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.
Points of Interest – Winter 2017
In this edition of our quarterly newsletter, Points of Interest, we discuss the issue of sovereign and regulatory risk from an Australian perspective. This follows a number of policy announcements which have created considerable investment uncertainty. We also review the global situation, with concerns rising that we are entering an ‘everything bubble’.
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.
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
Points of Interest – Autumn 2017
In this edition of our quarterly newsletter, Points of Interest, we consider the upcoming Australian Federal budget, where a number of significant tax changes are expected. We also provide an update on the global political situation and the impact on financial markets.
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!
Points of Interest – Summer 2016
In this edition of our quarterly newsletter, Points of Interest, we discuss the somewhat unexpected outcome of the November US election. We also outline our concerns over growing levels of geo-political uncertainty.
It’s my mug
This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 30 July 2016.
People are becoming increasingly aware that our emotions and psychological biases play an important role in how we approach investment decisions. The relatively new field of behavioural finance attempts to explain how these biases influence our actions and decisions, usually for the worse unfortunately. Instead of being calm and rational when confronted with complex decisions regarding risk and return, we instead tend to let our base instincts and emotions take over. The end result is generally an unpleasant one from a financial perspective.
One of my favourite psychological biases is called the endowment effect. This is one which most people can relate to and is simple to understand. The endowment effect was illustrated by an experiment conducted by three researchers, Kahneman, Knetsch and Thaler, in 1990. In the experiment a number of volunteers were divided into two groups. The first group were given a coffee mug and told it was theirs to keep. They were then asked what price they would accept to sell the mug. The second group of volunteers weren’t given the mug, but were shown the same mug and asked what price they would offer to buy the mug. As you might expect, the first group who ‘owned’ the mug expected an offer to buy the mug that was on average much higher than the price the second group, who didn’t have a mug, thought was a reasonable price for the mug. Remember, this is the same mug, with a random bunch of volunteers. The only difference was that the first group, the owners of the mug, felt that it was worth much more simply because they owned it. In essence, value is ‘endowed’ on the mug (hence its name, the endowment effect) simply through the act of ownership.
The endowment effect translates very easily to the stock market. If I owned Telstra shares, for example, the endowment effect suggests that I’m likely to think they’re worth more than they really are, or the price that buyers are prepared to pay for them. So instead of selling at an appropriate price, I’m likely to hang on, waiting for my unrealistic price to be reached, which may never happen. And so another bad investment decision gets added to the tally. The emotional feelings associated with ownership have outweighed the rational decision-making process we all like to think we follow. If this has happened to you, don’t feel too bad, you wouldn’t be the first and certainly won’t be the last to feel like a mug.