In the latest edition of the Sound Investing podcast, published by FundAdvice.com, Paul Merriman, Tom Cock and Don McDonald discuss stock pickers failing during bear markets, why you should buy stocks now, and myth or reality - professionals beat amateurs at investing.

One warning, the radio show is 51 minutes in length and will use up 47MB of download.

If these constraints are not a problem, I recommend you take a look at the latest podcast - Sound Investing - November 14, 2008

For those who have limited time and/or limited download capability the following is a brief summary of the more relevant material that was covered:

Stock Pickers Fail During Bear Markets

The presenters discuss a recent piece of research conducted by the Vanguard group which shows that in 3 of the last 6 bear markets since 1970 the majority of active managers have failed to beat the relevant market index.

Paul Merriman comments that investors do need to become active, actively taking responsibility for their investments by making changes to decrease expenses, turnover and taxes and to get into asset classes that are in your best interests.

Why should you be buying shares now?

The presenters comment on a recent article written by Knight Kiplinger suggesting now is a great buying opportunity and a wise approach is through dollar cost averaging.

Pau Merriman commented that we can not absolutely depend on the past as a guide to the future.  However, in 1973-74, if you adjusted the losses for inflation a 40/60 strategy has experienced almost the same losses as now.  After 73-74, a diversified portfolio over the next 2 years provided a 34% per annum return.  After October 1987, a diversified portfolio provided a 24% per annum return over the next two years and after the declines of 2001-02, a diversified portfolio provided returns of 25% per annum over the next 2 years.  Finally, after the 1929-32 period the next two years saw a compound rate of return of 23% per annum over the next two years and 47% per annum over the 4 years after 1932.

The key point, investors with staying power won the day.

Back to the Basics

Don McDonald reminds listeners not to invest in investments which you do not understand.

Merriman's Simple Steps

Paul Merriman listed his simple steps to success:

• Own the right asset classes
• Own the right amount of equities and fixed income investments
• Control expenses
• Control hidden charges
• Know your risk tolerance
• Know how to take money out in a low risk way
• Have enough information so that you understand your investments
• Allow markets to do their thing

Myth or Reality: Professional investors have an advantage over amateurs

The presenters suggested that the proxy for professional investors were mutual funds (actively managed funds in our language).  From 1980 to 2005 mutual funds provided investors a compound annualised rate of return of 10%.  If an investor had invested in the S&P 500 they would have received a 12.5% compound rate of return.

The conclusion an average amateur investor who invests in an index fund is likely to be more successful than professional investors.

Regards,

Scott Keefer

Last Saturday, 15th November, Scott Francis joined Warren Boland's "Weekends with Warren" program on 612 ABC Brisbane.  The major topics covered were:

1. The Four Factors Weighing on Share Markets
2. The Role of Interest Rates
3. The Difficulty of Forecasting

Click on the following link to be taken to a summary of the material covered in the segment - Four Factors Weighing on share Markets / Interest Rates / Difficulty of Forecasting

Any introductory economics course will have at its heart theories surrounding the business / economic cycle.  The basics of this theory is that economies go through cycles moving from periods of expansion into contraction and then back to expansion.  The basic point of economic policy is to try to smooth out these cycles so that we do not have too strong growth leading to high price increases (inflation) or stong contraction leading to high levels of unemployment.

A lot of the talk in the media is whether we are moving towards or are already in one of those contractionary periods.  The technical term is a recession and the technical definition of a recession is a continuous period of two quarters (6 months) of negative growth.

Unfortunately we can only be sure about whether we have had a recession after the fact.  But even if we knew where we were on the economic cycle how does this flow through to the investment world?

A small article in today's Australian newspaper discusses an investor's perspective of the recession debate - "Future strategy easy in retrospect".  The original article was written for the Wall Street Journal by David Gaffen.

