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Talking Finance

Hi Mum, I’ve won the lottery

This article originally published in The Northern Daily Leader on 15 October 2011.

We recently had reason to drive from Tamworth to Rockhampton and back – just over a thousand kilometres with a nine month-old baby on the back seat, plenty of time to learn every Wiggles song off by heart. Long trips can be a drag and besides endless games of I-spy or ‘twenty questions’, one way we occasionally while away the hours is a deep discussion about what we would do if we won the lottery (ok, not quite helping to advance the cause of humankind or world peace, but it can kill a few hours on the road). Would we want to buy that small farmhouse in Tuscany or the beach house at Sawtell? What about that small, red and fast sports car, or the 80 inch fl at screen TV? Shoes and clothes are also popular with certain members of our household, while I’m sure my wife wants a fully kitted-out shed and workshop.

A second dilemma is who to tell and how much to give away. Family would presumably expect to be the beneficiaries of some of your good fortune, but it’s not always a straight forward decision. Have I forgiven my sister for telling me that socks had left and right feet, and laughing when I spent ages trying to figure out which was which? What about my brother-in-law, who once confided over a few beers that he had no plans to share any lottery win which might come his way? Perhaps dealing with a windfall is not as straightforward as you would think. Unfortunately, your real chances of winning the lottery are slim – winning Powerball is a 1 in 55 million long shot. However your odds of having to deal with a windfall of a different sort are quite high – every one of us has money in superannuation and many of us will need to decide what to do with our lifetime savings when we retire. While not quite on the same scale as a lottery win, you may still be required to decide what to do with hundreds of thousands of dollars.

Don’t do what many Australians do, which is to ask their dentist, neighbour or drinking buddy at the pub for their opinion. Make sure you get professional advice from someone you like and trust. You may only have one opportunity to get it right. And Lauren, if you’re reading this,I finally figured out that nobody can see through your shoes, so it doesn’t matter if you’ve got your left and right socks mixed up.

Jumping off a cliff can hurt

This article originally published in The Northern Daily Leader on 1 October 2011.

A short distance from Victoria Falls, sandwiched between the borders of Zambia and Zimbabwe, is a deep gorge, part of the extensive canyon system created by the Zambezi River as it winds towards the Indian Ocean. Perched high on the edge of the gorge, a couple of Englishmen run an inventive and possibly illegal business. Many years ago they had the bright idea to string some cable wire across the gorge, and for US$90 they let thrill-seekers jump off the edge of the cliff, their only lifeline being a climbing harness linked by a few ropes to the middle of the cable. The highlight for anyone who is willing (or crazy enough) to pay the fee is an amusing activity called the ‘death drop’. This involves being lowered backwards into the gorge until past the point of horizontal, at which stage you plummet head first into the gorge at 180 kilometres per hour until the rope straightens and swings you across the gorge at high speed. Sounds like fun doesn’t it?

I was reminded of the gorge swing and the ‘death drop’ during a discussion about the state of the global economy last week. One way to view the current upheaval on global markets is to imagine that Greece has paid US$90 for the opportunity to do a ‘death drop’ and is at this very moment plummeting head-first down the cliff-face. Standing at the top of gorge, having just watched Greece go over the edge, are Germany and France. Although Greece is wearing the climbing harness, instead of being attached to the cable cross the gorge, the climbing ropes are tied to the legs of both Germany and France. As the rope gets shorter and shorter as Greece approaches the bottom of the gorge, Germany and France are engaged in an animated discussion about what to do next – do nothing and let Greece pull them both over the edge or work together to slow Greece’s fall and then haul it back to safety to the top of the cliff?

The wild gyrations we’ve been seeing on global stock markets are largely because there is no certainty that Germany and France will make the right decision, or even if saving Greece is the right decision. With any luck the outcome is more positive than when I paid my US$90 to experience the ‘death drop’ a little over a decade ago. On that occasion I blacked out on the way down and nearly threw my back out – here’s hoping Greece avoids the same fate.

