This article originally published in The Northern Daily Leader on 2 August 2014

A guy I used to work with, Dom, had a wonderful sense of humour. A couple of Irish tourists, Phil and Eamon, were in town visiting Phil’s brother. Dom wanted to show Phil and Eamon a slice of country life and invited them to come rabbit shooting one night on his property outside town. The day Phil and Eamon were due to come shooting, Dom found a dead brown snake in one of his paddocks. Although it was already dead, Dom put a bullet in its head and hung the body in a nearby tree. That night Phil and Eamon arrived for their rabbit hunt. After a few hours of driving around shooting rabbits, the boys were standing around the vehicle having a break, when Dom yelled out ‘Look! Snake!’ and gestured wildly into the darkness. Before Phil and Eamon could move a muscle, Dom raised his rifle to his hip and fired off a hasty shot into the dark. “I think I got it” he said, before leading Phil and Eamon toward a distant tree, where his torch light fell upon the dead brown snake with a neat bullet hole in its head. To say that Phil and Eamon were amazed would be an understatement. In their minds they had just witnessed one of the greatest shots of all time – a brown snake shot through the head, from 400 yards away, in the pitch dark and without even aiming! For weeks afterward Phil and Eamon would breathlessly recount Dom’s amazing shot to any who would listen, much to Dom’s immense enjoyment.

Without even knowing it, Dom had accurately recreated his own version of the Texas Sharpshooter Effect. This sleight of hand is where an aspiring marksmen would fire away blindly at the side of a barn and then paint targets around the bullet holes; inviting friends and family to come and view his or her amazing sharpshooting skills. A financial version of the Texas Sharpshooter Effect is a clever illusion of performance called backfill bias. Fund managers create a host of new managed funds, all employing different strategies and holding different investments. After a few years the underperforming funds are quietly closed, while those which have generated positive returns are loudly and widely publicised. The unsuspecting investor has no idea of the truth of the matter however, blindly accepting the past performance history at face value. The reality is that the outperforming funds which make it through the elimination process owe their survival more to luck than skill. If you fire enough bullets you’re likely to eventually hit one target, though this has little reflection on your skill with a firearm. So the next time you’re thinking of putting money into a managed fund, think of Dom and his dead snake and perhaps think again…

This article originally published in The Northern Daily Leader on 19 July 2014

How did you feel after you read the heading of this column? Maybe got up from the sofa and dragged yourself to the kitchen? Or perhaps couldn’t get up at all, and just spent five minutes having a lazy half-snooze? Well, either one of those outcomes could have described your response if you are anything like the people in an intriguing study carried out by three researchers at New York University. In a 1996 paper with the forgetful title of ‘Automaticity of Social Behavior: Direct Effects of Trait Construct and Stereotype Activation on Action’, the researchers outlined an experiment which looked at the impact that words can have on behaviour. In one of the experiments, participants were asked to unscramble the words in a sentence, under the ruse of it being a language proficiency test. For one group of people, the words had been carefully selected as to be associated with being elderly, although any words which had connotations to being slow were excluded. The other group were given words which had no particular association. After the participants had finished the word-unscrambling task, unbeknown to them, they were timed as they left the room and walked down a corridor to the lifts. The results of the experiment showed that those people who had been exposed to words associated with being elderly walked significantly slower to the lift than those who hadn’t. In essence, just seeing words like old, lonely, grey, retired and conservative changed the physical behaviour of people. Other similar experiments showed that being exposed to particular words made people either rude or more polite, depending on the words which they were asked to unscramble. The message again was that just seeing certain words can change behaviour, a tendency known as ‘priming’.

An easy way to see priming in action is to consider the response of the public to the Federal government budget in May. For weeks in the lead up to the budget, and for some time following the budget, the Prime Minister and the Treasurer were splashed across the media, warning of the ‘debt crisis’ and the ‘budget emergency’. Under the relentless bombardment of negativity, consumer confidence wilted, finally cracking in the week the budget was released, despite the fact that most of the major spending and entitlement cuts were at least a year away (and assuming passage of the budget through a hostile Senate). The detail was lost however in the noise and negativity. If you tell someone there’s an emergency or a crisis often enough, they’ll change their behaviour appropriately, regardless of the truth or otherwise. With the passage of time, the effects of priming will eventually dissipate, but not before more significant damage is done than a slow amble down the corridor to the lifts.

