How to Double Your Money

Stop whatever you’re doing and do the following equation in your mind. No calculators, okay:

5 + 5 + 5 + 5 + 5

Got it? Great. Now do the following equation in your mind:

5 x 5 x 5 x 5 x 5

Not as easy is it? Why?

As human beings we underestimate the power of small numbers and the impact they can have when added together – we underestimate the power of compounding. Because it isn’t intuitive we ignore it and try and solve the problem through other means.

The compounding of investments is such a powerful thing. Even the average investor can double their money in the stock market, time and time again – that’s if they stick with their stocks over the long run. One of my favourite bloggers, Josh Brown AKA The Reformed Broker recently hit the streets to help people wrap their heads around exponential growth and real wealth building. Here’s the video – watch it.

Source: CNBC

If the link doesn’t work, click here.

Time can be a better friend to investors than experience, connections, expertise, or even research. And yet so few people seem to have a good grasp of the power of compounding.

By the way, the answer to the above equation is 3,125. But hey, you knew that right?

My Monday Rant

Last week I copped a bit of criticism following my Safe As Houses post. Here’s the first:

2 major flaws in your chart, which would suggest your post is indeed ‘enticing narrative’; – If you factored in the income from each of these assets, including the fully franked dividend from the CBA, you would find the CBA has delivered somewhere around 200% of the income return of property – What is the impact if you took said income and reinvested it? Massive… I’d love to see your chart then. Capital Growth is only one component of your return and in the case of the CBA, represents around half your return.

This reader raises a valid point – dividends and the impact and power of compounding returns. I decided to ‘tidy up’ my analysis. So I included CBA’s dividend, reinvested it (although not everyone reinvests dividends), and compared the return to Melbourne and Sydney house prices in nominal terms. I chose Melbourne and Sydney given the share of CBA’s loan book these two cities.

And voilà, here’s what we have. Although I didn’t have time to incorporate rental income from the two cities, the outcome is no different. I also note the chart is not a common base chart, i.e. all investments start at the same point, which means Melbourne’s end price would be higher given the lower start price.

You can see the correlation and behaviour is very similar. Another reader writes:

With two sides of the story being capital growth and income received I don’t think you have provided great understanding of the correlations and drivers of both property & shares and underrepresented both.

My original article was providing evidence of the correlation between residential property and CBA’s share price, and was being done so not based on the two being mutually exclusive.

The reader continues…

Families need to understand whether they want to have a part time job, maintaining a property portfolio, chasing rent, keeping tenants, fixing broken water pipes, paying real estate agents, paying lawyers. Or whether they would like a set and forget strategy of investing in the great companies of this world, where they pay a financial adviser, a platform and investment fee and they can enjoy what’s most important to them.

Although the reader seems to have misunderstood the intent of my original article, they raise a valid point. Investing in direct property can be both time consuming and costly. For this reason, most investors hire a real estate agent. They take care of the maintenance of the property, they both find and keep tenants, they arrange for the broker water pipes to be fixed, and yes, we pay them a fee. Just like our clients pay us for the services we provide. I would have also thought that property can be a ‘set and forget’ investment too, can it not?

The alternative the reader provides us with is to hire a financial adviser, pay them, hire a platform, and pay them, then pay the investment fees, and forget all about it.

I admit, my comments are tongue in cheek, but what these comments proved to me, yet again, is that those with vested interest will continue to peddle the narrative that best suits them. Walk into a Holden dealership, you won’t be sold a Toyota.

Investors deserve the truth. Investors deserve to be educated. Investors deserve the right to know what we as advisers can help them with and cannot help them with, not what we will and will not help them with – there is a difference.

My original article was not to spark debate between property or shares. Both asset classes not only behave very differently, they both serve different objectives. History tells us that both Australian shares and Australian residential property have performed broadly in line with each other over the long-term. Australian shares have provided a slightly higher rate of return, however Australian residential property has provided investors with a smoother ride along the way.

Source: AMP

I kindly remind you, as investors, look beneath the investment and ask yourself the following questions:

  1. Where am I allocating my money?
  2. What is the underlying investment?
  3. What is the investment influenced by?
  4. What am I really investing in?

Most importantly, ask yourself this question:

What is the objective/purpose of my investment?

Here’s the blueprint for how to think about investing in it’s simplest form – a snippet from our Intergenerational Wealth Transfer forum in 2018.

God speed.

Safe As Houses

I recently attended an investment forum lined up with a bunch of bond and equity managers pitching their great ideas. It was held in Crown’s Palladium, and the room was full. I can’t imagine what it cost these folk to get a guernsey for the day – but I know who’s ultimately paying for it (and I’m sure you do too).

Our industry is full of smart people and not so smart people. It’s dominated by cool charts, engaging narratives, long disclaimers, Italian neckties and hand bags, and fancy lunches and dinner. Whatever can be controlled will be controlled, all in the pursuit of influence – one way or another.

There was one presentation by a stock market fund manager that confused me slightly. Yet it provided me with such clarity.