In the article Gaffen points out that investors start discounting an economic recovery about halfway through a recession which prompts a rise in stocks that continues as the economy picks up steam.  However two pieces ofthe puzzle are missing:

1. When has the recession started?
2. When is it going to end?

He suggests that many believe that a recession began in the US somewhere around the first quarter of this year.  In the 16 periods of economic contraction in the US since 1919, the average length of the contraction has been 13 months.  And the conclusion he makes is that the US recession is at or even past the halfway point.  (To add some further perspective, the two worst recessions of recent times began in November 1973 and July 1981 and both ran for 16 months)

Based on this analysis , have markets already priced in the recession and shouldn't we be jumping in boots and all into equity markets?

Unfortunately, Gaffen goes on to point out that the recession this time might be worse than average and we may not make halfway for another few months yet.

Whichever way you lean on the recession, this discussion provides an interesting perspective and some hope that the worst of the declines at least might be behind us.  We will never know until years down the track.

Regards,
Scott Keefer

An article written by Scott Francis has been published in the ASX Investor Update Email Newsletter for November - Strategies for volatile times.  A copy can also be found on the ASX website.

The key points from the article are:
- The risk of timing markets
- Building an effective asset allocation

Scott concludes by providing an example based on a couple about to retire with $700,000 of assets.

In his latest article written for Alan Kohler's Eureka Report, Scott discusses Warren Buffett's recently released official biography - The Snowball.

Scott takes away 5 key factors emerging from Buffett's disciplined approach to investing:

1) He is an exceptionally intelligent investor
2) His use of the margin of safety
3) He is a dedicated entrepreneur
4) He uses minimum borrowings
5) The snowball effect

Click on the following link to read Scott's analysis - Warren Buffett's textbook on investing ... and life.

A natural reaction of late, especially since the strong falls on share markets across the world through October, has been a flight to safety namely cash.  The Australian government guarantee of cash deposits has solidified at least one area of the market.  This looks pretty attractive when most other asset values, even residential property based on data out today, are falling or have already fallen significantly.

Unfortunately, interest rates on these cash deposits are also falling.  Central banks around the world (whole heartedly supported by their respective governments) have cut interest rates in what has been viewed as a coordinated response to the looming downturn in the global economy. (Some would say slashed but I think emotive language such as this coming out of the media has been less than helpful and is in a small degree responsible for the scale of the falls on markets.  I'll get off my soap box now.)

The economic theory behind these moves is that through reducing interest rates, access to credit becomes more accessible and at the same time fewer resources are needed to pay back outstanding debt.  This in turn leads to more money being freed up by and for consumers and companies to spend in the real economy.  This in turn leads to higher levels of economic growth.  The economic term to explain this policy move is loosening monetary policy.  The sooner this is done the better as economic theory suggests the time lag between a cut in interest rates and for this to lead to a stimulation of the economy can be up to 18 months in duration.  Let's hope the impacts are felt sooner rather than later!!

These reductions in interest rates flow on to the rates paid by institutions for customers to loan them money by depositing their money with the bank or other financial institution.  These rates paid by banks and the like in Australia are still comparatively high compared to other developed parts of the world, thinking particularly of Japan and the USA, but are starting to fall.

As rates fall it makes the decision to hold cash that touch more difficult.   In a Eureka Report article published early in October - Yields the new king? - Scott Francis pointed out that the yields (or income) on Australian shares and listed property trusts are making these asset classes look a whole lot more attractive compared to cash deposit interest rates, especially when taking into consideration franking credit benefits. 

Nicole Pedersen-McKinnon provided a similar angle in her article published in the Sydney Morning Herald and dated the 26^th of October - Cash is safe but it isn't king - where she in particular referred to the dividend yields of 8% or more being offered by the big four banks.  The big assumption here is that company dividend payments will at least remain steady.  There is some doubt as to this but so far the big banks, the part of the market which has suffered the most from the credit crisis so far, have at worst maintained dividends (ANZ) or in other cases continued to increase.  What this is telling investors is that if you buy shares in the banks now and held them like holding a term deposit, the income returns - the money coming into your bank account - would be 8% compared to what could soon be 6% or even in the 5% range for cash deposits after a few more RBA cuts.

