher level of inflation and still meet your retirement goals all the better.
But how will investments respond in different inflationary environments?
A final aspect to consider is how might investment returns behave in various inflationary environments?
Historically, over the long term, returns on asset classes tend to be within percentage bandwidths from the prevailing level of inflation. For example an oft-used rule of thumb is that shares should provide a return of 6 to 7% above inflation.
The real art is to make sure that your investment mix has enough exposure to investments that tend to perform better in inflationary periods.
Unfortunately there is not enough time to go into details now but I will come back to it in another day.
Regards,
Scott
Monday, April 29 2013
Paying more than the minimum on your mortgage from the first year saves interest for the life of the loan - much like nstarting a regular saving or investing program.
Scott Francis in his latest Eureka Report article - Advancing your home loan - takes you through 3 key benefits to be gained from paying more down on your home loan
- You reduce the amount of your loan by the extra repayment.
- Every future repayment becomes more effective.
- You reduce the overall riskiness of your financial position by being ahead in your loan repayments.
Take a look at Scott's article for more details. Well worth a read.
Monday, April 29 2013
No matter what your opinion is on where investment markets will go next, one area of agreement is that markets have been volatile in recent years. Nobel Prize Winner – William Sharpe – has recently provided his thoughts on investing in a turbulent market for the Stanford Graduate School of Business where he is a professor emeritus of finance - William Sharpe: How to Invest In a Turbulent Market
We think highly of Sharpe’s work and it forms a major part of the investment philosophy we use to develop investment portfolios for clients.
So has Sharpe’s views changed since the GFC started in late 2007? In a word, NO.
In the Stanford article Sharpe provides an overview of his four pillars of investing - Diversify, economize, personalize, and contextualize.
In a nutshell these pillars are:
Diversify – invest in a broad range of shares and bonds – preferably all of them.
Economize – keep costs low.
Personalize – make invest decisions that are most appropriate for your own situation.
Contextualize – the price of an investment reflects the average opinion of investors about its future. You may think your opinion is superior, but it pays to be humble, investing in the market rather than trying to beat it.
Sharpe provides some really important concepts that in our opinion should be the basis for developing a successful investment philosophy.
Regards,
Scott
Wednesday, February 20 2013
Scott Francis has just published his latest article in the Eureka Report looking at the topic of gearing - Gearing up: It's all in the timing.
The article provides some food for thought for those contemplating a gearing strategy to build wealth. With interest rates at historical lows it might be an interesting time to implement such a strategy for those who have a very aggressive risk profile.
However, as Scott points out at the conclusion of the article, there are some serious considerations to take on board before jumping in such as the market timing "bet" you would be making and the decision not to hold cash or fixed interest assets that would be involved when using debt.
Well worth a read.
Regards,
Scott
Tuesday, January 22 2013
In my previous blog I mentioned the fascinating challenge in the UK which pitted Orlando the cat against students and a panel of market professionals to see who could invest £5,000 the most successfully across a one year timeframe. Orlando won and also beat the broad UK FTSE All-share market index by over 3%.
The professionals were well beaten by both Orlando and the index.
Jim Parker from Dimensional has followed up on this discussion with a more in depth discussion in his latest Outside the Flags article. Jim also discusses the forecast from a well known finance commentator at the end of December 2011 to sell down share holdings. This call did not turn out so well with what followed being a well above average year in 2012 for Australian shares.
By no means was this a scientific experiment so don't go out and get your household cat or dog (or octupus for those who remember Paul from the 2010 World Cup) to pick your investments. Rather build your portfolio around a well diversified portfolio of assets and minimise taxes and costs where possible.
Jim's full article can be found here:
January 22, 2013
Cool for Cats
You've heard the line about stock picking being better left to blind-folded, dart-throwing orangutans. Now there's new competition – from cats.
UK newspaper The Observer staged an experiment, pitting a panel of market professionals and a group of students against a ginger feline called Orlando in a competition to see who would have the most success in picking stocks in 2012.1
Each team invested a notional £5,000 in five companies from the FTSE All-Share index at the start of the year. After every three months, they could exchange any stocks, replacing them with others from the index.
