Your Expectations Versus Reality

I remember learning about tech stocks in my high school economics class. It was the late 90’s, and the internet was a new thing for me (and us). I remember my friends and I would stop by the local computer store after school and book the one computer that was connected to the internet just so we could see what the fuss was all about. Sausage Software was the company that was making all the noise at the time – a Melbourne based company, who I believe, were in fact based in Doncaster (I could be wrong!).

At its peak, just before the dot com crash in April 2000, Sausage shares hit $40, briefly valuing the company at close to $1 billion. A year later the stock had fallen to $1.80.

The company no longer exists.

Here’s a rare interview by Business Sunday of the founder, a 23 year old Steve Outtrim. It’s funny how the tech scene hasn’t really changed since the mid 90’s – kids in crazy t-shirts, baseball caps, roller blading into the office.

You never know what’s around the corner, and how these things will play out. I recently saw these two posts on Twitter, which caught my attention. They are truly interesting facts.

Hindsight is a wonderful thing. And for all the headlines these companies are making, investors would have had to go to hell and back in order to participate in the triumphs of these two extraordinary companies. Sure, it’s all smiles and champagne for Bezos and Hastings, but allow me to shed some light on this journey:

Amazon

  • The stock drops 50% in 1999.
  • In fact, the stock has seen multiple drops of 50%+.
  • Later in 1999, the stock tops US$107 and tumbles to US$7  over 2 years – a 93% decline.
  • It took another 10 years to get back to where it was in 1999.
  • In 2008, the stock fell 60%.
  • In 2015 the stock fell another 25% over the course of 12 months.

Netflix

  • Within 12 month of floating, the stock fell 55%.
  • Through 2005, the stock fell 76%.
  • During 2012, the stock fell 81%.
  • Through 2015/2016, the stock fell another 37%.
  • Most recently the stock fell 35% during 2018.

The point I’m trying to make is that these headlines are written in a way that appear as though the company went from US$1 to US$1,000 just like that. The reality is that most investors would not have been able to handle the volatility that comes with these gains. Human beings are wired in such a way that we fear losses more than we enjoy gains. And because of this, I am confident you would have sold your Amazon and Netflix position after your 55% decline. Or the 60% decline. Or the 81% decline. Or the 93% decline. You get my point (hopefully).

Sausage Software was also worth billions. And just like that, the company is gone and Steve Outtrim is now making headline for different reasons.

I’m not saying Amazon or Netflix are terrible companies, in fact quite the opposite. I think they’re great businesses, which I am a customer of both. I just think that investors need to avoid falling in love with these fantasy headlines – they never happened as easily as they’re made out to seem.

The Boy Who Cried Wolf

A shepherd-boy, who watched a flock of sheep near a village, brought out the villagers three or four times by crying out, “Wolf! Wolf!” and when his neighbors came to help him, laughed at them for their pains.

The stock market reminds me a little of this classic story. Human psychology fascinates me. For all the market’s ups, downs, twists and turns, you would think that investors would have become accustom to the stock market’s cry for wolf. Alas, human beings are not wired to do so.

It wasn’t too long ago that the Aussie stock market was down 10%, and global stock markets down around 20%. The Aussie stock market has recently made a high we haven’t seen since pre GFC.

To celebrate the recent milestone, let’s take a look at what is considered a pullback, a correction, and a bear market. These terms that I am using are basically financial jargon – made up by pundits. Generally speaking, a pullback is a decline of 5%, a correction implies a decline of 10%, and a bear market is a decline of 20%. Now that I have impressed you with my financial terminology, let us continue.

Pullbacks

These happen a couple of times a year – most people don’t even realise.

Corrections

On average, the stock market sees one correction per year. The average length of a correction is 71.6 days. On average stocks decline about 15.60%. Once the decline hits it’s bottom, the market typically takes about 4 months to get back to where it was.

Ben Carlson found that when stocks cross the 10% decline threshold, almost half of the time they don’t fall more than 15%. About 60% of the time, according to Carlson, a decline of 10% doesn’t foreshadow a bear market; 40% of the time it does. Perhaps this explains nervousness among investors about a moderate and normal 10% decline. Since we tend to fear losses more than we like gains, this might account for the anxiety — the expectation that worse is to come.