Now of course the growth side of owning shares, taking the big 4 banks as an example, have been anything but stellar over the past 12 months.  If you might need to access the capital contained in a bank account or a share investments there is real risk in buying shares as the underlying investment may still fall in value.  But if you have a buy and hold strategy, for the long term, you would have to think that asset prices are pretty compelling at present levels.

A third piece of commentary on the problem with holding cash over the long terms is that inflation is a killer and eats into the returns from cash.  Warren Buffett makes this case in his article - Buy American.  I am. - which I have referred to in a previous blog posting.  Growth assets, such as shares, also have a growth component and their income tends to grow over time, both providing a hedge against the impact of inflation.

As Nicole Pedersen-McKinnon suggests in the conclusion to her article - buying bank shares (or any shares) is not for the faint hearted but dipping the toes in and taking a conservative, measured approach through techniques such as dollar cost averaging might make some sense.  However in my view this should only be contemplated by buy and hold long term investors in consultation with their financial advisor and in relations to their current portfolio allocations, as the share market might just keep falling in value and/or dividends might not hold up over the coming year.

Regards,

Scott Keefer

The following is an article written by Jim Parker, Regional Director, DFA Australia.  It nicely sums up the approach taken by Dimensional Fund Advisors (DFA) towards investing.  From reading our website you would be well aware that we utilise Dimensional trusts within our recommended portfolios for clients. The following commentary sits very comfotably within our approach.  For more details about our particular approach to investing please take a look at our Building Portfolios page.

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They are comments frequently overheard these days on the bus, at the gym, supermarket and at Saturday sport: "The markets are in such a state. I'm worried about my retirement. There has to be a better way to invest."

There's no doubt about it. At times like these, when markets are hugely volatile and unpredictable, the patience of even the most disciplined investor can be tested. The good news is that there is a better way:

• First, there is nothing to be gained from trying to second guess the market. The fact is most people go wrong taking stock-specific bets or seeking to time their entry and exit points. Ultimately, they just end up buying high and selling low. This is never a recipe for success.
  
  
• Second, it's worth recalling that not only are risk and return related, but that not all risks are worth taking. This means the best approach is to structure your portfolio around the risks that research shows carry a reliable long-term reward. In tough economic times, uncertainty increases and people gravitate toward safe assets. To attract investors back to risky assets, prices adjust lower. What's often overlooked is that a lower price equates to a higher expected return.
  
  
• Third, the best protection against volatility is diversification. It should be evident by now that even "gurus" have no idea which asset class will be the next top performer and which will lag. But if you remain broadly diversified, you don't have to take those sorts of bets.
  
  
• Fourth, the biggest determinant of the performance of your portfolio is in how you allocate your capital toward the respective asset classes: Cash, fixed income, domestic and global equities, property and emerging markets?and within equities, large, value and small stocks.
  
  
• Fifth, while markets are inherently unpredictable, there are things you can do to lessen the pain. Among them is paying heed to the costs. Paying big fees to fund managers to invest your money based on a hunch is not recommended. Neither are high turnover strategies that leave you with a big tax bill. You can control these things.
  
  
• Sixth, indexing is not the only alternative to stock picking and market timing. Why pay managers to outsource decisions to an index provider? There are unnecessary costs involved there as well, as stocks enter and leave the index. A better way is to structure highly diversified portfolios around specific dimensions of risk.
  
  
• Seventh, in choosing someone to invest your money, ensure that in their own practices they follow the above advice. They should minimise transaction costs, be mindful of the tax effects of trading, and remain patient, disciplined and focused on long-term returns. The emphasis should be on implementing those strategies as efficiently as possible, not chasing last year's best performers or following fickle fashion.
  
