Scott Francis in his latest Eureka Report article highlights ten tax mistakes to be avoided:

1: Making tax considerations drive your investment strategy
2: Parking money in managed funds
3: Attempting a “wash sale”
4: Deductions that don’t match your personal situation
5: Putting too much in super
6: Putting too little in super
7: Squandering tax cuts
8: Failing to claim for charitable donations
9: Not claiming the $1000 tax exemption for employee share programs
10: Failing to get organised

To look further into these ten items please take a look at Scott's article - 10 costly tax mistakes

One of the great traps with investing is the tendency to follow investments or asset classes that have done well in the past under the assumption or hope that they will do likewise in the future.  Jim Parker in his latest commentary piece for Dimensional highlights some research showing the pitfalls with this approach.

Stars or Straws?
Jim Parker, Vice President, DFA Australia Limited

Investors frequently seek external validation to ease the anxiety of putting their money at risk. Problem is there is no guarantee that a "five-star" rating on a chosen fund will lead to a "five-star" investment experience.

It is human nature for consumers to seek comfort in the idea that the products they are buying are proven in the marketplace. That need is met by ratings agencies that play a legitimate and vital role in providing independent assessments of various investment products.

Those assessments are made in professionally compiled and detailed reports that can be a useful yardstick for investors and their advisors in comparing funds so that they can make a fully informed decision.

But despite diligent cautions from the agencies about chasing returns, problems arise when consumers blindly extrapolate star rating systems for various funds into imagined future performance.

The risks of this approach were highlighted in a survey by US private wealth management business Burns Advisory Group, which went back to 1999 to study the subsequent 10-year performance of Morningstar's five-star funds.¹

Burns found that of the 248 funds rated five-star by Morningstar on December 31, 2009, only four were still receiving that rating a decade later. Of the original sample, 87 had ceased to exist. Of those still existing, all had been downgraded to an average of just under three stars. Even worse, in all categories except international stocks, the average performance for five-star funds over this 10-year period was worse than the average for all funds.

"These findings imply the star ranking methodology leaves long-term investors in the lurch," Burns concluded. "If nothing else, it demonstrates clearly why investors should not rely on one measure as their sole research tool."

But it is not just unsophisticated investors that are chasing performance. Another recent report suggests that even wealthy individuals and institutional investors can be blind-sided by past returns.

The study by researchers at the European School of Management and Technology, quoted in The Economist magazine, looked at how investors allocated money to hedge funds over 10 years from 1994.²

The researchers found that the funds that had performed well in the previous three quarters attracted significantly more money than their competitors. In other words, the supposedly "smart money" was chasing past returns.

Bear in mind, also, that indiscriminately chasing returns can be even more costly with hedge funds, which typically charge management fees of 2% or more, plus 20% of the returns they generate for clients.

Given the large body of academic evidence that it is extremely difficult to predict market returns with any confidence, it should be evident that past returns should not be the foundation for choosing one fund over another.

Leading academics Gene Fama and Ken French, in a recent study of mutual fund performance, showed how hard it is for investors to distinguish skill from pure chance in analysing the returns of individual funds.³

So what should an investor and his or her advisor weigh up in making a decision? The key here is to focus on items within their control, such as:

While many of these attributes can lead to good outcomes for investors, they are no guarantee of positive returns every year. Anyone who makes those sorts of promises risks disillusioning those who put their faith in them.

But the above characteristics can give investors comfort that their money is being invested in a consistent, transparent way and that ensures that when the targeted premiums kick in, they are positioned to receive them.

This is a grounded, completely defensible approach. The alternative is that by reaching for the stars, investors are left clutching at straws.

1. McGuigan, Tom and Courtenay, Tim, Star Gazing: Five Star Funds Revisited, Burns Advisory Group, April 2010

2. Buttonwood, Who's the Patsy?, The Economist, May 29, 2010

3. Fama, Eugene F., and Kenneth R. French. 2009. Luck Versus Skill in the Cross Section of Mutual Fund Returns, SSRN

Jim Parker, Vice President, DFA Australia Limited

Anyone who still believes that you can make money consistently by forecasting market movements might want to interview clients of US investment bank Goldman Sachs.

According to Bloomberg, seven of Goldman's nine recommended top trades for 2010 had been losers for clients as of mid-May. These included 14 per cent losses by buying the Polish zloty against the Japanese yen and nearly 10 per cent trading the British pound against the Kiwi dollar.¹

The Australian dollar was not mentioned as a 'top trade', but judging by the recent run of media commentary, pundits trying to anticipate the Aussie's movements in the past two years might be licking their wounds as well.

Indeed, forecasts have been so bad they have almost proved to be a contrarian indicator of the currency's actual direction, as the chart below of the past three and half years of the $A's movements shows.

Back in mid-2008, the Australian dollar reached more than 98 US cents, its highest levels since it was floated in the mid-1980s. Economists were quoted as saying the currency would "match the greenback cent-for-cent by Christmas, if not within months".² That is shown above as 'forecast 1'.

No sooner had the parity parties been called than the $A fell spectacularly out of bed, crashing more than 40 per cent in the space of three months to a five-year low just above 60 US cents. This was during the worst period of the global financial crisis when risk appetites shrank dramatically.

By October 2008 (forecast 2), economists were saying the $A was on a one-way ride to below 60 US cents and to the levels prevailing during the tech boom 10 years ago when Australia was judged to be an "old" economy.³

But hold off on the last rites. As risk appetites revived in March 2009, the Australian exchange rate took off again and, within just over a year, had appreciated all the way back to nearly 94 US cents.

So what did the economists say this time? You guessed it: The little Aussie battler was on its way back to parity. (forecast 3)⁴

Well, talk about tempting fate. Sure enough, no sooner had this call been made than the currency turned tail again and sank more than 10 per cent in the space of a couple of weeks. The trigger, said analysts, was a global unwinding of so-called "carry trades" as Europe's sovereign debt crisis sparked a sudden aversion to risk.

True to form, economists responded by warning of more of the same, calling for the currency to drop to 77 US cents and lower. (forecast 4)⁵

It should be evident from all of this that pundits have a knack for turning what has already happened into a forecast. In other words, predictions of a currency's decline seem quite feasible when it has just dropped 10 per cent.

But the market tends to be always a couple of steps ahead of the professional forecasters, so that the trigger for any turnaround is the capitulation phase when everyone is jumping on the same bandwagon.

The Australian dollar is such a good example because it is often seen these days as a kind of canary in the coal mine of global investor sentiment. Despite Australia's relatively small economy (18^th in the world in size), its currency is the sixth most traded globally, behind the US dollar, Euro, Japanese Yen, Pound Sterling and Swiss Franc.⁶

Depending on circumstances, the $A is perceived, rightly or wrongly, as a yield play, a China proxy, a commodity proxy, a signaller of market expectations for global growth and as a barometer of risk appetites.

What this means is that people who try to forecast the Aussie's movements must be able to get all of these perceived drivers right, as well as correctly anticipating the traditional currency influences of trade and investment flows.

What are the odds of them calling it all accurately? Judging by the above examples, you would have to say dollars to donuts.

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¹'Goldman Sachs Hands Clients Losses in Top Trades', Ye Xie, Bloomberg news, May 19, 2010

²Courier Mail, July 28, 2008

³Australian Financial Review, Oct 21, 2008

⁴The Sunday Telegraph, April 11, 2010

⁵Aussie outlook marred, Reuters, May 21, 2010

⁶BIS Triennial Central Bank Survey