The confusion

The gentlemen was speaking about the ‘over-inflated’ property market, at the same time presenting the audience with a number of convincing PowerPoint slides. He then went on to explain why Australian shares, specifically the Australian banks, provided investors with far better value. This was difficult for me to follow. As an investor and avid market follower, I am fully aware that the Australian banks have their fair share of exposure to the property market. I mean, this is how they make their money, right? So I decided to run the below chart. It shows Australia’s real house prices (blue), and CBA’s share price (orange). Can you spot the trend?

On one hand we’re being told not to invest in Australian property, yet on the other, we’re being told to invest in ‘blue chip’ Australian banks. Can you see the reason for confusion?

The clarity

What was made very clear to me was that the stock market guy or stock market gal is going to plug their asset class by torching others. It’s sad, but true. I guess you’re not going to be sold a Holden when you walk into a Toyota showroom, right?

What’s worse is that investors are being fooled into a narrative that lacks evidence and substance. The pitch also got me wondering about the extent to which investors undertake analysis about their own investments. Where am I allocating my money? What is the underlying investment? What is the investment influenced by? What am I really investing in? Investors really need to be peeling back the onion.

Secure debt is another example. Investors hear the words and shake their heads, that’s too risky. Yet they’re very comfortable to take an equity position in a business that does this very thing. Where am I allocating my money? What is the underlying investment? What is the investment influenced by? What am I really investing in?

If you haven’t seen this before, it’s a simple table that shows you the lowest risk (senior secured debt) investment to the highest risk (equity) investment.

Next time you are reviewing an investment opportunity, ask yourself these questions. Take the time to truly understand what and where you are investing. Filter the noise and start to make informed and educated decisions about where you allocate your capital.

Those investments, make sure they’re safe as…houses?

The Greatest Property Bubble or A New Beginning?

Melbourne’s population is booming, and it has not only become one of the wealthiest cities in the world, but has also developed an international reputation as one of the greatest cities in the world.

Melbourne is in the midst of a land and property boom. Rather than building high-density apartment blocks like the European cities, Melbourne expanded wide and far. Real estate is ‘The Land of Promise’, as proclaimed by this sales poster for Moreland Road, Brunswick.

Investors are buying up farms and subdivided them. They are luring buyers with free railway passes out to the new estates, feeding them and serving champagne before bidding gets underway. In fact, the value of land in parts of Melbourne is as high as London.

The Argus newspaper wrote, ‘[The hunger] that has seized hold of so many people is the result not of an hallucination, but of an awakening to the value of land as a safe, a sound, and a profitable investment.’

I’m talking about Melbourne in the 1880’s – it was dubbed ‘Marvellous Melbourne’. Here we are in 2019, and the tune hasn’t changed in 140 years.

In April of 1893 the bubble had popped, and the boom was over. Melbourne’s unemployment rate jumped to 20%. Property prices dropped almost 40% (Melbourne) within years, which compares to a drop of 20% during the 1930’s depression. It would take Melbourne 60 years to recover.

Every bubble is different. Their formation varies from duration, magnitude, and cause. It was higher interest rates that would eventually pop the bubble of the 1890’s, and the banks’ failure to take security for loans written during this frenzy would lead to the collapse of a number of them.

With bank lending having soared since 2012, prices having doubled during this time, and interest rates at an all time low, could we be facing another crisis like the one that has been buried in history books for decades? Or is it different this time?

According to the media, Australia’s property bubble is akin to that of the US.

When people refer to the US property bubble, I ask them which city they’re referring to. Sure, the US had a property meltdown, however not all cities we’re wiped out. New York fell 24.45%, Dallas down 7.53%, and Boston fell 16.38%. In fact, it wasn’t even the cities that had the largest growth pre-GFC that fell the most (refer LA and San Francisco). On average, prices in major cities fell around by one third of their value.

Similarly, when people talk to me about the Australian property bubble, I ask them which city/ies they’re referring to. In Australia, it’s largely been a story of Sydney and Melbourne.

I decided to run a few charts to analyse the current state of play:

Australian Real House Prices

Here’s a long-term view on real house prices:

Major City House Prices

Since the RBA started cutting rates in 2012, house prices doubled in major cities. Since peaking in 2017, Sydney is down 14% and Melbourne 11%. Hobart continues to climb, and prices rises in Sydney and Melbourne guide investors to cheaper cities.

Residential Building Approvals

The story of Australia’s construction boom has been one of apartment construction. Detached housing has been moving sideways for sometime now. Economics 101 tells us that when the supply increases, price decreases, and when supply decreases, price increases. This is the story of apartments and detached housing.

Price to Income Ratios

This ratio tells us how much of the median income (as a multiple) does it take to buy the median house. For example, in Melbourne, it takes 10 times the median income to buy the median house. In Sydney it’s 13 times. In Hong Kong it’s 20 times. It seems as though global ratios are converging following a massive divergence pre GFC.

Housing Finance Commitments & House Prices

There’s a strong correlation between the amount of debt the banks lend out and house prices. In fact, house prices lag lending by about 6 months. The data tell us that lending is still falling.