What sort of car are you?

This article originally published in The Northern Daily Leader on 17 September 2011.

Early last year my wife and I experienced two momentous occasions: we found out we were having a baby and we had to buy a new car. Clearly the latter was brought about by the former, for as much as I argued otherwise, it was apparent that fitting a baby capsule to the ute’s passenger seat was not an option. With that began the long process of new car hunting, with nearly its own nine month gestation, and everyone I spoke to during that period had an opinion and some advice: buy something bigger than you need now, it’ll save you in the long run; you can’t go wrong with Japanese cars, they never break down; get something with sliding doors, it’s easier getting the baby out at parking lots; buy second-hand, you know you lose 30% of the value as soon as you pick up a new car don’t you? Everyone had an opinion and no two were alike.

Personally I thought we needed something small, red and fast – all the better to avoid the bad drivers out there. My wife wanted something large and boxy, with forty air-bags and a reversing camera. We ended up with a station-wagon, so you can see how that one played out. In many ways the whole car-buying process reminded me of investing in the stock market – just as many theories and opinions and plenty of free advice if you want it: put all your money in the bank, it’s just a lottery to invest in shares; when the 200 DMA crosses the 50 DMA at the Fibonacci retracement of 68.1%, that’s the signal to sell; invest for the long term, don’t be alarmed by short-term movements; when the moon is in the Seventh House and Jupiter aligns with Mars, that’s the time to buy. See what I mean?

So what should you do? Well here’s more free advice– do whatever makes you feel comfortable. Some people are happy flipping shares every 5 minutes like hot cakes; others believe in the steady accumulation of wealth over the long-term, and can live with short-term volatility. Think about the type of person you are and the investing strategy most suited to your personality. But remember, large and boxy, just like the small, red fast option, gets there in the end, but often with far less excitement (or crashes) along the way.

When bulls and bums collide

This article originally published in The Northern Daily Leader on 3 September 2011.

Committing life-threatening acts with little protection besides a red scarf and the false invulnerability of a dozen full-strength beers under the belt sounds pretty silly. Yet this is exactly what many young Australians do each year at Pamplona – the scene of an annual experiment to determine what happens when the sharp end of a bull’s horn meets a soft bum. Of course we all know the answer to that one and each year the TV news shows us in graphic detail as the bulls stampede over the hapless runners.

In typical laconic Spanish style, the Pamplona city council’s official website contains this nugget of encouragement for aspiring runners –“Number of injured a year: Between 200 and 300. Only 3% seriously.” There you go, on average only 9 people per year are seriously injured, nothing to worry about. The probability of hosting such an event in Australia? Zero. Clearly the nanny-state, a condition familiar to most Australians, has yet to arrive in Pamplona.

Surprisingly (or unsurprisingly, to regular readers of this column), there are some parallels with the stock market and the chaos in Pamplona. Much like the unfortunate runners at Pamplona who are trampled underfoot by a herd of bulls, investors in the stock market can suffer the same fate. When faced with uncertainty, investors fall prey to herding behaviour, where they simply start copying what everyone else is doing, in the hope that everybody else knows what they’re doing. Reasoning and rational analysis get discarded in a hurry as investors join the rush towards gold, cash, property or tulips – it actually doesn’t matter what it is, if everybody else is doing it, then so am I! Researchers describe these manias as self-organised, in that they are brought about by a combination of uncertainty and mimicry.

So how do you stop yourself from becoming one of the herd, or even worse, being trampled by the herd? The majority of our investment mistakes result from our cognitive and emotional biases, where our emotions get in the way of rationality, so a simple solution is to let someone else make the decisions for you. It’s easier to make rational decisions about someone else’s investments than your own – there’s no emotional attachment to complicate the process. Of course should you find yourself at Pamplona next July, there’s no point being rational when confronted by a real bull – just run like hell.

