Skip to main content
rss feedour twitterour facebook page linkdin
home

Financial Happenings Blog
Thursday, December 17 2015

A common discussion I have with new clients or existing clients adding funds into an existing portfolio is the issue of market entry risk.  This is the risk that you purchase investments at a peak only to see values fall after entry.  A strategy to moderate this risk that I canvas with clients is to spread out this market entry risk through either investing an immediate amount and then dollar cost averaging the remaining funds over a year or two or simply dollar cost averaging over a set period of time.

Jim Parker in his latest article for Dimensional sets out some thinking around this issue including the dollar cost average method I often use.

December 17, 2015

The Deep End
Vice President

Have you ever seen a child standing tentatively at the edge of a swimming pool? She's torn between her desire to join the gang in the water and her fear of diving in. In committing to the market, investors can be like that.

You can always find a reason for not investing. "Perhaps I should wait till after interest rates rise?" goes one line of the thinking. "Or maybe I should delay till there's more clarity on China? Or hold back until after earnings season?"

Emotions and assumptions usually underlay this indecision. The emotion can be anxiety about "making a mistake" or fear of committing at "the wrong time" and suffering regret. The assumption is that there is a perfect time to invest.

Obviously, the ideal solution would be to enter the market just as it bottoms and exit the market right at the top.

But the reality is that precisely timing your exit and entry is close to impossible. If it were easy, millions would be doing it and getting very rich in the process. Instead, the only ones who tend to consistently make money out of market timing are those who write books about it.

The financial media certainly love market timing stories. For one thing, there is always some event or variable they can peg it to—like a decision on interest rates or upcoming earnings or a chart indicator. For another, the idea of timing the market is a powerful one and tends to get readers' attention.

For example, one high-profile US forecaster in early 2012 predicted a 50-70% equity market decline over the following two-to-three years. It was to be a replay of the 2008-09 crisis, he said, but with an even deeper recession.(1)

That turned out to be a bad call. Global equity markets, as measured by the MSCI World Index, delivered a total positive return in Australian dollars of 93% from the end of 2011 to the end of 2014. (2) In USD, it was 53%.

Others advocate more elaborate timing strategies. For instance, one recent academic paper suggested the stock market delivers better returns relative to Treasury bills in the second, fourth and sixth week after each of the US Federal Reserve's policy-setting meetings in a given year. (3)

The idea here is that the Fed leaks information about its interest rate intentions in such a predictable way that, even without the information, savvy investors can make money by just buying stocks in certain periods.

While these theories can be fascinating, it is arguable how many of us have either the time or inclination to try them out. And even if we did, this does not take account of the costs of all the required trades or the possibility that as soon as we implemented the idea it would be arbitraged away.

So ahead of a central bank meeting, some would-be investors fret about whether they should hold off until they see how the market reacts. Others already invested worry whether they should take their money out.

The truth is that for long-term investors, these issues should be irrelevant. What matters is how their portfolios are structured and how they are tracking relative to their chosen goals. Markets will go up and down, security prices will change on news and it makes little sense to second guess them.

But while no one yet has come up with a consistently successful strategy for timing the market to perfection, there are some things that everyone can do to help ease the anxiety they feel about investing.

One is to realise that it does not have to be a choice between being 100% in the market and 100% outside. Ideally, an investor should stick to their strategic asset allocation—be it 70/30 or 60/40 or 50/50 equity/bonds.

Another is that this strategic allocation can be combined with periodic, disciplined rebalancing, in which the investor shifts assets from well performing asset classes to those less favoured. This is a good way of controlling risk without necessarily trying to time the market.

A third option is that there is nothing wrong with investors taking into account the returns they have already enjoyed and adjusting their asset allocations if they are on course to meet their goals. So, for example, for some investors it might make perfect sense to lock in returns after a good period and put the money into short-term fixed income if that meets their needs.

Yet another option is dollar-cost averaging. This is a method where an individual invests small amounts of an available pool of cash into the market over a period, rather than investing a lump sum in one go.