The professionals used their experience, insights and market knowledge to select stocks. The cat's method was rather less elaborate. Orlando simply threw a toy mouse onto a grid of numbers allocated to stocks in the index.
The newspaper reports that while the cat was trailing the pros at the end of the September quarter, his feline intuition kicked in the final months. As a result, his portfolio increased to end 2012 at £5,542. This represented a gain of nearly 11% for the year, outpacing the index's 8.2% rise and shading the professionals' portfolio by 7%.
While this experiment was hardly scientific, it does provide another reminder about the difficulty of generating consistent above-market returns by picking individual stocks or making forecasts. And it's something to keep in mind when you are confronted by media and market prognostications for 2013.
In the US context, Bloomberg highlighted this difficulty recently in a piece entitled Almost All of Wall St Got 2012 Market Calls Wrong.2
While many forecasters began 2012 by issuing downbeat calls for equity markets - based on the ongoing Euro Zone crisis, China's slowdown and US political logjams – the market value of global equities increased by about $US6.5 trillion last year.
As one analyst quoted by Bloomberg noted, many pundits were too wrapped up in the "fear du jour" and failed to keep an eye on the big picture.
So it was in Australia, where one prominent television finance commentator said at the end of 2011: "The conditions are in place for a panic sell-off. It is not certain that it will happen…but the risk is now such that you must take action. I will be significantly reducing my already reduced exposure to equities possibly to zero".3
More fool him and commiserations to anyone who had the misfortune to act on his advice, because the Australian equity market delivered a total return in 2012 of 20% in local currency terms. Gains in many other equity markets were even stronger.
It should be plain by now that basing your investment strategy on someone else's forecast is a haphazard way to build wealth. No matter how diligent and expert your forecaster is, unexpected events have a way of messing up their expectations.
As well, those who insist on believing that forecasting is a sustainable investment strategy tend to under-rate the capacity of capital markets to very quickly build all those expectations into prices. You think markets will tank/soar this year? So does someone else and they're trading off that belief.
The good news is you don't need a crystal ball to build wealth. You just need a regularly rebalanced diversified portfolio of assets designed for your needs and risk appetite. You also need to keep an eye on costs and taxes.
Most of all you need to keep your cool and exercise patience. Like a cat.
Sunday, January 20 2013
APRA have recently released the rates of return for Australia’s 200 largest superannuation funds and it does not make great reading for Bookmakers Superannuation Fund. It has performed the worst over the past 5 years and second last over 9 years.
We became aware of the fund back in 2006 when a potential client was seriously looking at using the fund after some positive reporting including from Alan Kohler. To be fair the fund had provided some strong returns in the years to 2005 and had a low fee basis. (The fund became publicly available in September 2004.)
Unfortunately if you had joined the fund after it went public the results have been disappointing. If you serch for why returns have been poor a major reason was that the fund had a heavy exposure to investments held with MFS which failed in 2008.
This story reminds me of the Legg Mason Value Fund in the US. For 15 straight years through to 2006 the fund outperformed the S&P 500 index. In the five years later following it trailed the S&P 500 by more than an average of 7% per annum.
The clear message from both of these stories is to be very careful "chasing" active fund managersand advisers who report strong historical returns. History also shows us that keeping this performance going is extremely difficult. If you get in at the top of the wave you are potentially heading for a huge dumping.
The following editorial piece was published in Monday's Advocate newspaper by Peter Mancell, the Managing Director of FYG Planning Pty Ltd, in Peter's capacity as director of the Mancell Financial Group and director of FYG Planning.
Peter regularly publishes opinion pieces in The Advocate and I thought this one was well worth republishing here. In this week's piece Peter talks about the Bookmakers Superannuation Fund along with a really interesting story out of the UK where a cat has beaten stockbrokers in a stock picking challenge over a 12 month period.
I hope you enjoy the article.
Regards,
Scott
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Bookies Finally Lose, While Cat Beats Brokers
Given the self important and often overpaid nature of the finance industry, each week often throws up at least one irony.
