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Talking Finance

All in on red

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 17 December 2016.

I read a book recently which told the story of a man who lived in Melbourne, working as a croupier at Crown Casino, and how he invested in the stock market. Spending that much time in a gambling den must have had an impact on his investment approach, which consisted solely of looking for a company with a share price close to $0.01 (a so-called ‘penny dreadful’), putting his entire life savings into the company and hoping for the best. On two occasions he managed to turn over a hundred thousand dollars into nearly a million, only to lose it all. On the third occasion (you’ve got to give him credit for being persistent) he tried the same approach, struck a winner and made nearly two million dollars in profit, enough to chuck in his croupier job and become a stay-at-home dad and fulltime investor.

Sounds great doesn’t it? A struggling everyday Joe strikes it rich through the share market and lives happily ever after. In reality however, this is the exception rather than the norm. As befitting his time spent in a casino, the hero of our rags-to-riches story was really doing nothing more than gambling. You could argue, statistically speaking at least, that he would have been better off to put his life savings on red at the roulette table and leave it there for a couple of spins. Certainly the odds of the roulette ball landing on red three times in a row are probably better than the likelihood of picking one company from the five thousand on offer on the stock market, and then watching it quadruple in value.

For most people, losing their entire life savings (twice!) is simply too much to bear, despite the allure of a potential massive payday. For every croupier-turned-millionaire there’s probably ten thousand ‘investors’ who’ve lost their shirt by mistaking the stock exchange for a casino. Undoubtedly there is a myriad of ways to make (and lose) money on the stock market. Betting your life savings on the roll of a dice may well be your thing; there’s also merger arbitrage, long/short pairs, rumourtrage, momentum investing and enhanced options trading strategies. It really is like one of those ‘Choose your own adventure’ books which made a brief appearance in the mid-nineties. For normal, sane and rational investors however, none of these methods are likely to leave you able to sleep at night. If a sound night’s sleep is important to you, an investment adviser can help; otherwise, I have a book I can lend you to help pass the hours.

Be the best

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 3 December 2016.

My wife and I recently attended a parent teacher interview at our eldest son’s school. Jack is only nearing the end of kindergarten, so perhaps my expectations were set a little bit too high, but I came out of the meeting feeling underwhelmed. We were shown some of his drawings, his list of sight words, his level of reading ability and the extent of his numeracy skills – all interesting enough information, but I wanted more. Perhaps it’s my finance background, but I felt the relative performance aspects of his year in kindy were impossible to ascertain. In which percentile of his class for reading skills does he fall? What about compared to other kids in NSW? In Australia even? How does his ability to recognise shapes compare to everyone else in his class? Where would he rank nationally in terms of his drawing ability? Are his colouring-in skills in the top 1% of kindy kids in the country? And so on. When I raised these important questions with my wife, Liz, after the meeting, her reaction was simply to laugh at me, karate chop me in the solar plexus and tell me to stop being so stupid and relax. Clearly the issue of relative performance is not one which keeps her up at night.

When it comes to investing however, relative performance is about as serious a topic as one can get. If I told you that your investments generated an annual return of 10% in the past year, you would probably be quite happy. 10% per year is pretty good, at that rate it would only take around 7 years to double your investment. However, if I then told you that everybody else in the world made at least a 20% annual return, how would you feel? Not nearly as happy I suspect. It’s your performance, relative to an appropriate benchmark, which is most important. The appropriateness of the benchmark is critical too. There wouldn’t be much point for Jack’s teacher to tell me that Jack was in the top 1% for skipping when compared to children aged six months or less. That’s a useless comparison and provides no information on how he compares to other kids in kindy, which is the most relevant benchmark for him to be compared against. If you’re investing in shares and your performance is being compared to interest rates on a savings account, you’re also not learning anything useful. Relative performance may not matter when you’re a five year old and just embarking on a lifetime of learning and development, but when you’re talking about your life savings, it really is no laughing matter.

Come on summer!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 19 November 2016.

