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Talking Finance

What you want to hear

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 26 March 2016.

If you know someone who has a particularly strong political view, you may have noticed how this influences the newspapers or magazines they read and which television channels they watch. It’s a generalisation of course, but if they were somewhat conservative they might prefer to read The Daily Telegraph or The Australian, and get their TV news from Sky News. If their political views leaned to the left however, they probably prefer to watch the ABC and read The Sydney Morning Herald. That’s not to accuse the various media outlets of deliberate bias, it’s simply an acknowledgement of the fact that most news sources tend to attract readers or viewers of a particular political viewpoint.

This propensity of ours to seek out sources of information which corroborate and reinforce our views and opinions has a name – confirmation bias. If we hold a particular view, we feel more comfortable reading articles or watching television shows which broadly support our opinions. It’s as though we draw comfort from the thought that we’re not alone; we’re happy that there are others that feel the same way we do. While it’s arguable whether the presence of confirmation bias is a good or bad thing when it comes to politics, confirmation bias should be avoided when it comes to your investments. The danger with confirmation bias is the selective thinking which clouds your judgement. You may own shares in a company which you believe has great prospects so you decide to do a little research, perhaps reading the company’s marketing material and financial reports, or listening to a recorded interview with the CEO. You might even jump onto an online forum where fellow shareholders discuss the latest news and developments emanating from the company, all heartily agreeing with one another about what a great investment they had purchased.

Can you see the danger? All you’ve done is look for evidence which confirms your already-held view of the company and you’ve made no effort to seek out information which contradicts your views. This is a perfect example of confirmation bias. Proper due diligence should include an active effort to find information which challenges your views and opinions – it helps you to question your own position more forcefully. It doesn’t mean your opinion is wrong; you just want to make sure you have considered every angle. Not that it’s going to help much when it comes to politics, as said by John Kenneth Galbraith, “Politics is the art of choosing between the disastrous and the unpalatable.”

Be Don Chipp

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 12 March 2016.

One of the (admittedly trivial) difficulties in my life is coming up with the 450 words needed for this column each fortnight. 450 words of interesting, snappy and fresh writing, which yet somehow links back to finance and investing. Did Jack say something hilarious after school that I could relate back to the stockmarket? Or is there some event in my school or university years that I haven’t yet somehow translated into a lesson on the dangers of over-trading? Are there any behavioural characteristics, however obscure, that hadn’t yet had a mention? Fortunately, when the well of clever ideas runs dry, there’s always one ready source – the government.

Yes, the government can always be relied upon as a ready source of financial fodder. As Americans like to say, the scariest sentence in the English language is: “We’re from the government, and we’re here to help”. The problem with the government, and in this I mean every government, not just the current majority in parliament, is that they’re alternatively torn between protecting us and stealing from us. Superannuation is a perfect example of this conundrum. The government wants us to save and provide for own retirement, thereby not relying on the government-funded Age Pension to cover our living expenses during retirement. However, every dollar that we save towards our retirement deprives the government of a small amount of immediate tax revenue. Now, seeing as our elected leaders are surely the smartest, most knowledgeable and forward thinking examples of humankind, surely it would be readily apparent to them that foregoing say, five cents in taxation revenue now, but saving a dollar in pension payments in 30 years’ time, is a reasonable compromise? Wouldn’t it? Well sure, on the same basis that Father Christmas does exist, Harold Holt is alive and well in a small village outside Beijing and I really did see Elvis at the self-service checkout at Coles last week.

Unfortunately, for most politicians, especially the new breed of ‘career politicians’, the short-run imperative of getting re-elected tends to outweigh the obvious long-term benefits of wise economic and financial policy. Which is why superannuation, while possessing wonderful taxation benefits (under current legislation, ahem), should be a key plank of your retirement planning, it shouldn’t be the only one. Having money in superannuation is smart; having all your money in superannuation is a risk. In exchange for the tax benefits you have effectively given the government control of your money in superannuation. Which is why, where possible, we have always recommended having assets both inside and outside the superannuation environment. For without Don Chipp around to ‘keep the bastards honest’, you need to do the job yourself.