This article originally published in The Northern Daily Leader on 5 July 2014.

It is probably fair to say that the world of finance, and investing in general, suffers from something of an image crisis. Many people consider finance to be a dry, dull and uninteresting topic. They imagine mind-numbing days of gazing at numbers, tapping away at tiny calculators and getting excited about the fifth decimal in a number as long as your right arm. Those people working in finance are thought of as either fast-talking brash fat-cats, or cardigan-wearing introverts who love their spread sheets more than their families. In fact, this picture can be the complete opposite to an actual day in the financial markets. During my time at an investment bank in London in the 1990’s I witnessed frustrated traders smashing their telephone handsets on their desks as markets plummeted during the Asian financial crisis; on other days cigars and champagne were passed around the trading floor after another successful day of making millions for the bank. Life was anything but dull in that type of environment.

Somewhat surprisingly however, showing too much emotion can have serious consequences for your investments – our emotional biases can lead to very poor decision-making. In many ways the cardigan-wearing introvert is likely to do a better job of looking after your money than the fast-talking fat-cat. A clear example of this is the concept of loss aversion. Research has shown that most people feel the pain of losing money twice as much as the happiness they gain from making money. So rather than selling a poor investment at a loss and reinvesting the proceeds into an investment with better prospects, loss aversion pushes you to hang on to your dud investments in the vain hope they may one day recover. Of course, some investments never recover, no matter how long you wait. The smarter course of action is usually to ask yourself this question: am I prepared to invest more into this investment at its current price? If you aren’t, but you’re continuing to hold the investment, then you’re a perfect example of loss aversion. You can avoid loss aversion by ignoring the purchase price of the investment and simply dealing with it on its merits – it’s not easy but it can be done.

Cardigan-wearing introverts who are able to disassociate themselves from the emotional aspect of investing are likely to do better than somebody who lives by the seat of their pants, riding an emotional rollercoaster. So next time you’re casting your eye over your investments, try to concentrate on being as detached and emotionless as you can, your investments will thank you.

This article originally published in The Northern Daily Leader on 21 June 2014.

I came across a recent article on the BBC’s website which raised the scary prospect of ‘word poverty’. Apparently as humans advance (or regress, depending on your view) we seem to be losing words – our vocabulary is shrinking, despite estimates that a new word is created every 98 minutes. Unfortunately a fair few of those new (and old) words are of the most useless type: technical slang and buzzwords. Some years ago I used to see a doctor who seemed to make it his personal mission to promote buzzwords and technical jargon as often as possible. The common cold became a ‘rhinovirus’, a sprained ankle became a ‘minor soft tissue injury’ and a bruise was always referred to as a ‘contusion’. I usually just nodded blankly and hoped he knew what he was talking about because I sure didn’t.

As you would expect, the world of finance and investing has its fair share of jargon and technical slang. It’s usually trotted out to both confuse and impress and its usage seems to have a direct correlation with your investment management fees (translation: the bigger the words your adviser uses, the higher your annual fees). For all that however, there are one or two words worth remembering when it comes to your investments. These are the phrases ‘standard deviation’ and ‘Sharpe ratio’. Standard deviation is borrowed from statistics and is simply a measure of how spread out a sequence of numbers is from the average of those numbers. For example, take the numbers 10, 20 and 30. The average of these three numbers is 20, as is the average of the numbers 0, 20 and 40. The second set of numbers would have a higher standard deviation however, as there is a greater range between the average of 20 and the low of 0 and the high of 40. The same reasoning applies to investment returns. Would you rather have a portfolio which earned 5% in January, February and March; or a portfolio which earned -5% in January, 20% in February and 1.5% in March? In both cases your final return is the same, but the second example is far more volatile and with a much higher standard deviation (in fact the first example has zero standard deviation as all the numbers are exactly the same). The Sharpe Ratio is simply your portfolio’s (or investment’s) return (less the risk free rate) divided by its standard deviation. So for two portfolios with the same return over a year, the one with the lower standard deviation will have a higher Sharpe Ratio and is the portfolio you should want.

So next time you’re being bamboozled with financial jargon, bamboozle back and ask to know your portfolio’s Sharpe Ratio compared to the alternatives. You may be surprised at what you find.