We’re only a few weeks away from the official start of summer – a time for outdoor barbeques, relaxing around the pool, planning the beachside holiday and the lazy drone of test cricket on the radio. In fact, my favourite part of summer is the start of the cricket test season. Cricket, particularly test cricket, is definitely not everyone’s cup of tea. Many would rather watch grass grow, than spend eight hours at the ground, hoping not to miss the sole five minutes of action with an ill-timed toilet trip. I recall one day at a test match may years ago, where only five wickets fell and I missed every one, either being in the aforementioned toilet or stuck in the beer/food queue. For other people the language of cricket stops them from understanding the game. This is a valid criticism – cabbage patch, cow corner, googly, jaffa, long hop, silly mid-on, yorker and dibbly-dobbly are just a few of cricket’s unusual terms. There are whole websites dedicated to demystifying the language of cricket, principally aimed at Americans, who unfortunately remain steadfastly immune to cricket’s charms.

The other aspect of test cricket which bamboozles many, is the confusing ebb and flow of a test match. Even though a team can be in the lead partway through a match, that doesn’t necessarily mean anything. An expert in the game would mournfully shake their head, pointing out that the new ball was still to come, the bowler was a trundler, the keeper had missed a dolly and the pitch was a bunsen burner. In test cricket, a team can be in front yet still be behind. And what other sport venerates a player who can bat for two days to save a game, while only making 35 runs? If you grew up on a diet of basketball, rugby, or soccer, with non-stop action and a plethora of points, tries or goals, then test cricket’s sedate and meandering pace is probably not for you. Perhaps that aberration, T20 cricket, might be more to your liking, but the purists know that Don Bradman turns in his grave every time a T20 match is staged.

In many ways, test cricket is much like the investment process. There is the same arcane and indecipherable language; the long periods of boredom interspersed with moments of terrifying action and the vague feeling that no-one really knows what is going on. And truth be told, perhaps that’s how it should be. Action-packed investing is not going to deliver the outcomes you expect. Wealth creation is a slow and deliberate process – just be sure not to be stuck in the investment ‘toilet’ when all the action occurs.

Flat packed

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 5 November 2016.

Recently our daughter, Kate, turned 4. Or at least, that’s what my wife tells me. I was convinced it was actually her 14th birthday, but apparently I’m simply overdramatising what it’s like to have a 4 year old daughter who thinks stubbornness is an endearing personality trait. On the other hand, friends with older children warn me that the toddler years have nothing on the teenage years, a scary thought which already has my hairline receding at breakneck speed. Anyway, it was her birthday and it was my job to assemble her present. This year we had decided to reinforce gender stereotypes by giving her a toddler-sized kitchen (Jack will be getting a chainsaw and 4×4 for his 6th birthday later this year). The kitchen was one of those flat-pack things that most furniture seems to arrive as these days. I knew I was in trouble when I opened the box and found the little bags of nails, screws and bolts – there seemed to be hundreds of them. Of course there was also the obligatory allen key, along with its own assorted little collection of socket bolts and screws. As usual the allen key was so small it was obviously made for a 3 year old’s fingers, as though the poor child would be required to assemble the product themselves. In my hands it looked like a toothpick and was about as useful.

The five days I spent assembling the kitchen gave me plenty of time to ponder the deeper questions in life – such as, is there life on Mars? What is the purpose of our existence? And most importantly, who was the crazy person who invented the allen key and thus ruined the lives of parents all over the world? The kitchen-assembly ordeal also reminded me of how some people approach the investment process. Like the convenience of a flat-pack product, financial institutions have made it easy to take control of your investments. Push a button here and you just bought ten thousand shares in Microsoft. Click a link there and your life savings were just invested in a merger arbitrage specialist hedge fund. But is this control and convenience leading to better outcomes? The process may be easy, but what about the end product? Just like my efforts with the kitchen, which required the services of a structural engineer a week after I was finished, it may be that your investment decisions need some specialist assistance too. Just because you can control your entire financial destiny through the click of a mouse button, it doesn’t mean you necessarily should.

