Winter is Coming. Avoid These Mistakes.

It was over 150 years ago Admiral Robert FitzRoy took his own life. Today FitzRoy is primarily remembered as the captail of HMS Beagle during Charles Darwin’s famous voyage in the 1830. However, during his lifetime FitzRoy found celebrity not from his time at sea but from his pioneering daily weather predictions, which he called by a new name of his own invention – “forecasts”.

Discovering how seasons worked, and understanding that winter came around once a year, has helped humans thrive for centuries.

Financial markets, not dissimilar to the weather, goes through patterns. And winter, is a harsh season for both. The current bull market has been running for over 10 years now, making it one of the longest in history. As summer doesn’t last forever, neither do bull markets. By understanding how the seasons of financial markets work will give you an enormous edge over the average investor.

The only value of stock forecasters is to make fortune-tellers look good.

– Warren Buffett

Here are 7 facts you need to understand and remember about the stock market.

Fact #1: On average, corrections happen once per year

For more than a century, the market has seen close to one correction (a decline of 10% or more) per year. In other words, corrections are a regular part of financial seasons – and you can expect to see as many corrections as birthdays throughout your life.

The average correction looks something like this:

  • 54 days long
  • 13.5% market decline
  • Occurs once per year

The uncertainty of a correction can prompt people to make big mistakes – but in reality, most corrections are over before you know it. If you hold on tight, it’s likely the storm will pass.

Fact #2: Fewer than 20% of all corrections turn into a bear market

When the stock market starts tumbling, it can be tempting to abandon ship by selling assets and moving into cash. However, doing so could be a big mistake.

You would likely be selling all of your assets at a low, right before the market rebounds!

Why? Fewer than 20% of corrections turn into bear markets. Put another way, 80% of corrections are just short breaks in otherwise intact bull markets – meaning that selling early would make you miss the rest of the upward trend.

Fact #3: Nobody can predict consistently whether the market will rise or fall

The media perpetuates a myth that, if you’re smart enough, you can predict the market’s moves and avoid its downdrafts.

But the reality is: no one can time the market.

During the current nine year bull market, there have been dozens of calls for stock market crashes from even very seasoned investors. None of these calls have come true, and if you’d have listened to these experts, you would have missed the upside.

The best opportunities come in times of maximum pessimism.

– John Templeton

Fact #4: The market has always risen, despite short-term setbacks

Market drops are a very regular occurrence. For example, the S&P 500 – the main index that tracks the U.S. stock market – has fallen on average 14.2% at least one point each year between 1980-2015.

Like winter, these drops are a part of the market’s seasons. Over this same period of time, despite these temporary drops, the market ended up achieving a positive return 27 of 36 years. That’s 75% of the time!

Fact #5: Historically, bear markets have happened every three to five years

In the 115 year span between 1900-2015, there have been 34 bear markets.

But bear markets don’t last. Over that timeframe, they’ve varied in length from 45 days to 694 days, but on average they lasted about a year.

Fact #6: Bear markets become bull markets

Do you remember how fragile the world seemed in 2008 when banks were collapsing and the stock market was in free fall?

When you pictured the future, did it seem dark and dangerous? Or did it seem like the good times were just around the corner and the party was about to begin?

The fact is, once a bear market ends, the following 12 months can see crucial market gains.

Fact #7: The greatest danger is being out of the market

From 1996 through 2015, the S&P 500 returned an average of 8.2% a year.

But if you missed out on the top 10 trading days during that period, your returns dwindled to just 4.5% a year.

It gets worse! If you missed out on the top 20 trading days, your returns were just 2.1%.

And if you missed out on the top 30 trading days? Your returns vanished into thin air, falling all the way to zero!

You can’t win by sitting on the bench. You have to be in the game. To put it another way, fear isn’t rewarded. Courage is.

– Tony Robbins

Source: Visual Capitalist, Tony Robbins, Peter Mallouk, S&P

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?

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

You’re Being Fooled Into Overpaying For Underperformance – Here’s How

When people ask me what I do, I tell them I’m in the business of helping people make money. The business we’re really in though, is helping improve the lives of our clients. It comes from the belief that life is about more than money. I believe money is an enabler – it provides us with options, choice, and flexibility. So if we can help our clients preserve and build their financial wealth, we can help them live a more meaningful and fulfilled life – a life that is truly rich.

Sadly, most people never achieve a life that is truly meaningful and fulfilling – true wealth. Why? Because they’re focused on the scoreboard, and not the process. They’re focused on chasing the money.

Enter the world of investments, stock brokers, financial advisers, fund managers, and high flying financial institutions. If you’re not careful, you might be sailing toward financial freedom with a hole in the bottom of your boat. That hole, is in fact lining the pockets of those purporting to be helping you sail toward the sunset.

When was the last time you looked at your superannuation or investment portfolio statement? Your portfolio has probably grown, especially over the last ten years, so you haven’t taken too much notice. The real question is, how much have you left on the table?

