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.

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

How You, The Amateur, Can Beat The Pros

My family and I spent the Easter weekend over in Ballarat. Our kids had never been to Sovereign Hill. We ate boiled lollies, freshly baked tarts, and panned for gold. What a time consuming exercise gold panning is, but oh, how much fun it was. The amount of time, energy, and patience that is required is enormous. And even if you endure the process, the reward, a speckle. After spending almost 2 hours entertaining myself, here’s what I walked away with. I was assured the gold I had discovered was worth more than the $1 bottle I bought to put it in.

It’s been one month since the AFR reported It’s the end of an era in Australian funds management. Funds management is a tough gig, especially in this day and age as technology and fee pressure adds fuel to the fire. Professional investors are not all they’re made out to be – unlike professional sports. Consider this. You’re an avid boxing fan. You’ve got all the top gear, gloves and all. Would you jump in the ring with Mike Tyson?

Charles Ellis (founder Greenwich Associates) said, “Well, 90% of stock market volume is done by institutions, and half of that is done by the world’s 50 largest investment firms, deeply committed, vastly well prepared — the smartest sons of bitches in the world working their tails off all day long. You know what? I don’t want to play against those guys either.”

Playing their game on their terms will leave you and your portfolio for dead. There are however, a number of advantages amateur investors have over the pros. Here are my top 5:

Benchmarks: As a pro, you are measured against a benchmark day by day, second by second. Arbitrary or not, that’s that game. Rather than applying a considered long-term philosophy, short term comparison of benchmarks will eventually take hold. As an amateur, you have no benchmarks to compare yourself to each week, quarter, or year. You can feast on all the free market have to offer over the long-term.

Short-termism: As an amateur investor, you don’t have to trade as frequently as the pros. With all the twists and turns in the stock market these days, you can avoid making sticking plaster decisions by not reacting to all the noise and remain focused on the long game.

Doing nothing: With every zig and zag of the market, the pros needs to act. It’s difficult to justify fees and demonstrate expertise by doing nothing. So, they do more. As an amateur investor, you probably sat idle for that last 20% correction. Am I wrong? The pros, pulling their hair out for either missing the decline or not positioning themselves to participate in the recovery. Jack Bogle once said, “Don’t do something, just stand there.”

Fees: You can keep yours low. The pros cannot. Staff, conferences, flights around the world, expensive offices, legal and compliance departments are only just the beginning for these guys and gals. As an amateur, you have access to the US stock market for just 0.04%. The average pro charges 1.09% – that’s a 2,725% increase on what the amateur has access to.

Forecasts: You don’t need to make them. The pro’s do. And then they trade on it – despite there being ample evidence that they have any capability in this area. And I get it. Acknowledging that markets are very unpredictable in the short-term and responding with, “I don’t know” to questions that are asked of you, is not the way you climb the industry ladder. I guess it’s better to have a sophisticated point of view and be wrong.

Like panning for gold, stock picking is a damn hard game to play. Sure, it’s entertaining for those panning, but when the spectators (investors) have been waiting this entire time, and all you can produce is a speckle of gold (if that), and the speckle (return) is not worth more than the bottle of water (fees) you bought, which is more often the case, they’ll spit in your face and leave you for the dogs.

25 Things You Probably Know & Don’t Know About Investing

If you are ready to give up everything else and study the whole history and background of the market and all principal companies whose stocks are on the board as carefully as a medical student studies anatomy – if you can do all that and in addition you have the cool nerves of a gambler, the sixth sense of a clairvoyant and the courage of a lion, you have a ghost of a chance.

– Bernard Baruch

Making money in the modern market is tough. As investors, there are so many things we think we know, yet very few spend time thinking about the things they don’t know. Jim O’Shaughnessy, founder, Chairman, and CIO of O’Shaughnessy Asset Management recently shared what he thinks he knows and doesn’t know about the financial markets. I think investors should take note. Here they are:

  1. I don’t know how the market will perform this year. I don’t know how the market will perform next year. I don’t know if stocks will be higher or lower in five years. Indeed, even though the probabilities favor a positive outcome, I don’t know if stocks will be higher in 10 yrs.
  2. I DO know that, according to Forbes, “since 1945…there have been 77 market drops between 5% and 10%…and 27 corrections between 10% and 20%” I know that market corrections are a feature, not a bug, required to get good long-term performance.
  3. I do know that during these corrections, there will be a host of “experts” on business TV, blogs, magazines, podcasts and radio warning investors that THIS is the big one. That stocks are heading dramatically lower, and that they should get out now, while they still can.
  4. I know that given the way we are constructed, many investors will react emotionally and heed these warnings and sell their holdings, saying they will “wait until the smoke clears” before they return to the market.
  5. I know that over time, most of these investors will not return to the market until well after the bottom, usually when stocks have already dramatically increased in value.
  6. I think I know that, at least for U.S. investors, no matter how much stocks drop, they will always come back and make new highs. That’s been the story in America since the late 1700s.
  7. I think I know that this cycle will repeat itself, with variations, for the rest of my life, and probably for my children’s and grandchildren’s lives as well.
  8. Massive amounts of data have documented that while the world is very chaotic, the way humans respond to things is fairly predictable.
  9. I don’t know if some incredible jump in evolution or intervention based upon new discoveries will change human nature but would gladly make a long-term bet that such a thing will not happen.
  10. I don’t know what exciting new industries and companies will capture investor’s attention over the next 20 years, but I think I know that investors will get very excited by them and price them to perfection.
  11. I do know that perfection is a very high hurdle that most of these innovative companies will be unable to achieve.
  12. I think I know that they will suffer the same fate as the most exciting and innovative companies of the past and that most will crash and burn.
  13. I infer this because “about 3,000 automobile companies have existed in the United States”, and that of the remaining 3, one was bailed out, one was bought out and only one is still chugging along on its own.
  14. I know that, as a professional investor, if my goal is to do better than the market, my investment portfolio must look very different than the market. I know that, in the short-term, the odds are against me but I think I know that in the long-term, they are in my favor.
  15. I do know that by staking my claim on portfolios that are very different than the market, I have, and will continue to have, far higher career risk than other professionals, especially those with a low tracking error target.
  16. I know that I can not tell you which individual stocks I’m buying today will be responsible for my portfolio’s overall performance. I also know that trying to guess which ones will be the best performers almost always results in guessing the wrong way.
  17. I know that as a systematic, rules-based quantitative investor, I can negate my entire track record by just once emotionally overriding my investment models, as many sadly did during the financial crisis.
  18. I think I know that no matter how many times you “prove” that we are saddled with a host of behavioral biases that make successful long-term investing an odds-against bet, many people will say they understand but continue to exhibit the biases.
  19. I think I know the reason for the persistence of these “cognitive mirages” is that up to 45% of our investment choices are determined by genetics and can not be educated against.
  20. I think I know that if I didn’t adhere to an entirely quantitative investment mythology, I would be as likely—maybe MORE likely—to giving into all these behavioral biases.
  21. I know I don’t know exactly how much of my success is due to luck and how much is due to skill. I do know that luck definitely played, and will continue to play, a fairly substantial role.
  22. I don’t know how the majority of investors who are indexing their portfolios will react to a bear market. I think I know that they will react badly and sell out of their indexed portfolio near a market bottom.
  23. I think I know that the majority of active stock market investors—both professional and aficionado—will secretly believe that while these human foibles that make investing hard apply to others, they don’t apply to them.
  24. I know they apply to me and to everyone who works for me.
  25. Finally, while I think I know that everything I’ve just said is correct, the fact is I can’t know that with certainty and that if history has taught us anything, it’s that the majority of things we currently believe are wrong.

What is it about investing and financial markets that you don’t know?

The Hayne Royal Commission Could be Taking Things too Far. Here’s Why.

When you want to help people, you tell them the truth. When you want to help yourself, you tell them what they want to hear.

– Thomas Sowell

As the royal commission on financial advice continues to crucify the banks and their executive teams, I’ve been watching with great interest and can’t argue with the revelations to date. Late last week I came across this article, which irritated me a little to say the least.

Source: AFR

As grandfathered commissions are all but dead – and I would argue they should never have been grandfathered to begin with, the Hayne royal commission seems to now be moving its shiny bazooka toward ongoing fees charged by financial advisers.

The financial industry has evolved from not charging clients anything at all and being remunerated via product commissions, to percentage of assets under management (AUM), to no commissions whatsoever and simply charging their clients a flat dollar monthly/annual retainer (with some charging a combination of percentage of AUM and flat dollar).

At my firm we charge a flat dollar monthly retainer as we think it removes most if not all conflicts of interest. It means we remain outcome focused rather than product focused. It also removes the vested interest to gather as much ‘AUM as we can. We’re free to advise clients across all asset classes instead of guiding them toward assets we would otherwise control/manage (and charge a fee on).

The commission is exploring the idea of overhauling ongoing advice fees, so financial advisers, like accountants and lawyers, must provide the service before they can invoice their customers.

When NAB chief executive Andrew Thorburn tried to defend ongoing fees as a “transparent upfront fee” of $12,000 a year that is paid $1,000 monthly, Mr Hodge challenged the need for such expensive financial advice.

“How many Australians do you think really need to be paying a thousand dollars a month for financial advice?”