Future guesswork

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 22 October 2016.

One of the most heavily populated sections of any bookstore are the many shelves holding business and investing related books. Investing books in particular are a dime a dozen, all full of dubious advice as to how you could turn $10,000 into $1m in just five years, or something similar. The business section is a little bit more serious, with many thoughtful and carefully worded treatises on a variety of topics. Just to mention a couple of examples: in my time I’ve read books about how Ray Kroc launched the global juggernaut that is McDonalds; how IBM lost its way in the 1980’s and early 1990’s; how Phil Knight turned Nike into a sporting phenomenon; what went wrong at Barings Bank in 1995 and one of the most interesting, Maverick!, the story of Ricardo Semler and his unorthodox management approach.

Of all these books however, one which really made a mark was a book about the Japanese economic miracle of the post-war period, which I read in about 1993. I can’t remember the exact title of the book, however it was something along the lines of ‘Rising Sun – The unstoppable economic rise of Japan’. The gist of the book was that the Japanese way of doing business (just-in-time manufacturing and all that) was evidently superior to anything else the world had to offer and soon Japan would be the dominant global economic force. Believing that the Japanese economy would continue to grow to the point of global domination was not difficult – the country had rebounded in spectacular fashion from its parlous state at the end of World War II and there was nothing to suggest that this was anything but a permanent trend. The book was full of breathless admiration for Japanese management and manufacturing techniques and how the economic wealth of Japan was changing the world. While there is no doubt that Japanese companies such as Toyota, and others, have made a global impact and remain relevant to this day, the same cannot be said of the Japanese economy. It was almost as though the publication of the book rung the bell on the high point of Japanese economic development. Ever since then, the Japanese economy has been firmly stuck in reverse gear and any dreams of economic domination have long since vanished.

The book on Japan shows the danger in extrapolating current events well into the future. The assumption that conditions today will be the same in 10 or 15 years’ time, is a dangerous one. There are simply too many variables to be able to accurately predict the future with any degree of accuracy. The same rule applies to investing – predicting the future is guesswork, not science.

The hot-handed gambler

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 8 October 2016.

Imagine you are a finalist at the World Championship of Coin Tossing. Your goal is not to toss the coin higher or further than anyone else; rather, you just need to correctly guess what the result of the next coin toss will be. The rules of the game are reasonably simple: the coin gets tossed five times and you need to correctly call the sixth toss. If you get it wrong, your only solace is a Mad Monday celebration with the other losers. Get it right however, and you get to stay awake partying for five days straight and even appear on the national news, complete with the obligatory sunglasses and husky voice. Or something like that. Anyway, back to the action. The coin gets tossed five times and amazingly comes up heads five times in a row. Your entire coin-toss calling career now depends on correctly calling the next toss; what’s it going to be? Heads or Tails? Given that the coin has landed heads side up five times in a row, you may be thinking that the next toss is more likely to be a tail than a head, right? Wrong, it’s still a 50:50 call. The fact that the coin has landed on a head the previous five times is completely irrelevant to the potential outcome of the next toss. The coin has no idea it just landed on heads five times in a row – the outcome of the next toss is always going to be 50:50 between a head or a tail. Even if the coin landed on heads 100 times in a row the probability of the next toss being a tail is still no more than 50%.

Welcome to The Gambler’s Fallacy. Not the latest release by Kenny Rogers, but rather, a behavioural trait in humans where we expect a sequence of random events to have an influence on the outcome of the next random event in the sequence. Keen followers of roulette are particularly prone to The Gambler’s Fallacy, erroneously believing that certain numbers are more likely to come up than others, or that patterns can be discerned in what are only random events. Related to this is the Hot Hand Fallacy. Not a Nick Cave single, but the incorrect belief that streaks of ‘luck’ can be divined in what are essentially random events. By now, you’re probably asking yourself, what’s the link to finance? Well, in essence, short term movements in share prices are effectively random events, but that doesn’t stop people from trying to discern patterns where none exist. The truth is, short term share trading is nothing but guesswork. In the longer term, company fundamentals such as revenue and profits are the true drivers. My advice: forget the gambling and focus on the fundamentals.