  
• Eighth, keep it simple. Much of the financial services industry has a vested interest in making investing sound complicated. That, after all, is how this global crisis started. People got complacent and started taking highly leveraged bets on complex securities that few understood. You need to be absolutely clear about what risks you are taking on.
  

The eight points above reflect how Dimensional views investing. We recognise that markets are unpredictable. We don't pretend to know what will happen next. But we do understand the sources of long-term returns. And we have built up formidable expertise over nearly three decades in capturing those returns as efficiently as possible, without taking unnecessary risks.

Unlike other fund managers, we don't try to pick stocks or time markets. That's speculation, not investment. Neither do we leave the definition of our strategies to index providers.

What we do is structure highly diversified, low-cost strategies around the known sources of risk and return. We have a disciplined, transparent and patient trading process that is not dependent on hunches or the talents of star individuals riding their luck. We are not interested in chasing trends.

Our clients share this belief, which means our strategies aren't subject to the sort of hot money inflows and outflows that blight other fund managers. That in turn becomes a source of strength, as it helps to keep our costs low.

Yes, the market volatility is causing a lot of pain right now. There is no getting away from that. But we have built up deep insights over the years in how to efficiently trade in those parts of the market subject to large swings.

For instance, we developed sophisticated execution tools that enable us to trade in very thinly traded stocks, so we can take advantage of price volatility. With this sort of volatility now evident even in much larger, more liquid stocks, these tools are proving even more invaluable.

Bear in mind, also, that even in volatile markets, momentum effects still need to be taken into account. We do this by delaying trading "fast-moving" stocks. In other words, we don't sell the companies that are moving up the fastest and we don't buy the companies that are falling the hardest.

Another major risk in volatile markets is that there is an increase in unnecessary trading. This is expensive. Momentum filters control this effect, delaying trades and preventing unnecessary turnover.

This is a patient, low-key disciplined approach, one focused on ensuring clients' assets are invested with little or no market impact. Informed by the most rigorous academic research, it's an approach that takes the guesswork out of investment and reflects the broad philosophy described above.

Obviously, there will be periods when markets go down. But crises come and go and markets eventually recover. By minimising volatility and focusing on things you can control, you can ensure you are properly positioned for the inevitable rebound in risk assets when it comes.

It simply is a better way to invest.

Scott Francis has provided commentary towards an article written by Alex Tilbury and published in Monday's Courier Mail - 27th October 2008 - Tips for saving money in your 20s.

In the article, the following comments were attributed to Scott:

Scott Francis, a financial planner from independent advisory A Clear Direction at Milton, says the difference between financial success and failure might be as little as $20 a week.

"If someone saves $20 a week through their 20s, and invests in some sort of balanced portfolio, they can expect to have somewhere around $30,000 by the time they turn 30," he says.

Conversely, someone who spends $20 a week more than they earn is likely to have around $30,000 in debt.

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Francis says the 50 year return from Australian shares to the end of June 2008 has been 12.2 per cent a year, while inflation has been 5.2 per cent a year.

So he says if someone put aside the equivalent of $1,000 (in today's dollars) 50 years ago would now have an amount of $29,500 today - that's a 30 fold increase in purchasing power.

That's the "miracle of compound interest" which means the sooner money is invested, the sooner it is working for you.

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Francis says the 50 year return from Australian shares to the end of June 2008 has been 12.2 per cent a year, while inflation has been 5.2 per cent a year.

So he says if someone put aside the equivalent of $1,000 (in today's dollars) 50 years ago would now have an amount of $29,500 today - that's a 30 fold increase in purchasing power.

That's the "miracle of compound interest" which means the sooner money is invested, the sooner it is working for you.

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Francis recommends 20-year-old start now and save a small amount of your income every week (even $20 a week adds up over time)

"Stay away from the lure of credit cards and high interest loans - spending money that you don't have now only means that you have to pay more (because of the high interest) later," he says.

"Challenge the idea that greater consumption leads to greater happiness: there is no evidence for this everywhere, yet it is what every advertiser wants us to believe"