Do the time, earn a dime

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

Another important life milestone was reached recently when our eldest son, Jack, started school this year. Just Kindergarten of course, but still a big step up from lolling around on the lounge floor playing with his wooden train set all day. Uniforms, bells, lessons and set meal-times; the poor kid probably can’t decide whether he’s in the army or in prison. But thinking of the rites of initiation, bullying in the yard, and intimidation by long-term muscle-bound inmates sporting beards and tattoos, prison is probably the best analogy. Those Year 5 kids are much more mature these days than when I was at school. Still, Jack seems to be coping well with the change and it only requires a moderate level of force to drag him out of the car at school drop-off.

The purpose of being at school is to gain an education of course, not to meet girls (or boys) and have a good time, which is what most kids tend to think of school. They’re too young to understand it, but time spent learning is the best indication of how wealthy you’ll be in later life. There is an extensive body of research which clearly links the level of household wealth with the level of education of the primary wage earner. In the United States for example, the average weekly wage of someone who finishes high school but goes no further in their education is $668. If you went to university and completed a university degree your average weekly wage rises to $1,101, and if you decided to do some post-graduate study (a Master’s for example), your average weekly wage rises to $1,326. So if you go no further than high school, your annual salary is probably going to be around $34,000 – push on to complete a Master’s degree and you can expect to earn around $69,000 (on average of course and all in US dollars, although the same relationships would also apply in Australia).

While the accumulation of wealth and money should not be your overriding goal in life, it’s clear that the longer (and harder) you are willing to study, the better off you will be from a financial perspective. Naturally, studying extensively beyond high school comes at a cost, both of your time and your wallet. A Master’s degree could set you back $15,000 or $20,000, or even more. But think of it this way – if you pay for both undergraduate and post-graduate degrees, costing $50,000 in total, your expected increase in annual earnings of around $35,000 (in US dollars), means your studies pay for themselves in less than two years. From then on the extra income is all for you. No wonder it’s said that education is the best investment – even Commonwealth Bank shares can’t match that return.

Selling sand in the Sahara

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

A couple of people recently commented to me that they had read the headline of my last article, thought it was interesting, but didn’t get round to actually reading the article. My first thought was that they obviously didn’t scare easily, as the headline read ‘The end is nigh’. But then again, newspaper articles with civilization-ending headlines are hardly new these days, where every newspaper subscription should come with a lifetime supply of Prozac. Reading (or watching) the news is rarely an emotionally uplifting activity, as the news media slavishly follow the old adage of ‘bad news sells’.

My second thought was that I appreciated their honesty – ‘Hey! I liked the look of your article, but only had time to read the headline, sorry’. It’s a bit like ordering food at a restaurant but leaving before it arrives and saying to the chef on the way out – ‘The food sounded great on the menu but I just don’t have time to eat it, but thanks anyway’. But I can’t blame them, I’m just as guilty when it comes to skimming through the newspaper. It’s all the same stories everyday anyway – political crisis? Check. Economic crisis? Check. Murder, murder, murder? Check, check, check. By then you’re onto the sports section which is just stories of bad behaviour and drug cheats. And it’s not like this is a new phenomenon –the front page of the Sydney Morning Herald from the 10th of November 1975 (to choose a date at random) contained vital news regarding a government budget crisis (so no change there), deaths by drowning, deaths from horseback, international espionage and a financial crisis. So 2015 all over again really, bar the fact that we all evidently commuted to work on horseback in the 1970’s.

However, while sticking to just the newspaper headlines is acceptable, don’t make the same mistake when it comes to your money. You’ve got to know the details. Where is your money going? What is it costing you? What are the risks? Can you get at it if you need it? Who’s in charge of it? What’s the worst thing that could happen to it? Asking these questions should be the basics in assessing any potential financial investment. It’s strange how people will drive across town to save a few dollars at a cheaper fuel station, yet will leave their retirement savings in some hopelessly inappropriate investment, all because they didn’t go beyond the glossy front page of the marketing material. And if that’s you, there’s probably a guy with a sand-making factory in the Sahara who would like a chat with you.