Back breaking

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 24 September 2016.

In just under a week’s time we’re moving house, an event I’m not looking forward to with any great enthusiasm. According to reports, based on the levels of stress generated, moving house is up there with poking your eye out with your thumb or cutting off your arm with a jigsaw. Ok maybe that’s not entirely true, but it sure feels like it. Mind you, it has been over five years since our last move, so the pain and horror associated with that event has at least been partly dulled by the passage of time. On that occasion we foolishly decided to move ourselves, after all how hard could it be? Well it was incredibly hard. Maybe not fighting-a-rear-guard-action-along-the-Kokoda-Track hard, but certainly I’m-not-sure-my-back-will-ever-be-the-same-again hard. Really, why else do removal companies exist, if it was that easy to pack up a house and move it from one spot to another? Technically we all could do it ourselves, but does that mean we should?

Moving house, as with most things in life, is best left to the people who do it for a living. Sure you don’t need a post-graduate qualification to get a job at a removals firm, but someone who has packed a truck two hundred times and has the back and muscles for it, is probably going to do it a lot better and more easily than you. The same principle applies to investing and managing your finances. There’s nothing to stop you from managing your own investments or looking after your own superannuation. Many people do, and they do it well, but they either love doing it and would happily stare at a stock price chart all day, or they have put in the hours and hours of necessary reading, research and planning to allow them to make informed decisions. If your idea of the perfect retirement involves checking share prices every hour and thinking about the correlation between changes in interest rates in the US and household spending patterns in Australia, then by all means do it yourself. For most people however, that scenario is more akin to a stint in hell than the relaxing trouble-free retirement they’ve spent 40 years working towards. That’s not to say that the professionals never get it wrong, of course they do, just like when the removalist packs your gym weights on top of your glass vase. However, the consequences are usually and hopefully less destructive when they do. So next week we’ll be paying the professionals to move while I focus on markets and the economy. Let them do their job and I’ll get on with mine.

It’s magic!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 10 September 2017.

Before I became a parent I had very little knowledge or experience of small people. I knew they came with sleepless nights and a much-reduced bank balance for example, but that was about as far as my familiarity stretched. I had no idea, for instance, that they are incredibly easy to fool. My current favourite trick to play on the kids is to move their toys around when they’re asleep at night. In the morning, they might inexplicably find Kate’s ballerina Barbie doll hanging off a ceiling light fitting, along with one of Jack’s Star Wars figurines. Or Jack’s teddy, Jerry the Giraffe, might be found having a tea party with Kate’s Pooh Bear on top of the lounge curtain rail. It always prompts much conjecture about how they got there (did they fly?), what they’re doing and how they’re going to get down. Sometimes I’ll forget to move the toys on to a new location, sparking much speculation about whether they’re asleep or why they haven’t moved for a week. This serves as a timely prompt for me to relocate the toys to a more exotic spot – hanging precariously from the smoke alarm for instance. When the toys get spotted in their new location, we’re eagerly summonsed to come and view this startling finding for ourselves. I always shake my head in wonderment and solemnly proclaim it must be magic. This unbelievable revelation is, of course, accepted without question. From Jack and Kate’s perspective, we must surely have one of the most magical houses in the world.

Unfortunately, when it comes to investing and managing your finances, there is no magic. There’s no fairy dust to sprinkle over your investments; no ‘secret sauce’ to making money; no conjuring tricks to grow your bank balance overnight. Sometimes people think that they must be missing out on something; that there’s some easy step to making money which they just haven’t yet heard about. I have bad news for those people – there’s no such thing. And don’t mistake complexity for magic: in my experience more complexity usually means greater costs, not greater returns. Just because you can’t understand how an investment works, doesn’t mean it’s magical, in fact it’s more likely to be improbable. There really are no shortcuts to wealth, short of winning the lottery, and for most people the odds of that happening are about as likely as catching sight of Jack and Kate’s toys as they fly from one picnic spot to another each night

Gooooal!!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 27 August 2016.