Don’t just do something, sit there!

This article originally published in The Northern Daily Leader on 20 August 2011.

Nearly thirty years ago, as a knobbly-kneed schoolboy, winter meant more to me than just cold weather and frosty mornings, it was also the start of soccer season.
Before ‘grown-up’ sports like cricket and rugby captured my attention, life revolved around soccer, evidenced by my Liverpool doona, Liverpool pyjamas and Liverpool slippers. On the other hand, Dad was a Spurs supporter, so we always had plenty to talk about.

Like many soccer players, my greatest dread arose whenever I was asked to take a penalty kick – all that attention and pressure, and all at the tender age of 9 years old! Of course I never considered the feelings of the goalkeeper, who faced his or her own dilemma – dive left, dive right or just do nothing and stay in the middle? Unsurprisingly, these are the sort of questions that scientists love to answer, and a 2007 study by a group of Israeli researchers found that when facing a penalty kick, goalkeepers have an ‘action bias’ – which means that they tend to dive left or right more frequently than was useful. The study showed that goalkeepers went left or the right 94% of the time – meaning they stay in the middle for only 6% of the kicks they faced. However, the penalty shot went straight at the middle of the goal 29% of the time, so it turns out that goalkeepers could increase their chances of saving the penalty kick simply by doing nothing. The explanation for the goalkeeper’s actions is that they are motivated by the fear of regret rather than the fear of failure- to have dived and failed to stop the goal feels better than standing still and watching the ball go past you into the back of the net.

Recent stock market volatility presents investors with the same dilemma – should you sell out or hang in there? The action bias exhibited by the goalkeepers is just as strong in investors, where we feel the urge to do something…anything! Don’t let this happen to you – if you have an investment plan, then stick to it. A plan becomes even more important when markets get rocky, it’s definitely not the time to throw it out the window. And if you don’t have a plan (or a Liverpool doona), then do yourself a favour and get both. You won’t regret it.

Take That

This article originally published in The Northern Daily Leader on 6 August 2011.

They say there is a little bit of prison-camp guard in most of us. Not a pleasant thought, but that’s what Yale University psychologist Stanley Milgram discovered in a series of controversial experiments in the 1960’s. In the experiments, unwitting university students were instructed to give apparently painful electric shocks to another person (in reality an actor, privy to the full experiment) each time that person gave the wrong answer to a simple memory test. At each incorrect answer the voltage of the shock increased, to a point where it would apply a fatal shock of 450 volts. The students could hear the person scream when they were zapped, but could not see them – in fact the cries of pain were actually a series of tape recordings, as there was no actual shock applied – it was all an elaborate ruse to determine how far the students would go in applying ever more painful ‘shocks’ to the hapless person in the adjacent room. Somewhat worryingly, Milgram found that 65% of the students who participated in the experiment were willing to administer the final and fatal 450 volt shock, despite the obvious discomfort (to put it mildly) of the actor in the room next door.

You’re probably asking yourself what all this has to do with finance – well fortunately psychologists do more than simply terrorise students into thinking they’ve shocked someone to death; they also explore people’s behaviour when dealing with money and investments. And they have unearthed some surprising findings – for example, did you know that most people ‘feel’ a loss twice as keenly as they appreciate a gain of the same magnitude? So losing $5 makes you twice as upset as the happiness you gain from making $5, which seems fairly irrational! Psychologists also found that most of us suffer from ‘confirmation bias’, which means that we tend to favour information that confirms our views, regardless of whether the information is true or not. Another discovery is the ‘house-money’ effect, which found that people tend to gamble more recklessly with money from a windfall (such as a profitable investment or a winning scratchie). It’s no surprise why casinos are happy to give you free chips when you join their loyalty club. It turns out that investing behaviour is driven by our cognitive and emotional wiring, a lesson learned thanks to psychologists like Milgram and his tyrannical students!

Hello Brian!