This article originally published in The Northern Daily Leader on 7 June 2014.

Have you ever noticed how television and movie producers use music to set the mood or convey emotion? You can see this in action by watching a horror movie with the television on mute. Instead of scary, frightening, edge-of-your-seat viewing, it turns it in some very dull footage of people aimlessly walking around. You can try this next time you are home alone watching a scary movie and the music starts building up to a dramatic moment. Simply put the volume on mute and all the drama and tension is lost. It can be a bit boring watching an entire movie without any volume, but it probably beats being scared to death by some guy wearing an ice-hockey mask and wielding a chainsaw.

Unlike silent movies however, in the investment world, being boring should be welcomed. Many people may associate boring investments with low returns, but the reality is that the relationship between risk and return is not always a linear one. You may increase the possibility of a higher return by taking on more risk, but sometimes the level of risk increases far more quickly than the potential return. I was reminded of this during a recent discussion with a client. We were discussing risk and return and I retold an anecdote from my earlier days as an investment adviser. This was in the years preceding the global financial crisis, where annual stock market returns regularly exceeded 15%. Potential new clients had come in regarding the investment of the proceeds of the sale of a small business. After listening to an outline of our approach and investment philosophy, the potential clients left and were never heard from again. Sometime later we bumped into the potential clients at a social function. During a brief and friendly discussion, they apologised for not returning but said that our firm was simply “…too boring for us.” Instead they had invested their life savings with another firm called Storm Financial. Of course, you may recognise the name Storm Financial as being the Townsville-based business which was involved in the loss of billions of dollars of investor’s funds in the GFC. Storm Financial offered an apparently exciting approach to making money, founded on using debt to juice returns. The problem with debt however, is that it amplifies both gains and losses, as many investors with Storm sadly discovered during the GFC.

Given the choice between a slow and relatively uneventful accumulation of wealth, or a wild ride which may leave you either living like a king in the penthouse or struggling to get by in the doghouse, it’s not hard to see why boring can be an attractive option.

This article originally published in The Northern Daily Leader on 24 May 2014.

Once of the joys of living away from the coast is that you get to enjoy the seasons. Instead of the monotonously perfect weather you might find at the coast, we get to be hot in summer and cold in winter, just like it should be. While summer can be fun, winter is my favourite time of year – not only is there no need to dust off the lawnmower, but you get to settle down each evening in front of a warm and cosy wood fire, if you’re lucky enough to have a wood heater. Some people may prefer the convenience and instant warmth of central heating or a reverse cycle unit, but for me a wood heater wins hands-down. I even enjoy the rigmarole which accompanies having a fire – splitting and stacking the wood, fiddling with paper and matches, trying to coax a cold fire back to life and hunting for kindling in the garden.

Over the weekend, during a search for suitable kindling, it occurred to me that perhaps looking for kindling was more dangerous than you might think. It probably depends on where you live of course, but our house is on a bushy block, with plenty of trees and scrub. I imagined myself reaching out to grab a piece of kindling in the evening gloom, only to find I had latched on to a wriggly snake (I guess it would have to be a snake with poor hearing, as it would be impossible not to hear me stomping through the scrub). Sticks and snakes look quite similar in the near darkness, so it’s not an impossible outcome. Always on the lookout for ideas for this column, I immediately thought that this is a good analogy for the investment process. When you invest in a company on the stock market, you can’t be completely sure of whether you’ve just picked up a stick or a snake. The problem is that both good and bad investments, as with sticks and snakes, can appear remarkably similar, at least on the surface. They both probably have a professional website, publish glossy financial reports and have suitably-qualified management and directors. Some go on to reward investors, others however join the ever-growing list of duds (ABC Learning, Babcock and Brown and HIH, just to name a few).

So how do you tell the difference between a stick and snake in the world of investing? At Baiocchi Griffin Private Wealth we focus on a number of key issues: governance and management; balance sheet strength; industry sustainability and consistency of profits and dividends. To truly distinguish the good from the bad means taking more than a cursory glance; just the same when it comes to spotting the difference between a brown stick and a brown snake.

This article originally published in The Northern Daily Leader on 10 May 2014.