Last week there were two.
Firstly, APRA released the rates of return for Australia’s 200 largest superannuation funds.
The number one fund over the past five years was the Challenger Retirement Fund, while over nine years it was Goldman Sachs/JBWere’s corporate staff fund.
Of course as interesting as who finished first, is who finished last.
For those who’ve lost a little too much money on the horses over the years, they’ll be interested to know the Bookmakers Superannuation Fund came last over five years, and second last over nine years!
Between June 2008 and June 2012 the Bookmakers Superannuation Fund failed to have one positive yearly return.
I don’t know what their strategy is, but by the looks of it they might have done better ‘investing’ at the racetrack!
Secondly, the news out of England that a cat named Orlando managed to beat stockbrokers, fund managers and a group of schoolchildren in a stock picking challenge.
At the start of 2012 each group invested a hypothetical £5,000 in the FTSE (UK share market); the groups were allowed to revise picks every three months.
Orlando picked his stocks by throwing a toy mouse onto a numbered grid, while the experts used their knowledge.
After 12 months, Orlando’s portfolio had grown to £5,542, the experts’ portfolio to £5,176, while the schoolchildren’s portfolio fell to £4,840.
While the schoolchildren finished last, they did perform the best in the final quarter which led to some misplaced optimism from their deputy headmaster, Nigel Cook.
“We are happy with our progress in terms of the ground we gained at the end and how our stock-picking skills have improved,” Mr Cook said.
Despite his students being shown up by a cat, Mr Cook still missed the point of the exercise.
Stock picking remains futile and you can’t ‘improve your skills’ at it because no one can predict financial markets with any certainty.
Peter Mancell is a director of Mancell Financial Group and FYG Planners AFSL/ACL 224543, www.mfg.com.au This information is general in nature and readers should seek professional advice specific to their circumstances.
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Mancell Financial Group
Mancell Financial Group ABN 29 009 541 253 is an Authorised Representative No. 226266 and Credit Representative No. 403187 of FYG Planners Pty Ltd, AFSL/ACL No. 224543
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Friday, January 18 2013
I am in the process of writing a client update for clients reflecting on the past year and looking forward. The overall results have been pleasing with all major investment asset classes (barring cash) performing strongly.
If we look back at where we were at the beginning of January 2012 I think it would be fair to suggest that sentiment was poor. 2011 returns had been poor for everything other than bonds. There did not seem to be any major progress with the European debt crisis, growth was slowing in China and the US had only a few months previous been through a bruising political period culminating in the downgrade of the credit rating of US government debt. Not a great environment to provide confidence for the year ahead.
So why did things turn out so much better than what we might have expected?
The key driver in markets through 2012 seemed to be the hunt for yield underpinned by developments that were more positive than expected:
1) Increased Central bank stimulus measures including here in Australia.
2) The Chinese economy seems to have picked up after what appears to have been a stable political transition.
3) The US avoided the fiscal cliff ... for now.
4) Euro breakup fears eased after the head of the European Central Bank (ECB) Mario Draghi saying that the ECB will do whatever it takes to save the Euro
So what can we learn from the events of 2012?
Three really crucial lessons were evident for me:
1) Whilst current news might look negative (or positive), it's what happens next that is important for investment markets.
2) Trying to predict the next move for markets is very difficult.
3) The benefits from diversification are alive and well.
Jim Parker from Dimensional thrashes out these points in a little more details in his latest Outside the Flags article - Many Happy Returns. The article included some interesting data about returns from 20 developed markets and 20 emerging market some of which you might find surprising. I have included his article below.
Here's to a good year for 2013 hopefully with plenty of surprises on the upside!!
Regards,
Scott
The summer holiday season encourages media retrospectives about financial markets. It's fun to match these up with what people were saying a year before.
In December, 2011, the publication Barron's told investors to "buckle up". The consensus prediction of its panel of 10 stock market strategists and investment managers was for the US S&P-500 to end 2012 some 11.5% higher at about 1360. 1
"That sounds like a big gain, but a lot of things have to go right for the market to make such impressive headway," the writer said. "Even the most bullish of these Street seers fears stocks could be more wobbly in the next six months than in the six months past."