Here’s the transcript:

Source: AFR

Mr Hodge, my neighbour thinks paying $13.99 per month to Netflix for unlimited streaming of movies, documentaries, and shows from all around the world is expensive and unnecessary. He also thinks paying Spotify $9.99 per month for unlimited streaming of music from all around the world is expensive and unnecessary. In fact, he even thinks paying $100 per month for a gym membership that will help him get back into shape is expensive and unnecessary. You see Mr Hodge, regardless of the cost of a service, the customer or client must see value in the service. There’s an old saying, “price is an issue in the absence of value”. This also applies to financial advice.

Charging a fee for service via a retainer promotes engagement, it encourages dialogue, and it incentivises clients to pick up the phone and ask questions without the fear of being invoiced and charged for a phone call (or meeting). It’s the basis of a true partnership.

What’s interesting to me is the number of accounting firms we speak with who are moving to the financial advisers’ fee model – a monthly retainer. The concept of charging clients after the work is done is great for one off transactions, and if that’s the business you’re in – good for you. This, however, is not the business we’re in. We’re in the business of ongoing advice, ongoing oversight, ongoing discussions, ongoing dialogue, ongoing debate. Our clients’ financial lives are not a one-off transaction Mr Hodge. Global financial markets, economics conditions, and the ever changing legal landscape are not a one-off transaction.

Mr Hodge, more Australian’s need to and should be paying $1,000 per month (if not more) to a good quality financial adviser. To help them make good decisions with their money. To help them avoid speculation and grow their wealth the slow way. To help them avoid buying and selling at the wrong time and chasing investment returns.  To act as their sounding board when they are faced with options and confusion. To help guide them toward their financial goals. And to save them time, energy, and anxiety with managing their money and financial affairs.

Show me the incentive and I’ll show you the behaviour.

– Charlie Munger

Finally, some of the responsibility needs to fall on the consumer. If you are engaging a professional to help you with your financial matters, and you are paying them a fee to do so, yet you are not receiving a service, it’s up to you to call it out. Here are 16 questions you need to ask your financial adviser.

Despite all the negative press aimed at financial advisers, it’s not that hard to find a good quality, ethical adviser. Here are just a few of them:

Chronos Private

Marasea Partners

Your Family CFO

Rasiah Private Wealth

ICG Financial Planning

There are many of us that pride ourselves on our ethics, transparency, drive, and our purpose. And we won’t allow uneducated and misinformed points of view dictate the great work we do for our clients.

Next time I turn on Netflix or Spotify, and I’m not receiving the service I am paying for, I will not be waiting for a royal commission on the cloud streaming industry, as a consumer I will be on the phone to find out what’s going on. You need to do this same. You deserve better.

Visualising The Damage on The Stock Market

Bed goes up, bed goes down, bed goes up, bed goes down.

– Homer Simpson

Since the GFC stocks have been the perfect place to hide. In fact, there has been no safer bet with stock markets around the world trading at multiples of their GFC lows. Here’s how major stock markets around the world performed (total return) since the bottom of the GFC:

(orange line – Australia, purple line – Asia, green line – Europe, blue line – US, red – Emerging Markets)

Only when the tide goes out do you discover who’s been swimming naked.

– Warren Buffett

Financial markets however, have no regard for what you want or what you need, and will turn on you like the Melbourne weather leaving you perplexed as to which season it is.

The recent spasm of news coverage on the stock market correction prompted me to assess the damage done on stocks. For the last two months, these were the headlines investors have been reading – how exciting!

I’m not sure who defined a market correction being a decline of 10% or more, but it’s the widely accepted definition. What good is it for investors to know that the correction has begun based on some meaningless threshold someone fabricated? Why is the threshold not 12%, or 15%? Why should a manufactured definition trigger investors to revisit their investment strategy? To me, this threshold seems illogical, and to base investment decisions on these definitions seems foolish.

Let’s take a look at what all the fuss is about. Here’s a chart showing the total return of the above indices since 8 October (when the decline began) to Friday, 23 November 2018:

Within two months, the US stock market is down 10.69%, Europe is down 9.05%, Asia down 7.97%, Australia down 5.92%, and Emerging Markets down 5.25%. Having said this, if we were to look at peak to trough using 52 week highs, the chart above would look different again. In fact, Emerging Markets would look a lot worse if we pulled the start date back to earlier on in the year. It doesn’t matter where you were invested your money, there really was nowhere to hide.

If you think that’s bad, just spare a moment for the tech investors. Here are the FAANGs (Facebook, Apple, Amazon, Netflix, Google) against the S&P500 (orange line) and Nasdaq (grey line):

(purple line – Facebook, green line – Amazon, blue line – Apple, yellow line – Google)

Hey, what do you expect after a run up like this:

Netflix’s market cap is currently sitting at US$112 billion. To put that into perspective, Citigroup is currently valued at US$150 billion. Number of employees at each company: Citigroup – 209,000, Netflix – 5,400. Revenue (2018 est): Citigroup – US$216,000,000, Netflix – US$16 billion. Net income (2018 est): Citigroup – US$18 billion, Netflix US$671 million.