An old friend of mine from university, Mike, only just avoided financial disaster a few years ago, and it was purely by luck. Mike worked in the London office of Enron, the large US-based energy company. Enron traded in commodities such as electricity, natural gas, communications and just about anything else which could be bought or sold for a profit. At its peak, the company had revenues of nearly $100 billion and it was regularly named as one of America’s most-admired companies. Enron even figured out a way to make money from the weather, buying and selling futures and derivatives based on potential future weather outcomes. If it rained in Spain, Enron would most likely make money, based on how they structured a complex swaps trade involving the future profits of olive farmers in Catalonia. Wherever there was an opportunity to exploit and make money from, Enron found it and jumped in feet first. But back to Mike. After years of employment at Enron, Mike moved to another company, taking his pension plan with him. Much like our superannuation, Enron had set up a pension plan for employees, but when you left you had to cash in the proceeds and transfer it somewhere else. The difference with Enron’s plan was that it invested almost solely in Enron shares. So every employee in the company had their entire retirement riding solely on the fortunes of Enron.

In 2001 it was revealed that Enron had been falsifying its financial statements for years, with much of the reported profits being simply figments of management’s imagination. As you would expect, the company collapsed into bankruptcy and all 15,000 employees lost not only their jobs but also almost all their retirement savings, which was largely invested in now-worthless Enron shares. What is most surprising about the Enron saga, is that the people running the company and working for the company were widely viewed as some of the smartest people around. In fact, the documentary movie charting the rise and fall of Enron is titled ‘Enron: The Smartest Guys in the Room’, because that is often what they were: the smartest guys in a room full of other people usually were from Enron. But smarts counted for little when the company collapsed, everyone lost their jobs and the top executives ended up in jail. In the world of investing sometimes you can also just be too smart for your own good. A fancy title and a large office often leads to hubris, not humility, and that’s where the trouble starts. So next time you’re thinking of investing with someone who thinks they’re smarter than anyone else in the room, think of Enron and maybe think again.

This article originally published in The Northern Daily Leader on 26 April 2014

For many men, choosing a birthday or Christmas gift for their wife or partner is a tricky task. Do you go for the bold and high risk approach of making a unilateral decision regarding lingerie or perfume, or do you stick to the tried and tested – a bunch of flowers, some hand cream and nice smelling soap perhaps? For me the choice is always a simple one – kitchen appliances. Liz has a deep love for kitchen appliances and it shows – blender, bread oven, food processor, juicer, mixer, slow cooker, pie-maker and sandwich press. She has them all. There isn’t a kitchen appliance yet invented which hasn’t found itself a place in our kitchen. It’s got to the stage where I have to spend time hunting down rare and exotic appliances which haven’t yet become mainstream – internet-enabled toasters, talking kettles and nuclear-powered pressure cookers are all in the running for this Christmas.

Interestingly however, (Liz, it’s best you stop reading now), all these appliances haven’t necessarily resulted in a corresponding improvement in breakfast, lunch and dinner. The dishes prepared in the kitchen, while already of a very high standard (saved myself there I think), have not improved to the extent that would be expected, given the plethora of fancy appliances. What this seems to show is that the ability to cook well is not dependant on having access to a wide range of expensive appliances. If you know your way around a kitchen adding more and more appliances is not necessarily going to make an enormous difference to the quality of your cooking. It may be easier perhaps, but the skill comes from within, not from a heavy-duty mixer which costs as much as a small car.

The investment world too has a liking for fancy complicated devices that offer the promise of high returns at no risk. They usually come in the form of a computer program or newsletter service which promises to show you how to consistently buy low and sell high, all for the low price of thousands of dollars per year. There’s usually an abundance of technical buzzwords and acronyms, all designed to create the appearance of expertise and special knowledge. The reality however, is that if you had created a fool-proof method for making money from the stock market, would you be willing to sell it for a few thousand dollars a year? Wouldn’t you rather keep the secrets to yourself, making money while lounging around your own private island in the Caribbean? The truth is that there are no short-cuts, secret recipes or fancy electrical devices to help you succeed in investing. The principles of sound investing were laid down as long ago as 1934 by Benjamin Graham, long before talking pie-makers or flying kettles.

This article originally published in The Northern Daily Leader on 12 April 2014.