Australians have around $2 trillion sitting in superannuation, which has attracted fund managers like bees around a honey pot. And Australian are paying some of the highest fees for the management and oversight of this money. In fact, last year, Australian’s paid $31 billion in superannuation fees – totaling around $230 billion in the last decade.

So what can you do about it? Here are three things to consider:

1. Fund Fees

When it comes to truly understanding the cost of your investments, it’s hard enough for the professionals to do, let alone the general public. There are many hidden costs that lie beneath the surface – here they are (average):

1. Expense ratio – 0.90% pa

This covers marketing and distribution cost, as well as the management of the portfolio. Typically, this is the only fee investors are aware of.

2. Transaction costs – 1.44% pa

Typically investment managers buy and sell frequently. And with these transactions comes transaction fees. There are three types of transaction costs: 1) brokerage, 2) market impact, and 3) spread.

3. Cash drag – 0.83% pa

This is the portion of your portfolio that is invested in cash. It hurts your return over the long-term because of the missed opportunities in the market.

5. Taxes – 1.00% pa

When you by into a fund, sometimes you’re being taxed for other investors’ gains.

The total of these fees can be as high as 4.17% pa. Although on face value these fees don’t seem high at all, when you compound these costs over long periods of time, it will blow your mind. The above list didn’t even include performance fees!

Here’s what happens when you invest $100,000 into the market with a 7% pa return. The compounding value over 50 years is almost $3,000,000! Let’s start deducting some fees from this return – here’s what you’re left with when you take 1% and 2% in fees:

Even a small number like 2%, compounded over a long period of time, can lead to financial ruin. Jack Bogle, the founder of Vanguard once said:

You put up 100% of the capital, you took 100% of the risk, and you got 33% of the return!

2. Chasing Performance

Forget fees. Just invest in the top performing funds, or sell before the market falls and buy before the market rises (market timing). Easier said that done.

A) Chasing the top performers

Over the last 15 years, almost 80% of all Australian fund managers have failed to beat the broad Australian share index. And after 15 years, only 56% of Australian find managers survived.

Over the last 15 years, almost 90% of all international fund managers failed to beat the broad international share index. And after 15 years, only 46% of international fund managers survived.

B) Timing the market

Researchers Richard Bauer and Julie Dahlquist examined more than a million market-timing sequences from 1926 to 1999. Their research concluded that by just holding the broad market index outperformed more than 80% of market-timing strategies.

Clearly, neither of these strategies put the odds firmly in your favour. In fact, they’re akin to gambling more than anything. Making money in the markets is tough. So if you can’t beat the market by hiring the best, what to the the real experts recommend you do?

3. The Advice

Making money in the markets is tough. The brilliant trader and investor Bernard Baruch put it well when he said:

If you are ready to give up everything else and study the whole industry 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.

Jack Bogle says understand that what appears to be success in financial markets could just be dumb luck:

If you pack 1,024 gorillas in a gymnasium and teach them each to flip a coin, one of them will flip heads ten times in a row. Most would call that luck, but when it happens in the fund business, we call him a genius!

Warren Buffett wrote this in his 2013 letter to Berkshire Hathaway shareholders:

My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers

He even made a bet in 2008 and put his money where his mouth was. You can read my note about it here.

It’s super important to know that not all costs are bad. The right financial adviser can help you make better decisions over the long-term to save you money. Vanguard recently published a study to help quantify the value of a good adviser.

1. Suitable asset allocation – 0.75% pa

2. Cost effective implementation – 0.70% pa

3. Rebalancing portfolio – 0.37% pa

4. Behavioural coaching – 1.50% pa

Total – 3.32% pa of value added

This does not include any other benefits or value of a good financial adviser, such as strategic and structural advice. Compound that and see what your portfolio looks like.

Next time you pick up your investment portfolio statement, think twice about what you’re doing. Are you 100% sure the financial odds are firmly in your favour? Fees are the silent killer in your portfolio, and only a handful of funds beat the market consistently and over the long-term, and much of this can be attributed to randomness.

Being in the market, while minimising costs, can empower you to getting the real financial freedom you deserve.

Source: Forbes – The real cost of owning a mutual fund 2011, Visual Capitalist, Vanguard, SPIVA, Berkshire Hathaway Shareholder Letter 2013

A Bear Market is Just Around The Corner (or is it?)

You’d be totally forgiven for thinking no more of what a bad economy and market looks and feels like. I mean, how could you not?

Consumer confidence is the highest it’s been for a number of years, and well ahead of GFC lows:

Australia Consumer Confidence

We’re spending more:

Australia Consumer Spending

We’re saving less:

Australia Household Saving Ratio

We’re earning more money since the GFC:

Australia Average Weekly Wages

And of course, the stock market…say no more:

World stock markets continue to make all time highs. The current bull market (as defined as a 20%+ increase in the market) has lasted 3,255 days, which in fact is the second longest on record behind the 4,494 day bull market that ran from late 1987 through to the early 2000. The market climbed 13 years without a single decline of 20% or more.

