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Talking Finance

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?

The unknown unknown

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 26 September 2015.

Whether you love or hate George W. Bush, at the very least you should appreciate what will no doubt be his longest-lasting legacy – the ‘Bushism’. A ‘Bushism’ is of course a memorable and often humorous statement or phrase uttered by George W. Bush during his time in politics. Classic ‘Bushisms’ include gems like: “Rarely is the question asked: Is our children learning?”, uttered during a speech in South Carolina in 2000. This one, in New Hampshire in 2000, “I know how hard it is for you to put food on your family”. And my personal favourite, from a speech in 2004 in Washington D.C: “Our enemies are innovative and resourceful, and so are we. They never stop thinking about new ways to harm our country and our people, and neither do we”. George W. Bush didn’t have it all his own way however, facing fierce competition from his Secretary of Defence, Donald Rumsfeld. Who can forget the first time they heard him say these words? “Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.” Try and figure that one out after a few glasses of wine.

While Donald Rumsfeld may have sounded confused, there is in fact something worthwhile within that awkward and tangled sentence. The concept of an ‘unknown unknown’ is not new and has been used for some time, most prominently within NASA. There is a real danger in not knowing that you don’t know. If you don’t know that you don’t know, you might just go ahead and take action or do something anyway, with potentially disastrous consequences. This can be applied to fields as diverse as doing the electrical wiring in your house, to speculating with commodity derivatives at the Chicago Metals Exchange. In terms of its relevance to financial markets, an important attribute that successful investors share is knowing when they don’t know something (the known unknown). Be honest with yourself – are you really smarter than 99.9% of the rest of the population? Do you have an edge over everyone else when it comes to making successful investment decisions? Do you have some form of special knowledge which separates you from everyone else? Not everybody can fit into the top 0.01% of society unfortunately. So if you know you don’t know, adjust your investment approach accordingly and sleep better at night too.

Gone batty

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 12 September 2015.

From my office I can look out the window across town, over to the Peel River, where a colony of bats have made a home. The bats (or the grey-headed flying fox to be more specific) are a busy lot, flying from one side of town to the other, presumably looking for food or maybe they just like the exercise. Literally thousands of them will descend in on a small area, only to fly off a short while later, heading for somewhere else that offers food or shelter. I was reminded of the busy bats while thinking about the current turmoil in financial markets. It seemed to me that the behaviour of the media, in regards to the financial turmoil, was just like that of the bats. It certainly seems that the media (or parts of it) delight in dropping in on a crisis, squeezing as much news and airtime out of the crisis as they can, before lifting off in search of the next calamity. Just like the bats.

For some weeks now, the lead finance story on the evening news, or occasionally the lead story for the entire news bulletin, has been the ‘collapse’ of the Chinese stock market. While it is certainly very newsworthy and quite unsettling that the main Chinese stock market, the Shanghai Stock Exchange, lost over 30% of its value in just a few short weeks, you will struggle to recall the same level of attention paid to the Chinese market in the twelve months before that, when it went up like a rocket headed for Mars. The real story here was the clearly unsustainable boom in the Chinese market which commenced in May 2014 and ended in mid-June 2015 – a neat 149.90% return in just over a year. But that story didn’t make the news of course – ‘good’ news seldom does. Only when the Chinese market started correcting, as was inevitable, did the media turn its hungry gaze in that direction, delighted at finding another bad news story to ramp up, wring out and drag on for as long as possible.

The truth is that the current ‘crisis’ can be traced back to two very simple facts – the inevitable popping of the Chinese stock market bubble and that Chinese economic growth is slowing. Both of these facts were known to anybody who could read a newspaper or had access to the internet. Still, with enough money spent on flashy graphics and shots of ‘anxious’ investors watching the screens at the stock market, it’s easy to conjure up a crisis. As always, stick to your investment plan and ignore the ‘noise’ – the ‘bats’ will bother you only if you let them.

Five equals six

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 29 August 2015.