We recently returned from a short holiday at the coast, enjoying the waves, sand and relaxed atmosphere of a beachside town. The holiday itself was not as relaxing as it once used to be; both our youngest (18 months) and eldest child (3 years) have no concept of holidays, happy to wake up at 5:30 in the morning, holiday or no holiday. Rather than lazy long sleep-ins, hours on the beach reading and day-dreaming, it was a holiday of nappies, day-time naps, evening tantrums and early morning roll-calls. Still, I wouldn’t have changed it for the world, enjoying sand-castle building, fishing and braving two-foot high waves with Jack clutching tightly to my hand. Those days at the coast gave me some time to reflect on the concept of owning a holiday home. A permanent holiday house at the beach seems appealing – spur of the moment trips to the coast; a sense of ownership; no booking, availability hassles or rental costs. The reality however can be a little bit different: seemingly endless maintenance bills; holidays spent cleaning and repairing your property; that nagging feeling that you should be making more of your investment and being overrun with friends and family just when you feel like some quiet time at the beach.

As attractive (or not) as owning a holiday home may seem, one way to look at it is through a comparison of the alternatives. For example, if you owned a holiday home worth $400,000, you always have the option of selling the property and investing the proceeds. A reasonable income return assumption suggests that you could earn $20,000 a year from your investments (potentially tax-free, depending on your circumstances). Each year you could then spend $20,000 on holidays wherever you fancy. Skiing in Europe perhaps, maybe a cruise to Fiji and back, or you could even book a cabin at Cradle Mountain Lodge for nearly three months every year. No cleaning, maintenance or other issues to deal with. On hard numbers alone, owning a holiday home seems to make little sense. Much like renting usually allows you to live in a house you could never afford to buy, selling your holiday home and investing the proceeds may allow you to have the holiday you could never afford to have. But, and it’s a big but, this argument ignores the value placed on ownership. The ‘utility’ we derive from home ownership, whether at the coast or otherwise, can often far outweigh the rational financial argument of selling up and spending the investment earnings. In finance, just as in life, emotion can be more important than the hard numbers. Making the right decision in balancing the numbers versus the emotion is as important as judging when to jump or when to duck when that big wave comes.

This article originally published in The Northern Daily Leader on 29 March 2014.

The sporting world makes a significant contribution to the English language. Sporting terms and phrases form an evocative part of our everyday vocabulary. You can almost have an entire conversation using just sporting analogies: “How was your day today?” – “A little bit below par really (golf). I had a boring meeting with Dave from Accounts; you know him, the guy with the attractive girlfriend – he’s really punching above his weight (boxing). But the day ended well, I gave a sales presentation and knocked it out of the park (baseball).” And speaking of baseball, it was Warren Buffett, acknowledged as one of the most astute investors of all time, who had some insightful investing advice when he said “You don’t have to swing at every pitch”. What Warren was saying was that you don’t have to buy every company you come across. The market will ‘pitch’ an infinite number of companies at you, but you needn’t feel that every one of them is a buying opportunity. Choose what to buy carefully and you are more likely to be buying the right companies and not the wrong ones.

In fact, it’s arguable that what you don’t buy is more important than what you do buy. Just one HIH, OneTel, ABC Learning or Poseidon Nickel can wipe out all the hard-earned gains from success stories like Ramsay Healthcare, Commonwealth Bank or Flight Centre. More than half the battle is won if you can avoid adding the inevitable disasters to your portfolio. Outright fraud or theft are difficult to predict, but the usual suspects of too much debt, empire-building and structural change are easier to spot. Empire-building and too much debt often go hand in hand, as the empire is usually largely debt-funded. It’s one big party when the money is cheap and easy, but nothing unravels faster than an over-leveraged business that loses the support of its bankers. Just ask Nathan Tinkler or Eddy Groves. Structural change is less exciting and usually a lot slower, but produces the same results. Yahoo!, Holden and just about every manufacturing business in Australia are examples of the impact of structural change. Businesses can and do change and innovate, but the new business is often just a shadow of the first. Like the proverbial frog in a pot of slow boiling water, structural change can have a slow and almost imperceptible impact on a business, but the results can be just as fatal. So next time you’re thinking about having a ‘swing’, ask yourself if it’s going to be a home-run, or just another strike on your investing record?