Auction Clearance Rates

This is one of my favourite charts because they are timely and have a good cyclical relationship with property prices in Sydney and Melbourne. Clearance rates have been declining for some time now, although you can see a little kick post election – something to keep an eye on.

House Prices & Household Debt

This chart shows us the strong relationship between debt and property prices. Overvaluation in prices really started in 1996 –  it’s popular to blame negative gearing, the capital gains tax discount and foreign buying for high home prices and debt. However, the basic drivers are a combination of the shift from high to low interest rates over the last 20-30 years boosting borrowing power, along with a surge in population growth.

Dwelling Construction & Population Growth

For many years we have had a supply issue in this country (thanks to tight development controls and lagging infrastructure). It’s expected that Victoria will be home to about 8 million people by 2050.

And these people will want somewhere to live, surely. Based on these numbers, it may come as a surprise to most people, but we’re just now starting to build enough property to help support our growing population.

Sure, we’re going to see periods of oversupply and periods of under-supply, which in turn will result in periods of price growth and periods of price declines. This is not unusual, the free market has been valuing assets this way for centuries.

Bank Non-Performing Housing Loans

Although non-performing loans are down from their GFC peak, they have kicked up since late 2017. A switch from Interest Only loans to Principle and Interest loans have been driving servicing costs.

They say investors have a three year time horizon.

As human beings we’re wired in such a way that makes it difficult for us to be able to see so far into the future. Take the city of Melbourne for example.

Here’s the evolution of Melbourne city over 130 years, in images, taken from the top end of town – Spring Street:

Here’s Melbourne today:

Between 1% and 3% of a city is demolished and rebuilt each year, such that over almost a lifetime, a city is completely transformed and almost recognizable. Incremental change is so difficult for us to recognize, however over long-periods of time, it’s clear as day.

If for one moment you think our city can no longer be built out, here’s the City of Melbourne’s Development Activity Model. Here’s the city as we know it today:

Let’s add the buildings under construction (yellow):

And those that have been approved (green):

And those that are in application phase (blue):

As investors we need to fight the minute by minute news headlines that try and grab our attention each and every day. Although we are not wired to, we know deep down that true, significant, and sustainable wealth is created over long periods of time – yet we want it all now.

We’re clearly in for another interesting year in property, one with moderate price growth in some locations and virtually no growth in others and falling prices in others.

Australia’s property markets are very fragmented, driven by local factors including jobs growth, population growth, consumer confidence and supply and demand.

Investors need to have a sound strategy and game plan. So when the opportunity presents you know exactly what you need to do, and how to do it. It also ensures you maximise returns and avoid unnecessary market and asset risk. Shooting off the hip is not a strategy.

Our property markets are behaving as they always do – boom, downturn, bust, boom, downturn, bust…

The biggest profits are made during the downturn and bust stage of the cycle – that’s because downturns are only temporary, while the long term increase in the value of good property is permanent.

Take the long-view.

Here’s What Michael Jordan And The Stock Market Have in Common

“Look at the air, look at the hang time, look at the flying motion”

The debate is an ongoing one. Michael Jordan or LeBron James, who is the greatest player that ever lived. For me, it’s Michael – hands down. Sure, I’m biased – I grew up in the 80’s. The shoes, the jersey, the shorts, the posters – I was obsessed with him. Watching highlights of MJ now gives me goosebumps each and every time. His skill, his talent, his style, his accuracy, his precision, that air time would have not only the supporters in the stands up on their feet, but also the game’s commentators.

He was an absolute sniper with that ball in his hands. Leave him open for a split second, and he’ll put that thing away before you even had a chance to work out what happened.

Michael leads the NBA All-Time Points table with an average of 30.12 points per game. Quite impressive. But MJ’s scores per game were no where near his average. With the data that’s available, I have crunched the numbers. I looked at each game Jordan played and took the points he scored during that game. I was able to get my hands on 868 game data (Jordan played 1,072 games). I then calculated how many times Jordan scored 30 points in a game. The number is 35. Michael Jordan scored 30 points per game, 35 times in his career. In other words, 4.03% of the time he scored his average points.

Each blue dot in the chat below represents one game, and the red horizontal line represents an average of 30 points. You can see the range of scores that are well below and well above his average.

Data: www.landofbasketball.com

The Australian stock market has delivered an average annual return of around 13% since 1980. But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting your expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?

The chart below shows calendar year returns for the S&P/ASX 300 Index (Total Return) since 1980. The shaded band marks the historical average of 12.94%, plus or minus 2 percentage points. The S&P/ASX 300 Index had a return within this range in only four of the past 39 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.

Source: DFA

Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. The chart below documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the Australian market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.

Source: DFA

While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals during different market environments.

As you wouldn’t bench Michael when he’s scoring 15 points per game, investors shouldn’t be benching their investment strategy when returns are looking below average. If you’re not playing the game, you’re not scoring the points.

“There’s Michael Jordan and then there is the rest of us.”

— Magic Johnson

Take the long-view. Thanks for the memories Michael.