Life is full of challenges, some serious and some less so. A challenge of the less serious form arose recently, prompted by the discovery that my wife and I would be having our third child. It wasn’t how would we cope with another attention-demanding little bundle of love, when we already had two of those, or how would we manage with a family of five in a three bedroom house, an intolerable situation almost unheard of in the 21st century; no, it was much more challenging than that: how would we fit three children’s car seats in the back of the car? Obviously other families have faced and dealt with the same challenge, but it seemed impossible to me that we could fit a third car seat in there. Each car seat looked about two feet wide, while the width of the car was around five feet – fitting six feet of car seats into a five foot wide car was clearly some form of higher mathematics I had not encountered before. I must have been absent that day at school or university or wherever it is where they teach you that five equals six.

Undaunted by the apparent impossibility of the task, Liz and I ordered the new car seat online and awaited its arrival (choosing the car seat itself took the best part of a week – my main criteria was price, whereas Liz wanted a nuclear-bunker protection rating, the ability to withstand a direct meteorite hit on planet Earth and built-in video surveillance). When the new car seat finally arrived, we set aside an entire weekend to try and fit it in the car. Now, let me first say that I had always thought that Liz and I were both reasonably intelligent people. We had made it through life without been tripped up by some of the more tricky events, like poking your eye out with a stick or setting your hair on fire. Between us we also had over twenty years’ worth of tertiary and post-graduate education: that is, two Bachelor degrees, three Masters degrees, a PhD and a number of other qualifications thrown in for good measure. And could we make five equal six? Not on your life. After two days of wrestling with car seats, seat belts, clips, armrests and headrests, we gave up and took the car into town where some guy did the job in ten minutes for thirty dollars.

The same rule applies to managing your finances as it does to car seat installation – if you don’t have the right skills or experience, the best approach is to get help. Unless you already know how five equals six, in which case, go for it!


Oh thanks. Not.

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 1 August 2015.

When our eldest son, Jack, was two years old, my wife and I made the mistake of letting him watch the Disney Cars movie. It must have just been the noise and the colour, for he surely didn’t understand the plot or the dialogue, but from that moment on his life revolved around Cars and the main protagonist, Lightning McQueen. And as is the way in our very commercial world, he soon had Lightning McQueen pyjamas, plates, cups, cutlery, shoes, hats, shirts, underwear, stickers and bedding. Most important of all however, is his burgeoning Cars die-cast car collection. It started with one, then two, then three and pretty soon we lost count of the number of die-cast cars he had amassed. Wherever we went, we hunted around for a different car to buy for his birthday, Easter, Christmas or just to keep him quiet for five minutes. I’ve looked for Disney Cars characters in every toy-shop from Sydney to Brisbane; I’ve ordered them online; had them shipped from London and Los Angeles and yet somehow, there still seems to be a host of the wee little devils he doesn’t already own. They’re taking over the house and now have their own bedroom and en-suite.

Interestingly, with every car we (or friends and family) bought him, his open appreciation and joy began to diminish, little bit by little bit. If his first Disney Car scored 500 on the ‘Oh Wow!’ scale, by the time we got round to handing over car no. 64, it had fallen to the measly level of 10. This is of course, probably no surprise to parents with more experience than us. His behaviour also perfectly fits a well-known phenomenon in economics – the law of diminishing marginal utility. This law describes the situation where every additional unit of something that you consume gives you less pleasure than the one before it. For example, the first prawn you eat at Christmas is incredibly delicious, but by the time you’re on your 20th prawn they taste less and less so. And so it is with Jack, whom we suspect now fakes excitement when he unwraps yet another Disney car.

When it comes to investing however, the same law of diminishing marginal utility both does and doesn’t apply. In building your investment portfolio diversification is important. Starting with zero investments, each additional investment added provides positive diversification benefits. No diminishing marginal utility here. However, once you get to around 25 investments or so, diminishing marginal utility begins to apply and each successive gain in diversification becomes less and less. Your investments may cost more than a $10 car, but the rules are the same. Now, does anyone know where I can get my hands on the Dragon Lightning McQueen?


This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 18 July 2015.

