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Talking Finance

The unhandyman

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 29 January 2017.

This past week I have been busy ‘renovating’ the laundry at home. I’ve put the word renovating in inverted commas as, theoretically what I have been doing is a renovation, but in practice it’s in a category all of its own. When the previous owners added on the laundry extension they stopped after putting in the framework and studs – there were no walls or ceiling and no flooring on the slab. As you can imagine, this became a haven for spiders, bugs, dust, dirt, snakes and who knows what else. I could feel my white business shirts cringe every time I took them into the laundry for a wash. Accidentally dropping a shirt on the floor was enough to make you cry.

Armed with some nails, a hammer and lacking only really a clue about what I was doing, I set about finishing off the laundry. To be honest, looking at the finished article, I wonder why I bothered. I’m not entirely sure I have made an improvement on the dirt, dust and spider heaven. It’s as though you got a builder in to do the work for you, but before he could start you got him drunk and then made him work in the dark. I now have to find a way of convincing my wife that she need not go into the laundry ever again and we’re better off just buying new clothes every time something needs a wash. An expensive solution yes, but better than letting her see my unhandiwork in the laundry.

As I stood there and reluctantly viewed my ‘renovation’ job, it occurred to me that my attempt to finish the laundry was not unlike the approach that many people adopt to looking after their finances. Just because I had the tools to tackle the laundry (the hammer and nails), didn’t mean I had the knowledge how to use those tools to do the job at hand. In the same manner, the ability exists for you to manage your own investments and finances – the tools are there, but that doesn’t mean you necessarily know how to use them. In the wrong hands, an online stockbroking account can be more dangerous than a badly wielded hammer (and I saw a lot of that during the past week, and felt it in my thumbs too). The convenient and cheaper approach of doing it yourself is not always best. Getting professional assistance may be more costly, but the outcome usually more than justifies the cost. Ask yourself if you realistically have the skills required; and if you don’t, get some help. A badly managed retirement plan is much more serious than a badly mangled renovation job.

A vegemite sandwich

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 11 February 2017.

When it comes to lunch at work, I’m a little bit old school, preferring to bring lunch to the office from home, rather than popping out to grab a sandwich from a shop or takeaway. It’s often a healthier choice and generally much cheaper too. One day last week I was particularly looking forward to lunch – the previous night’s dinner had been an Asian-style BBQ pork salad; a refreshing mix of chargrilled pork, fresh salads, garlic, chilli and coriander. A perfect dinner during the hot summer months. There were enough leftovers to cater for lunch the next day and Liz offered to make a sandwich with the leftovers for me to take to work. So you can imagine my sense of anticipation the next day when I sat down to eat my lunch while reading the Financial Review, as is my usual habit. You can also imagine my disappointment when I opened my lunch box to find only a sad looking vegemite sandwich. To be fair, the lunchbox itself should have been a giveaway – it has been a long time since I demanded that my lunch was packaged in a Star Wars lunchbox.

As great as my disappointment was, I can only imagine how great was Jack’s surprise (at about the same time as I discovered my vegemite sandwich) at finding his lunch was a delicious Asian-style BBQ pork salad sambo. No doubt his fellow classmates in Year 1 were impressed with Jack’s sophisticated palate. While most them were most likely also having a vegemite or jam sandwich, Jack was on the cutting edge of Asian fusion style cuisine. Alas, I know for a fact that all he did was take two small bits out of the crust and politely returned the sandwich to his mum, along with the request that he never ever again be sent to school with such a disgusting lunch.

For my part, as I unenthusiastically ate my vegemite sandwich, I reflected on the fact that this experience was not unlike that of investing. When you make an investment decision, what you get is not always what you expect. You may be expecting annual returns of 10% plus, but may find that the real outcome is something entirely different. As far as investing goes, the potential for disappointment in the outcome is part of the territory. Just as there are risks in getting someone else to make your lunch for you, there are risks in investing too. Unfortunately, what you end up with may not be so much gourmet, as garbage

Make everything great again!