In fact, between 1980 and 2018, the US stock market has declined about 10% 36 times and 5 of those corrections resulted in longer bear markets. The other 31 transitioned relatively quickly back into bull markets. In other words, in recent history, about 14% of corrections were the start of a prolonged downturn – but most are just blips on the radar.

Bear Market

Now this is something different. Investors find a new level of craziness at this point – perhaps residual post traumatic stress from the GFC. Markets have always recovered from what has been proven to be a temporary bear market – although it never feels like it during the time. We’ve all experienced a bear market in varying degrees. From 1973 where the stock market fell about 57%, to the dot-com bubble where the stock market fell about 88%, to the GFC where the stock market also fell about 57%.

The world economy will continue to rise and fall. Investors will continue to anticipate and respond to global events. I will leave you with the below chart (click for larger image) which illustrates the performance of the US stock market since 1896. It shows the market’s peaks and troughs, a reflection of the US economy’s triumphs and tribulations.

At its simplest, the chart proves once again that over the long term, the stock market always rises because intelligence, creativity, and innovation always trump fear. Yet at the same time, it also underscores the basic mantra that market participants need to stay nimble during times of uncertainty to maximize their returns.

Elections And Investing

With Australia in the middle of another general election campaign and facing the prospect of a change of government, investors may ask what implications the political cycle has for financial markets and for their own portfolios.

Media commentators often say that elections pose significant uncertainty for markets, as investors weigh the prospect of policy change and how that might impact on overall sentiment, the direction of the economy and company earnings.

It is true that in this federal election, the opposing platforms of the incumbent Liberal–National Coalition and opposition Labor Party feature significant differences in tax policy that may impact on individual investors depending on their circumstances.

But it is also true that in terms of macro–economic policy, there is little separating the two major party groupings, who both express a commitment to fiscal responsibility, independent monetary policy, free trade and open markets.

Certainly, if you look at history, there is little sign of a pattern in market returns in election years. Since 1980, there have been 14 federal elections in Australia. In only three of those years (1984, 1987 and 1990), has the local share market posted negative returns. (See Exhibit 1).

This isn’t to imply that federal elections are ‘good’ for shares either. Firstly, this sample size is too small to make any definitive conclusions. And, in any case, it is extremely hard to extract domestic political from other influences on markets.

For instance, 1983, a year in which the Australian market rose nearly 70% and in which Bob Hawke led the Labor Party to a landslide election victory, also coincided with the end of an international recession and the floating of the Australian dollar.

Likewise, the election year of 2010 was one of the poorer years for the local market. But this was also the year of the Euro crisis as worries about Greece defaulting on its debt triggered concerns for fellow Euro Zone members Portugal, Ireland, Italy and Spain.

Neither is there much evidence of a pattern in returns based on which side is in government. Over the near four decades from 1980, there have been four changes of government in Australia—from the Coalition to Labor in 1983, from Labor to the Coalition in 1996, back to Labor in 2007 and to the Coalition in 2013.

During the Hawke/Keating Labor governments of 1983–1996, the Australian market delivered annualised returns of 16.4%, the best of this period. But this wasn’t markedly different than what was delivered by the global equity markets in the same period.

During the 11–year era of the Howard Coalition government from 1996–2007, the annualised return of the local market was 14%. While this was twice the return of the world market in the same period, the latter half of this period included the China–led resource boom. (See Exhibit 2).

Put simply, while Australian general elections are understandably a major media focus, there is little evidence that whoever is in power in Canberra has a significant impact on the overall direction of the local share market. Of course, specific policy measures proposed by an incoming government can impact on individual investors within that jurisdiction, depending on their asset allocation, investment horizon, age, tax bracket and other circumstances.

But these are the sorts of issues that are best explored with a financial advisor who understands your situation and how any tax or other change might influence your position. The bigger point is that markets are influenced by many signals and events—economic indicators, earnings news, technological change, trends in consumption and investment, regulatory and policy developments and geopolitical news, to name a few.

So even if you knew the election outcome ahead of time, how would you know that events elsewhere would not take greater prominence? In any case, if the major policy changes are flagged ahead of the election, markets have already had the opportunity to price them in.

In the meantime, for those concerned about individual tax measures, it is worth reflecting on the benefits of global diversification and moderating your home bias, as this reduces the potential impact of policy changes within your own country.