A useful contribution on this subject comes from Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College. In his role as an academic, Professor French says the optimal decision is to invest it all at once. But while this might give an individual the best investment outcome, he says it might not be the best investment experience. (4)

This is because people tend to feel regret more strongly when it results from things they did do than from things they did not. So, for instance, it feels much more painful to buy stocks now and see the price go down than it is to neglect to buy stocks and the price goes up.

Professor French says that by dollar cost averaging, people can diversify their "acts of commission" (the stuff they did do) as opposed to their "acts of omission" (the stuff they didn't do).

"The nice thing is that even if I put my finance professor hat back on, it's really not that damaging to your long-term portfolio to just spread it out over three or four months," he says. "So if you as an investor find that's much more tolerable for you, you're not really doing much harm."

So, in summary, it's always difficult to choose exactly the right time to get into or out of the market. For instance, it would have been nice to get out in late 2007 and back in around early March 2009.

But most mortals are unable to finesse it to that degree. The good news is that there are other options than just staying out of the market altogether and plunging back in.

These include maintaining a long-term strategic asset allocation in the first place, periodically rebalancing, taking money off the table if retirement goals are on track and dollar-cost averaging if that provides comfort.

(1) “Get Set for a Crash, Forecaster Says”, Globe and Mail, 10 January, 2012.

(2) MSCI World Index (net div, AUD), Returns Program

(3)  “Want to Play the Market? Count the Fed Leak Weeks: Study”, Reuters, 21 November, 2015.

(4) Fama/French Forum, “Dollar Cost Averaging”, 23 June, 2009. 

Posted by: Scott Keefer AT 03:36 am   |  Permalink   |  Email
Wednesday, December 16 2015

Probably the most important question when it comes to whether you have enough in savings to retire is what level of cash flow will you need through your retirement years.  For many this is a difficult question to answer.  However there are some tools to help in determining what this magic number might be.

1) A percentage of pre-retirement income

One rule of thumb is to look at your pre-retirement cash flow (spending) and estimate that this will reduce to approximately 70% to 80% of that level once in retirement.  So if you are spending at the rate of $100,000 you might estimate an $80,000 annual base spend through your retirement years.

Why might spending be lower in retirement?

The school of thought is that certain expenses will no longer be required or at least reduced especially in relation to work related expenditure.  Items such as transport to and from work, spending on work clothes and income protection insurance are a few of the costs that might disappear.

However there are also going to be costs to fill in the time that you now have available to you.

2) Create a budget

This is a really good exercise for anyone but particularly those preparing for retirement.  If nothing else the process should help identify what you are currently spending funds on and what you would like to be spending those funds on.  This exercise might actually shine a light not only on the financial implications regarding retirement but also how you intend on spending your time during those years.

A useful tool to get the buget started is through the ASIC Money Smart site's Budget Planner - https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/budget-planner

Unfortunately many find this exercise difficult so there is a third option that might not only help develop your personal budget but also shine a light on whether your spending plans are in the right ballpark.

3) Refer to ASFA’s Retirement Standard

Even if you are comfortable using one of the above methods you might well ask – but is my current spending pattern / budget realistic or indeed efficient?

This is where ASFA’s Retirement Standard may be a useful reference.  The Retirement Standard sets out the budget for a modest and comfortable lifestyle for a single and couple.  The numbers are updated every quarter to take into account price movements (inflation).

The current numbers as at the end of September 2015 were:

Modest lifestyle

Comfortable lifestyle

Single

Couple

Single

Couple

Total per year

$23,695

$34,090

$42,9621

$58,915

So for a comfortable lifestyle in retirement for a couple aged approximately 65 the budget is just under $59,000.

The bottom line annual amount provides a simple number to focus your attention.  However, included with the bottom line amount is a budget that sets out how these broad brush figures were generated.

To find the detailed budgets take a look at http://www.superannuation.asn.au/resources/retirement-standard

Concluding Comments

I would encourage those preparing for retirement, as well as those already in retirement but wanting to review cash flow requirements, to reflect on the budgets set out in the Retirement Standard.  Everyone’s budget will be unique but this resource provides a useful starting point for those seeking greater clarity.