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 14 January 2017.

The start of a new year is always an exciting time; an opportunity to look ahead with hope and anticipation. To push the reset button and forget about the year gone past. And what a year that was! 2016 was not the worst year we’ve ever seen – no major wars, crises or market collapses, but it still seemed to be a dramatic one. The UK decided it didn’t want to play in the European sandpit anymore; Malcolm Turnbull snuck back in the Lodge by a wafer thin margin and in the US, well, let’s just say that everything is apparently going to be great again! The truth is, every year has its ups and its downs. Humankind has an amazing ability to create new and novel ways to do both good and bad. From an investment perspective, the key to surviving any year is to make sure you have a plan. The old saying, failing to plan is planning to fail, really is true. Sure the odd major event might throw a spanner in the works (such as another global financial crisis), but having a financial plan helps to keep you pointed in the right direction, regardless of the odd bump encountered on the way.

A good financial plan is one which can adapt to the world around it. Just as circumstances change, so should your planning. Unfortunately, governments have a tendency to make unanticipated decisions which can have a major financial impact. While it’s not necessarily a requirement to predict those adverse decisions in advance, it is advantageous if you are able to adapt your finances to the new regime. The issue of superannuation is a perfect example of the ability of regulatory change to cause chaos. While you would assume the government is happy for more and more of us to be financially self-reliant during retirement, that is not necessarily the case. For every dollar that we squirrel away in superannuation, the government loses a few cents in additional tax revenue. It’s a case of long term gain (fewer retirees on the Age Pension) versus short term pain (less tax revenue now). Unfortunately, few politicians have a timeframe which extends past the next election. From their perspective, a few extra cents in tax now, is better than saving a few dollars in pension payments in twenty or thirty years’ time. That will be someone else’s problem, while the current crop of pollies will be retired on their generous government pensions by then. Here’s a new year’s resolution for our political leaders – stop squabbling amongst yourselves and let’s make government great again! It can’t be that hard, can it?

Pass the panadol

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 31 December 2016.

As I write this, we’re nearing the end of the year. In fact, if you’re reading this in the paper, it’s New Year’s Eve and you are no doubt debating whether or not to stay up until midnight to see in the New Year. I’ve found that as we started to have children, each successive one seemed to lop an extra hour off my ability to make it to midnight. With three kids this means I’m lucky to make it to 9pm. In pre-children days that was when the party was only getting started. Now however, I know that by six in the morning I’m likely to have two, if not three, small people yelling at me and demanding to be fed and entertained. Only a man more brave (or foolish) than me would stay up until the wee hours, knowing that was the fate which awaited him.

The end of the year is of course a perfect time to look back and consider your progress and achievements, particularly in regards to your finances. There’s no need to make it too formal, or else you’re unlikely to actually do anything about it; rather, just ask yourself a few questions and be honest with yourself. Things like: did you make much progress in reducing your debts this year? Were you able to add extra money to your savings or superannuation? Were you able to control your spending this year? We all have the odd occasional unexpected expense, but spending more than you earn is a certain path to financial trouble. Are all your insurances in order and are the insured amounts appropriate? Many people vastly underestimate how much life, home and contents insurance they need. Make time to review your policies.

The end of the year is also a good time to make some plans for the year ahead. Are there ways you can save more next year? If you’re lucky enough to get a pay rise next year, why not commit right now to salary sacrificing it to superannuation, rather than taking it as extra pay? If you were living well enough without the extra money, you won’t miss it anyway. Can you pay more off your mortgage? Changing your phone or electricity company can save money – direct it to your mortgage instead. Most importantly of all, save some money for yourself. There’s no point having a fat bank account and living on bread and potatoes. Indulge yourself every now and then, but do it sensibly. Failing to keep your finances under control is a lot more serious than dealing with three toddlers on a hangover.

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.