Contributor: Jim Parker

5 Strategies to Stop Your Kids From Blowing up The Family Wealth

Any fool can make a fortune. It takes a man of brains to hold onto it after it’s made.

– Cornelius “The Commodore” Vanderbilt

We’ve all heard the story of the Vanderbilt family. A US$5 billion (adjusted for inflation – 2017) balance sheet was depleted within 20 years. No Vanderbilt would be among the richest people in America after this time. In fact, when 120 of the Commodore’s descendants gathered at Vanderbilt University in 1973 for the first family reunion, there was not a millionaire among them.

From rice paddies to rice paddies within three generations.

– Japanese proverb

Statistics back up this folklore. Several studies have found that 70% of the time family assets are lost from one generation to the next, and all assets are gone 90% of the time by the third generation.

More often that not, families focus on those who have created with wealth. Seldom is the focus on the potential receivers of the wealth – this is where we need to focus if we want our legacy to continue. Investing your family’s assets and crafting a careful estate plan are critical in ensuring success, however, so too is the preparation of your heirs. A successful inheritance is just as much about parenting as it is about money management.

So what does it take to preserve the millions (or billions)? Here are five ways you can increase the chances of preserving the family fortune and not becoming just another statistic.

Money is not a dirty word

Money is not a popular topic over the family dinner table. Especially if parents are worried that it will spoil their kids. Young people who inherit such wealth, without any preparation, like lottery winners, can be completely derailed.

The uncertainty of whether they’ll outlast the family’s wealth, or the uncertainty of how to deal with the topic generally keeps parents silent. Yet, they’re forever discussing the topic between themselves, speculating a to what they children might or might not want. Whatever the reason for the lack of communication, heirs who are ill-prepared are left to wonder why their parents thought they were incapable of handling the information or couldn’t be trusted. It’s best to drop the ego, and get on with the conversation – discuss the wealth you have and your plans for it.  Get your children involved. Find out what’s important to them and the things they’re passionate about. And don’t forget about how it came to be in the first place, especially if it was created several generations ago.

Embark on a mission

Most people know it subconsciously, yet so many people ignore it consciously. Life is about more than money, and that money is simply a means to an end. Make sure your legacy is about more than just money too. What are your family values? What is your family’s purpose? What is your life truly about? What is your legacy?

Involving the entire family in determining common objectives and deciding how they’ll be accomplished avoids the trap of your children being dictated to, and you dictating to your children. It gives you the opportunity to express your preferences to you children, as well as the opportunity for your children to express theirs to you. It may also ease tension between family members, especially between those running a business for example, and those not involved.

Discuss money at a young age

Even at an early age, children should be taught money skills – having one thing may mean not having another – from budgeting to instant gratification. A common concept is to give your children three piggy banks, one for savings, one for spending, and one for giving. Children need to learn the concept of priorities and decision making. If you haven’t seen The Marshallow Test, it’ a must watch. Standford University ran this experiment, which was performed on young children demonstrating the significance of delayed gratification.

Put on the training wheels

Avoid the mistake of concealing all the family’s wealth in the pursuit of protecting your children and preserving your wealth. You’re probably doing more long-term damage than good.

Help you children invest they’re money. Assist them in researching different investment options. Match their contributions to incentivise their saving. When it comes to giving, ask your children to decide who and what they would like to support. More importantly, ask them to explain why. The onus is on us as parents to educate our children, our schools certainly aren’t doing it.

Assemble a strong team

Over and above your financial adviser, tax adviser, and lawyer, you may want to bring in mentors and coaches for your children (it could also be the same people mentioned above). The advice of an independent person or an outside expert, over and above mum and dad’s opinion, can make a big difference. Although the advice may echo the advice on mum and dad, the impact it has on your children can be remarkably different.

The outside expertise can come in handy when your children are faced with money related decisions. Whether it’s your children’s friends asking them for money, or the never-ending European trips with friends, or that next hot tip investment – one of the surest ways to wither away an inheritance, an independent coach can act as a sounding board and guide.

In the end, you’ll have the best shot at preserving both your wealth, your legacy, and your family with a multi-generational effort that begins when your kids are born, not when you die. Unlike investing, where timing can be critical, there’s no bad time to invest in your family’s legacy.

What’s your plan to preserve your hard-earned wealth?

Source: https://www.kiplinger.com/