Markets can remain irrational for a lot longer than you and I can remain solvent.

– John Maynard Keynes

Most money managers will highlight and emphasize performance for a select period of time (I’ll let you decide why), so it’s very useful to me (and investors) to look at things through a wider lens. So here it goes – the recent market declines since the GFC for stock markets around the world:

It comes as no surprise that the asset class that has performed the best over the last 10 years is the one that has fallen the most when things are seem a little uncertain.

Even following a market “correction”, the US stock market is still up 265%, the Australian market up 144%, and Asia, Europe, and Emerging Markets up 123%, 80%, and 59% respectively.

There are several narratives that are making headlines justifying the recent market decline. The general theme goes something like this: This bull market has been running hot for almost 10 years. Interest rates are rising, and cost pressures are rising, which will cause inflation. Whatever narrative you decide makes most sense to you, the reality is that the news that is floating around is not new and is probably priced into current market valuations anyway.

At the end of the day, the more you pay for an asset, the less the future expected return. The less you pay for an asset, the greater the future expected return. In life, and in financial markets, things sometimes just don’t make any sense – although they eventually do. Don’t try and keep up with the Jones’ or get caught up in the market and media hype – it takes guts, discipline, patience and time to make money.

When you decide to embark on the journey of investing, remember the wise words of Homer Simpson – bed goes up, bed goes down.

Source:

  • Charts and headlines – Thomson Reuters
  • Returns are denominated in AUD for all charts except the FAANGs

31 Reasons Why You Need A Financial Adviser

Someone once asked me that if I was any good as a financial adviser, why was I working as one and not simply making my money by managing my own investments? I thought to myself, that’s an interesting yet naive question.

So I decided to list 31 things good financial advisers will do for their clients, and why you need one. Here it goes:

  1. Takes as much time as necessary to genuinely understand where you are now, where you want to go, what help you need/want, and most most importantly, why.
  2. Helps define your goals, aspirations, desires, and fears.
  3. Understands what ‘truly wealthy’ means to you (because money is simply a means to an end).
  4. Thoroughly reviews your current position, then studies and analyses multiple scenarios/strategies to help enhance your current and future position.
  5. Will create an initial plan, which is simply a starting point, and make adjustments along the way to help support your goals.
  6. Helps makes wise choices about cash flow, management of debt, education funding, tax efficiency, personal insurance, estate planning, and investments.
  7. Puts in place strategy and structure to help achieve your future goals.
  8. Will explore all asset classes to help achieve your goals.
  9. Not only manages investments, but also manages investors.
  10. Helps you decide how, where, and when to invest.
  11. Helps match your balance sheet to your life.
  12. Will measure your performance not to an index, rather, to your personal goals.
  13. Helps you make better decisions with your money in the face of uncertainty and fear.
  14. Arms you with information to help you make better decisions.
  15. Helps reduce the uncertainty and anxiety that comes from making important financial decisions with your money.
  16. Stays on top of economic, market, and legislative changes so you don’t have to.
  17. Proactively keeps in touch with you.
  18. Liaises with your other professionals, and co-ordinates your banking, personal insurance, and estate planning with specialists.
  19. Gives you back time so that you can spend it on more important things in your life.
  20. Advises on the optimal mix of investments for you so that you can maximise your rate of return for a given level of risk.
  21. Monitors and oversees your investments.
  22. Maintains financial records on your behalf, such as tax reports, cost basis information, wills, and legal documents (basically your financial life).
  23. Acts as your sounding board.
  24. Is the ‘middleman’ between you and stupid.
  25. Provides as unemotional and unbiased point of view.
  26. Has your back.
  27. Is honest with you – they’ll tell you what you need to hear, not what you want to hear.
  28. Introduces you to the right people.
  29. Helps consolidate and streamline your affairs.
  30. Shares experiences of many other clients who have faced or are facing circumstances similar to yours.
  31. Get’s shit done (because you probably won’t).

It’s always simpler to do nothing. Chasing something you want is hard work – I guess that’s why not everyone gets what they want in the end. Personal finances are easy, right? Wrong. On our own, most of us lack clarity and objectivity, we get stuck in our own heads, we make emotional and careless decisions. We’re most likely busy doing other things in our lives, and we don’t have the information, resources, or time to sit down and dedicate thought, energy, and focus that personal finances take to make great decisions over the long-term.

Engaging an experienced and professional adviser to help you create your own personal financial blue print and game plan will help you understand your current position – your status quo, and more importantly what you need to do to get to where you want to go.

Asking others who are strong in areas where you are weak to help you is a great skill that you should develop no matter what, as it will help you develop guardrails that will prevent you from doing what you shouldn’t be doing.

– Ray Dalio

I’m curious. If money is the vehicle, what’s the destination?