The end is nigh

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 30 January 2016.

Outside of a cooking show like Masterchef, or a ‘talent’ show like Australian Idol, there can be few activities that generate as many opinions as finance and investing. If you want it, there is someone who will give their opinion on the future direction of interests rates; where the stock market is going to finish at the end of the year; what the Australian dollar is doing; what the next inflation figure is going to be; what wine the board of the Reserve Bank will drink at its next meeting (ok I made that last one up, but I’ll bet it has been discussed and predicted somewhere). My personal favourite is when the nightly news bulletin crosses to a reporter standing outside the stock exchange building in Sydney, who randomly accosts any passers-by to get their views on the stock market’s performance that day. I’m not sure we’re really going to get any useful information from such an activity, unless Warren Buffet or Peter Lynch happened to be stepping out to grab a sandwich during their lunch hour and foolishly made eye contact with the reporter.

The current stock market volatility has created a mini-boom in the opinion-giving and punditry business. Analysts, fund managers, investors, economists, taxi drivers, my aunt Fiona – everybody seems to have an opinion on the gyrations of the stock market and whether or not it’s merely a correction or the world is headed to hell in a handbasket. The first rule of Punditry 101 is that the more extreme your prediction, the more likely you will be invited back to the television show/magazine/newspaper/journal in the future, where the pressure will be on to amp your prediction into even more stratospheric hyperbole. Like the squeaky wheel gets the grease, the most bearish and gloomy commentator also gets the return invitation.

In the spirit of rampant opinion-giving, I’d like to give you my own (for free!). Are we on the verge of another financial crisis (as has been suggested by many prominent commentators – who have probably shorted the heck out of the stock market and are praying for further falls), or is this just a correction and normal service will resume once the panic and fear-mongering dies down? If you have picked the right investments, your answer should be ‘who cares?’ Put it this way, if you own shares in Commonwealth Bank do you think the bank is going to collapse at any time during this period of volatility? Or Telstra? Or Woolworths? Is this current crisis likely to put the entire population off food for life? Or stop us making phone calls? I don’t think so – and there’s a prediction you can rely on.

Use your brain, you must

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 19 December 2015.

Regular readers of this column will by now (hopefully) be aware of the many and varied behavioural biases which can turn a good investor into a bad one. These behavioural biases are where we let our emotions dictate our investment decisions, instead of being the cool, calm and rational person we all like to think we are. In our minds we’re all like Yoda from Star Wars: unflappable, wise, and all-knowing, but perhaps not green, two-foot tall and with a face like a thousand year-old prune. In reality however, we’re more like a teenager on their first date: your brain has been left behind at the Lost Property office and decisions get made in a hot and sweaty panic.

One of the most damaging biases, in terms of the potential negative effect on your investment decision-making, is recency bias. Recency bias is where we place too much importance on recent events, for the sole reason that whatever happened, happened recently, rather than in the distant past. This makes us believe that whatever is happening now is likely to persist well into the future. For example, in the United States there is a high level of correlation between the price of petrol (or gas as it’s called in the US) and sales of gas-guzzling SUVs. As the petrol price falls, sales of thirsty SUVs rise in almost perfect unison. It’s not hard to see the irrationality in this – because the price of petrol has fallen over the past six months (for example), you rush out and spend $40,000 on a car which you might own for the next five, ten or fifteen years. Is it likely that the oil price, and thus the petrol price, is going to be the same in five, ten or fifteen years, as it is now? Of course not. But everyone who buys an SUV based on falling petrol prices has just made a ten or fifteen year investment based on what has happened in the past few months. A perfect example of letting recent events dictate our decision-making, rather than taking a more long-term view.