There was so much for forecasters to get right - a negotiation of the Euro Zone crisis, uncertainties over the growth of earnings, the roadblock of the US presidential election and the challenge for emerging economies to sustain high economic growth rates.
More than a year later, markets are still grappling with many of the same issues, though from different angles. Much of Europe is either in recession or growing only modestly, unemployment is high and a number of countries that share the single currency are unable to pay their debts. The US presidential election gave way to worries over the so-called "fiscal cliff", while Chinese exports have been hit by the slowdown elsewhere.
In the meantime, however, there have been solid gains in many equity markets, including parts of Europe and Asia, as well as North America. That Barron's panel forecast of the S&P-500 reaching 1360, which the magazine said was ambitious, turned out to be conservative. The index ended the year 13% higher at 1426. What's more, some of the strongest performances have been in emerging and frontier markets.
The table below shows performances for 2012 (to December 31) and annualised returns for the past three years of 20 developed and 20 emerging markets, using MSCI country indices. Returns are ranked on a year-to-date basis and expressed in Australian dollars.
Among developed markets, three members of the 17-nation Euro Zone - Belgium, Germany and Austria - were among the top performing equity markets last year. Leading the way among emerging markets was Turkey, which regained its investment grade ranking from agency Fitch in November.
While not one of the very top performers, the Australian market nevertheless delivered solid returns of 20% for the year despite the difficult international circumstances and the uncertainties at home over the extent of the slowdown in the domestic economy.
And while much of the media focus has been on the so-called BRIC emerging economies of Brazil, Russia, India and China, the real stars in the emerging market space these past three years have been the south-east Asian markets of the Philippines, Thailand and Indonesia.
There a few lessons from this. First, while the ongoing news headlines can be worrying for many people, it's important to remember that markets are forward looking and absorb new information very quickly. By the time you read about it in the newspaper, the markets have usually gone onto worrying about something else.
Second, the economy and the market are different things. Bad or good economic news is important to stock prices only if it is different from what the market has already priced in. My research colleague Jim Davis has done an interesting study on this. 2
Third, if you are going to invest via forecasts, it is not just about predicting what will happen around the globe. It also requires that you to predict correctly how markets will react to those events. That's a tough challenge for the best of us.
Fourth, you can see there is variation in the market performance of different countries. That's not surprising given the differences in each market in sectoral composition, economic influences and market dynamics. That variation provides the rationale for diversification - spreading your risk to smooth the performance of your portfolio.
So it's fine to take an interest in what is happening in the world. But care needs to be taken in extrapolating the headlines into your investment choices. It's far better to let the market do the worrying for you and diversify around risks you are willing to take.
In the meantime, happy new year and many happy returns!
Thursday, January 10 2013
The article looks at a fascinating example from the early 19th century in London where investors were conned into investors in bonds for a fictitious Central American settlement Poyais. Well worth a read if you are interested in
The practical element from the article that caught my eye looked at why people fall for fraud. It refers to research out of Boston University by Tamar Frankel based on the study of hundreds of financial cons. The research suggests that the following are recurring traits of victims:
- Excessively trusting
- Have a high risk tolerance
- Have a need to feel exclusive or part of a special group
The article also refers to other research suggests that victims tend to:
- Harbour dissatisfaction with their current economic status
- Desire not to be left behind
- Feel envious of economic neighbours
This all leads to greedy or risk investing.
Many of us shake our heads when we hear of others being trapped by financial fraudsters and ask how could someone fall for the outrageous claims they make. Reading the list of characteristics might lead many of us to rethink our perceived safety from financial fraud. We could easily fit into the class of potential victim.
So what's the investment lesson?
A key to avoiding making the same mistakes as financial fraud victims of the past it is really important to carefully question any investment that you get into. Look for total transparency and not a black box where you really don't understand what you are investing in and finally seek trusted professional advice before jumping in.
Regards,
Scott
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