Our eldest son, Jack, recently started playing soccer for the Red Pandas Under 6 team. Jack doesn’t know it yet of course, but this is all part of my plan for him to turn professional, play for a top-ranked European club and earn millions of dollars, all so his parents can retire young and in style. My wife thinks it’s about making friends and having a good time. How naive! As you would expect at this age however, skill levels are pretty low. There’s just a knot of bodies pushing, shouting and aimlessly kicking each other without any real discernible purpose. And that’s just the mums and dads on the sidelines – on the field it’s even worse. Half the time the kids have forgotten in which direction they’re playing, with own goals a regular occurrence, although they’re still celebrated with the same exuberance as a normal goal. Sometimes a team member will simply decide that he or she doesn’t want to play anymore, just like in real life, only without the fake injury, although the forced tears and histrionics are apparently a feature at both the Under 6’s and professional level. Eventually however, a bunch of aimless kicks ultimately leads to the ball ricocheting off a knee, head and bum and into the back of the net and everyone cheers and goes home happy.

Unfortunately for some people, their approach to managing their finances is about as organised as two teams of five-year olds on a soccer pitch. The lack of structure is the same: put some money here; buy this property; invest in this share; open that superannuation account; sign up for this credit card….a bunch of seemingly random decisions, made in the faint hope that out of the chaos a goal gets scored, money gets made and everyone gets to retire happy. In reality, the chances of that happening are about as likely as Jack scoring a goal on purpose, and in the right direction. Just like a winning team never takes to the field without a plan and a strategy, so should you have a documented approach to your finances. Will you favour superannuation over your mortgage? Should you salary sacrifice or focus on paying off your non-deductible debt? Is money in the bank appropriate for your goals and objectives, or would a diversified share portfolio suit you better? Only around 1 in 10 Australians use the help of a financial adviser in drafting and implementing a financial strategy. For the other 9 out of 10 people out there, a comfortable financial future is sadly about as unlikely as Jack making the team at Manchester United.

Have a seat

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 13 August 2016.

In our office we all have standing desks. They’re a special type of desk which allows you to raise the height of your keyboard and monitor such that you can be standing while working. The principle is well-established: prolonged sitting is bad for you and you can add years to your life by getting up on your feet. A scary article recently claimed that more than four hours per day of screen time, a figure that the average office worker would easily eclipse, increases your risk of death by any cause by 50%! Inspired (or rather, unnerved) by this, the decision was made to buy everyone in the office one of the fancy desks. It’s all about squeezing in a little bit more motion and activity into the day. Rather than sit down for 8 hours, spend some of that time standing and in doing so burn a few extra calories and hopefully prolong your life. If you have to be at work for eight hours a day, you may as well use the time to reduce your chances of dying.

While it is commonly accepted that being active and moving around is good for your health, the same doesn’t necessarily apply to your investments. Many people operate under the misconception that your assets have to be ‘worked’. That is, you’ve got to be getting in there, buying and selling, chopping and changing and generally messing around with your investments as much as possible. If you own shares, you’ve got to be trading as much as possible; if you have managed funds or superannuation you have to try to chase the best fund managers and keep selling the others. The truth is, all this activity is more than likely hurting your wealth, not helping to grow it. Take shares for instance. A share is exactly what its name suggests – a share in a business. Yes, you might only own a really small share of that business, but you are still a part-owner. It’s the ownership aspect of shares that people often forget. The objective is to take a stake in a business (however small that stake is) and see the value of your investment grow over time as the business grows. The fact that someone is willing to buy your shares off you for 3% more than you paid for them only one day ago has no bearing on the performance of the company. To paraphrase the world’s most successful investor, Warren Buffett, every investment you make should be with the intent to hold it forever, though of course circumstances can change over time. So next time you are thinking of meddling with your investments, don’t just do something, sit there!