Reactions to the volatility in financial markets over the past year are also examples of recency bias. When the oil price reached over $100 in March 2008, investment bank Goldman Sachs confidently predicted it would soon reach $200. It didn’t, peaking at $147 per barrel three months later. In September this year, after the oil price fell from $145 to just $45, Goldman Sachs confidently predicted it would fall to just $20 per barrel. Both of these predictions look like recency bias in action. My advice to Goldman Sachs: sack some of those teenagers you employ, and hire more Yodas.

It wasn’t my fault

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 21 November 2015.

As a schoolboy I always liked to think that my dad was a little special when compared to my friends’ fathers, mainly because of his job. For over forty years he was a touring golf professional; a varied and interesting career which took him to golf tournaments and courses all over the world. Of course, some of my friends may have wondered if I even had a father, so frequent were his absences – the downside of a career where your workplace might be St Andrews golf course in Scotland one week, and Augusta golf club in Georgia the following week.

During school holidays I was allowed to caddy for my dad during whichever golf tournaments happened to coincide with the holiday. This was always a lot of fun, particularly if dad was playing well at the time. It was during these holidays spent caddying, however, that I discovered the real nature of the relationship between a professional golfer and their caddy. You had to listen carefully, but you could most easily detect it in a post-round interview. The golfer might say something like “…I hit a great approach shot on the 15th, but we misread the green and we couldn’t make the birdie putt.” Or he might say “…I hit a perfect tee shot on 16, but we still made a bogey unfortunately”. Can you see it? When it’s a good shot, great shot or birdie, it’s always “I”. A bad shot, duff shot or bogey and it’s always “we”.

The tendency for a professional golfer to blame their caddy when things go wrong has a name: self-serving bias. When things work out, I did it. When things go wrong, it must have been someone else’s fault. And as with most biases, what affects us in our personal life affects us when it comes to investment decisions too. A share investment which goes up is due to my great judgement; a share which falls is because of dumb decisions by management, for example. The problem with self-serving bias, as with many behavioural biases, is that it prevents us from learning from our mistakes and improving our future decision-making. How can you learn from your mistakes it you’re so certain you never make one? The key to avoiding self-serving bias is to value failure, own up to it when it happens and give others credit where it’s due. Or if you happen to be a golf professional, just employ a caddy who’ll tell mum if you blame him for anything. Making a nice smooth swing on the first tee can be difficult after a night spent sleeping on the sofa.

Make me an offer

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 7 November 2015.

In the minds of many people the stock market is a risky place and one best to be avoided. They point to the occasional market crash as confirmation of their convictions, opining that no-one should be comfortable with that level of volatility. That view partly misses the point, that volatility can be both good and bad. The movement of share prices is entirely normal, it’s just that upside volatility (share price gains) is far more desirable than downside volatility (share price falls). A stock market with no volatility goes neither up nor down and that hardly makes for an attractive investment.

The truth is that most of the potential investment opportunities open to you exhibit some form of price volatility. Take property for example, which many people favour over investing in shares (the saying ‘safe as houses’ stems from this belief). Imagine if every person who walked into your house made you an offer to buy it, based on what they felt it was worth (this is a fun game every homeowner can play). So when the postman drops off your mail he might yell out ‘$350,000!’ at you from the end of the driveway. Or if the guy who reads the electricity meter is the next visitor, he might yell out ‘$330,000!’ as his best offer. At that point do you turn to your spouse or partner and say ‘Oh my goodness, we just lost $20,000!’? Of course not. Just because the electricity meter reader thinks your house is worth only $330,000, doesn’t actually make it so. That’s just his offer for the property at that point in time. Can you see the similarity with the stock market? If a share you owned yesterday was priced at $15 and today it’s selling for $10, have you lost $5? No more than the homeowner lost $20,000 because the electricity meter reader is tighter than a photo finish at the Melbourne Cup.

All the stock market shows you is the current price at which someone will buy your shares from you. That doesn’t mean that is what the shares are worth. Price and value are entirely different beasts, particularly when it comes to the stock market. Price is what you pay for the shares; value is what they’re worth. So when the prices of your shares fall, as they occasionally do, don’t panic and resign yourself to a life of bread and potatoes. In the long run value always outweighs price, even if the only buyer is that tight-fisted electricity meter reader.