In the olden days, when just surviving was difficult and life could be short and brutal – I’m talking about pre-iPhone days of course, so circa 1990 – the art of investing was a simple one. You simply bought a couple of good shares – maybe BHP, Woolworths and Commonwealth Bank – put them in the bottom drawer and forgot about them, happy in the knowledge that your money was safely invested. Sure there might be the odd small economic recession that had to be navigated every now and then, but it was generally smooth sailing as you let your investments gradually grow over time.

Fast forward nearly 30 years however and there is a problem with this strategy. Now not only does every investor need to be able to judge the merits of individual companies accurately, they also need to be an expert on a wide range of topics. The debt position of the Greek government; the state of the Chinese property market; the internal deliberations of the US Federal Reserve’s Open Market Committee; the details behind Shinzo Abe’s ‘Three Arrows’ economic recovery plan for Japan; the influence of the ZIRP on global asset prices; the rise of high-frequency trading; the relative strength of the AUS/USD carry trade….I could go on and on.

The simple fact is that when it comes to finance, economics and the stock market, Australia is an island no more. Globalisation has meant that economies and stock markets are more connected than ever. The ability to effortlessly move billions of dollars around the planet at the push of a button; the ease with which an investor in Australia can buy shares listed in the United States and vice versa; 24 hour trading and lightning speed telecommunications; all add up to a world where what happens in your own backyard has only a partial bearing on the performance of your investments. A farmer in rural New South Wales with some money in superannuation would be surprised to know how much of an impact successful negotiations between Washington and Tehran over the Iranian nuclear program can have on the value of their superannuation. But it can and it does.

How does the average investor deal with this complexity? Fortunately the tools which are partly responsible for creating the complexity are also the solution. Facebook, Twitter, online newspapers and newsfeeds, Bloomberg, CNN, the iPhone, cable TV, 4G and omnipresent Wi-Fi – all the tools and sources of news you might need to use in keeping abreast of the daily developments across the globe. The head-in-the-sand approach adopted by the ostrich just won’t cut it today – the times are a changing and so must you.

Computer says sell

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 4 July 2015.

There’s little doubt that the age of computerisation has radically changed our lives. Laptops, desktops, tablets, smartphones and even smart watches, all devices which have become part of everyday life. Where computers were once the size of large rooms and could only perform a single function at a time, the smartphone in your pocket can literally perform thousands of functions and at blindingly fast speed. The combination of computerisation and communication links like the internet means that we’re more productive and more connected than ever before. I can receive my work emails while sitting on a beach in Coffs Harbour, while a friend eating lunch in New York can unfortunately share a photo of their meal instantly with their entire social circle via Facebook or Snapchat.

As you might expect, computerisation and advances in telecommunications have also radically transformed the world of finance. Did you know that nearly a third of all share transactions on the Australian stock exchange are carried out by computers deciding to buy or sell? There’s no human input beyond setting the parameters by which the software will trade. It’s estimated that in the United States around half of all share trades are executed automatically by computers. Sophisticated algorithmic trading software monitors the market and makes decisions in less than a millisecond. In fact, so advanced has algorithmic trading become, some algorithms are able to predict share price movements 30 to 60 seconds in advance. Speed is crucial too. If you submit a buy order through your online broker, smart computers can see your trade coming and can jump ahead of your order, buying and then selling to you whatever you wanted at a slightly higher price. It might only be a cent or two higher, but done hundreds of thousands of times per day, the cents start to add up. Read ‘Flash Boys’ by Michael Lewis for a fascinating account of the rise of high frequency trading.

What does all this mean for you? Well the computers don’t care what the underlying share is – is it a bank, a supermarket or perhaps a coal miner? They have no sense of the underlying value of the business, treating every share as though it was simply a chip in a casino. This is where humans have an edge over their computerised counterparts. A share is a small stake in a business that actually makes or sells things or provides a service. In reality the value of these businesses does not change by 3% or 4% or 5% per day, regardless if the stock market price says so. So ignore the computer and focus on the underlying business – we are all humans after all.