This article originally published in The Northern Daily Leader on 23 July 2011.

The ‘Do Not Call Register’ is a great idea – apparently signing up to the register means you won’t be troubled by pesky telemarketers, who have a knack for knowing when you have just sat down for dinner. Last week, while my wife and I were preoccupied with convincing our six month old son Jack, that liquidised pumpkin is a tasty food source, we were interrupted by a telephone call from ‘Brian’. In hindsight we should have just ignored the call, but we had been expecting a call from a family member.

Brian seemed to have skilfully evaded the restrictions of the ‘Do Not Call Register’, as it quickly became clear that Brian was neither friend nor family. However he did have some alarming news – apparently his company (which he failed to name) had detected, over the internet, that our home computer was corrupted or infected by viruses. Much of the conversation was actually inferred, as there were some language difficulties, but the gist of the call was that we needed to switch on our computer immediately and Brian would help us resolve our problems. Naturally, feeding Jack was more pressing, so we declined Brian’s advice, though I did get his number to call him back later.

Once dinner was finished, I entered Brian’s telephone number in Google, and was rewarded with a lot of information and many complaints about Brian’s employer. Apparently Brian was planning to show us the error log on our computer, which always contains a large number of innocuous warnings which have no impact on the ability of your computer to work correctly. Brian would then convince us that the only way to ‘fix’ these problems was to install (and pay for) some software provided by his company.

Essentially Brian wanted to sell us a product we didn’t need, by identifying a problem we didn’t have (and it wasn’t even illegal). Unfortunately there are also (still) many ‘Brian’s’ in the financial services industry – despite a lengthy ongoing process to clean up the industry, some financial advisers identify problems you don’t have and then try to sell you products you don’t need. Your response should be the same as mine – do some research, talk to friends or family and don’t feel compelled to do anything that makes you uncomfortable. And could somebody fix the ‘Do Not Call Register’!

Bubble in Paris

This article originally published in The Northern Daily Leader on 9 July 2011.

Life as a Parisian hunchback in the 18th century must have been a challenge. More likely than not the object of public disdain and ridicule, as suffered by Quasimodo, the titular protagonist in Victor Hugo’s The Hunchback of Notre Dame, it’s fair to say that there were probably few situations where being a hunchback was an advantage. However, one of the greatest financial bubbles in history provided an opportunity for one enterprising 18th century hunchback.

In 1719, an inventive Scotsman, John Law, established the Mississippi Company, which was granted exclusive trading rights to the East Indies, China and South Seas by King Louis XV (Law had fled to Paris to escape the wrath of the authorities following a fatal duel over the attractions of a young woman). Through a combination of clever marketing and royal patronage, Law was able to convince his fellow Parisians that an investment in the company was simply too good an opportunity to miss, with a promised initial income return of 120%! So enthusiastically did the citizens of Paris respond, that the street outside Law’s house became thronged with budding investors, desperate to purchase shares in the company. Day and night people gathered in the Rue de Quincampoix, frantically trading back and forth shares in the Mississippi Company, speculating that the stock price would continue to rise inexorably higher. The eagerness and desperation of the speculators provided the perfect opportunity for our enterprising hunchback, who, according to legend, earned a sizable fortune for himself by renting out his hump as a writing-desk to the would-be investors.

As it turned out, providing writing-desk services to the eager investors was probably more profitable than investing in the shares of the Mississippi Company. The promised riches failed to materialise and the company and the private bank Law had established to finance it collapsed in flurry of worthless pieces of paper. The lesson learned by those over-enthusiastic Parisians is as relevant today as it was back in 1719 – if it’s too good to be true, it usually is. Too often we see ordinary Australians being duped by the modern-day equivalent of John Law and his exciting yet ultimately worthless investment opportunity. So whenever a ‘John Law’ comes your way, be a sceptic first and a believer second. The Mississippi Company wasn’t the first speculative bubble to collapse, and it certainly won’t be the last.