Who made this mess?!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 24 October 2015.

As every parent in the world knows, there is no handbook to raising children handed out by the midwife or nurse at the same time as they give you your tiny, screaming little bundle of joy. Within a short while, however, most parents could probably write their own how-to manual. It might contain a useful checklist for new parents: Lack of sleep? Check. Not enough hands? Check. A semi-trailer too small to fit everything you need for a trip to the supermarket? Check. No social life? Check. No money in the bank? Check. The one item which would be missing, as this is obviously a secret which parents are sworn to never divulge, and which will come as a shock to any new parent, is the most important one: the unbelievable mess that children can create. I am constantly amazed that such small people can create such an enormous mess. It’s as though there are no boundaries for children: food is just as likely to be found in the bedroom as the kitchen; toys are apparently equally at home in the toy box and in the toilet bowl; clothes can be kept in both the wardrobe and the microwave oven. Some days when I get home from work my first instinct is to call the police, for surely the house has been ransacked and Liz and the kids have been abducted, based on the devastation which greets me when I open the front door. Always however, Liz will have just left the kids to their own devices for five minutes, more than enough time for them to simulate a nuclear detonation inside the house.

So a large part of being a parent is spent tidying and cleaning up – when you have children every day is spring cleaning day. Do not, however, adopt the same approach with your share portfolio. Your investments don’t need to be looked at every hour or changes made every day. If you have made the appropriate initial investment decision, you don’t need to fiddle with your portfolio on a constant basis. You don’t even need to know how the share prices are changing day by day, although these days it’s almost impossible to escape the financial news entirely. A dusty mountain of academic research has shown that the more you chop and change your share portfolio, the lower your returns are likely to be. Invariably you end up selling your best investments and swapping into bad ones and never mind the taxes and transaction costs. You can’t ignore your children, especially when they’re showing you how they figured out how to work the stove, but you can ignore your share portfolio. Do it and be wealthier for it.

Pick me! Pick me!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 10 October 2015.

When you think back to your years at school, for some people it’s a fond memory of days gone by; for others it’s more of a nightmare that they’re glad they never have to repeat. One school ritual which people either loved or loathed, was the regular PE session. Usually the teacher would select two captains, who would then take turns picking members for their team, whether it be soccer, rugby, netball or any team sport. It was truly a brutal process, for there was no hiding the implications of being picked in the last few rounds. As subtle as a slap in the face, the message was clear: you’re really hopeless at soccer/rugby/netball/whatever. You could sense the desperation in the remaining kids as the captains called out the better, faster, stronger players. You could also sense the hesitation and reluctance in the captains as the numbers were whittled down and they tried to judge who was least-worst between those who remained. It was schoolyard honesty at its most cruel – almost Lord of the Flies–like in its heartlessness, though of course without the chanting or the eventual homicide.

In some ways, building an investment portfolio is not too different from the team selection job faced by the (usually) reluctant captains. The key difference however, and this is the approach we adopt in regards to portfolio construction, is that what you leave out of your portfolio is generally more important than what you decide to include within your portfolio. This may sound like splitting hairs, but the essence of the argument is that avoiding loser investments is more important than selecting the winners. There are two reasons why this is important: firstly, always picking winners is a difficult task. It’s generally easier to identify those investments you should avoid (the losers), than it is to discover some unearthed gem of company whose share price goes from $10 to $100 in a week. There are however, all manner of warning signs which an astute investor should be able to detect in the next Enron or Lehman Brothers. The second and probably more important reason, is that the damage from one dud investment can easily far outweigh the gains from the rest of your portfolio. It can take a long time and quite a few winners to recover from losing 5% of your investment capital outright. So next time you’re thinking of an investment, think Lord of the Flies, and ask yourself, do you really want that ‘loser’ on your team?