Regards,

Scott

Posted by: Scott Keefer AT 08:51 am   |  Permalink   |  Email
Tuesday, December 15 2015

In his latest Outside the Flags article, Jim Parker from Dimensional Fund Advisors looks back at some of the individual company share forecasts made at the end of 2014. 

December 14, 2015

The Silly Season
Vice President

Aside from reports on shark attacks and cricket, the onset of the festive season and summer in Australia and New Zealand are traditionally lean times in the news business. So the forecasters come out to play.

Thinly staffed newsrooms and the prospect of lots of blank space to fill over the holidays prompt hard-pressed editors to assign reporters to crank out "Year Ahead" features before they go on leave.

For readers of the finance pages, this means lots of surveys about the outlook for the economy and markets in the coming 12 months. These can be diverting at the time, but they're much more entertaining a year later.

In its 'Top 100 Picks for Investing in 2015', published between Christmas and New Year, 'The Weekend Australian' newspaper canvassed staff and contributors for their recommendations on stocks to buy.

In its heavyweights list ("energised to move"), the paper selected BHP Billiton. It was energised all right, but the movement was all down. By early December, BHP had delivered a negative return of more than 30%.

The other chosen heavyweight was Alumina, which was picked because of expectations of improved prices and returns. Unfortunately not, as it turned out. Alumina was down nearly 27% over the year.

In the oil and gas sector, the newspaper asked "have prices hit bottom?" Clearly not, because four of its five favoured picks (AWE, Otto Energy, Origin Energy and Carnarvon Petroleum) were 30-55% lower. The fifth, Woodside Petroleum was a mere 6% lower.

Never mind, the paper said. Lower petrol prices would leave people more to spend. So it favoured consumer stocks Thorn Group and Carsales.com. The latter managed a 3% gain for the year, but Thorn was down 27%.

In financials, the newspaper said Treasury Group (later Pacific Current Group) was "fuelled to fly". Its stock delivered a negative return of 33% year-to-date. Gold stocks were "ready to rise"—like Independence Group (-40%). And watch out for the "rising stars"—like Colorpak (-18%), Nearmap (-44%) and Retail Food Group (-16%).

To be fair, there were also a few successful picks in the top 100, like food maker Bellamy’s, whose 12-month total return was more than 600% thanks to Chinese panic buying of its organic baby formula.

But the real issue is that building portfolios around bottom-up analysis of the prospects for individual stocks or sectors is not a sustainable or systematic way of investing. You might get lucky. But then again, you might not.

In a concentrated portfolio, idiosyncratic influences can have an outsized effect. For instance, The Australianpicked software developer Infomedia as an IT play. But the non-renewal of a key buyer agreement forced a profit downgrade and its stock was down around 40% for the year.

However, even in a well-diversified Australian portfolio, it can be hard to avoid the drag from heavyweight stocks like BHP Billiton. Facing plunging commodity prices and an environmental disaster in Brazil, its stock hit 10-year lows recently. 

The Australian market is small by global standards and highly concentrated, the New Zealand market even more so. That’s why it makes sense to diversify as much as possible across different countries, sectors and stocks.

The idea is not to think of your portfolio in terms of individual stocks, but in terms of the broad drivers, or dimensions, of returns. These are your exposure to the market itself, to low relative price stocks, to small company stocks and to profitable stocks.

These dimensions of return have been shown to be sensible, backed by evidence, persistent and pervasive across different markets. Most of all, they are cost-effective to capture in diversified portfolios.

Of course, there is still no guarantee you won’t have a bad year in the market, but you can take comfort from knowing your portfolio is built around systematic differences in expected returns, not the whims of a newspaper.

Many happy returns!

Posted by: Scott Keefer AT 06:20 pm   |  Permalink   |  Email
Twitter
Facebook
LinkedIn
Email
 
Request for Information 
If you have questions, or would like more information, please go to our Contact page and leave your name and contact information.