If this bull market was going to topple the record of the 1987 bull market, we’d see our stock market continue to climb until the 19th of June 2021. Hard to imagine right? It’s not as if it hasn’t happened before!

Here’s a chart of both bull and bear markets since 1926. It shows the number of days both bull and bear markets have lasted. A couple of things to note: 1) Bull markets last longer than bear markets (I mean, a lot longer!) – the average bull market has lasted 981 days, and the average bear market has lasted 296 days, and 2) Bull/bear market cycles have been lasting longer since WW2.

Source: BIG

Let’s dig a little deeper into the post WW2 period. The chart below shows all the bull (in green) and bear (in red) markets, when they started, ended, the percentage change, and number of days they lasted. The average bull market was up 152.4% and lasted 1,651 days, with the average bear market falling 31.8% and lasting 362 days.

Source: BIG

Meanwhile, pundits have been calling for the mark top since 2012. I want you to read these comments, seriously, read them. And next time you hear or see another attention grabbing headline about the market, I want you to recall this post. Here’s a summary of the commentary since (click for larger image):

Market All Time Highs (ATH) doesn’t necessarily mean the market will crash. Here are the number of ATHs each year since 1929. The year 1995 set the record with 77 ATHs, 1964 recording 65, and 2017 notching up 62. The year 2017 is sitting in third place with the number of ATHs in any given year. Presently, the year 2018 is in 27th place, with four months to go in the year – anything could happen.

No one knows how long this market will continue to run hot. No one knows when the market will collapse either.

What you can and should do however, is design your portfolio as if the market will collapse tomorrow. Because someday, maybe sooner rather than later, the market will collapse tomorrow. And you will exhibit precisely the same behaviour as you did in 2008. You will have forgotten how you behaved, however you will remember exactly how it felt. Your human mind will switch to ‘fight-or-flight’ mode, and you will either destroy a lifetime of savings, or you could create a lifetime of savings – the choice is yours.

As long as the music keeps playing, we’ll all continue to dance, until it stops.

The Most Expensive Game of Golf You’ve Ever Played

Last week I wrote an article on investing following a speeding infringement. I received quite a number of positive responses to this note – thank you. I also received a number of questions on the concept I talked about in my blog, that is, compound interest and market timing. I touched on this topic a little while back, but let me give it another go.

Have you ever played golf and placed a bet on each hole? You know, everyone places a small amount of money on each hole, and the winner on each hole takes the lot? Pretty simple, and a bit of fun. Have you ever played this game whilst doubling the amount of money you bet on each hole? Not a big deal…start with 10 cents a hole, and double this amount for 18 holes. Any idea what the number is on the 18th hole? Before reading any further, just take a guess, quickly, don’t take too long!

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$13,107.20! Ridiculous, right!?

How on earth does this happen I hear you ask? Here’s the above table in a chart.

Notice how nothing happens for a long time, the all of a sudden, BOOM, the amount explodes. This my friends is compound investing – the eighth wonder of the world.

If you think that all you need to know is which way the stock market is going in order to make money, think again. Talk to any successful business owner or investor, it’s more about being disciplined, having a game plan, and taking the long view.

Meet John – he’s the world’s greatest stock picker. He only buys when the stock market index is trading at 52-week lows, and assuming they are 17% below his last purchase. Meet Jane – she’s the world’s worst stock picker. She invests $2,000 only at market peaks beginning in 1970, when she’s 22 years of age. She increases her investment by $2,000 per decade – $4,000 per year during the 80’s, $6,000 a year during the 90’s etc. She retires at age 65.

The results? Hands down winner is John, right? The results of this experiment (thanks to Ben Carlson) may surprise you. John does quite well, as you would expect. But the results are very similar. You’d think John’s portfolio would be multiples of Jane’s as he was buying at market lows, and Jane at market highs, however this is not the case. Why? Compound interest.

Jump on any online calculator and calculate the capitalised interest on a 30 year loan. It’s okay, I’ve done for you. A $500,000 loan, with an interest rate of 5%, accumulates interest of $966,279.60. Think about that for a second – that’s only the interest. Imagine compounding capital and interest on your stock investment! The reason John misses out on the benefit of compounding, is because he’s out of the market for long periods of time. Carlson clearly states in his analysis, “Short-term moves in and out of the market don’t matter nearly as much if you have a long-time horizon. Thinking long-term increases your probability for success in the stock market while the day-to-day noise gets drowned out by discipline and compound interest.”

The strategy is so simple, requires no insight into the future, yet it is so powerful, and actually exists – unlike the perfect market timer. The catch? It takes a long time, and it’s b-o-r-i-n-g! The irony is however, that the group of people who have the greatest capacity to absorb the market’s volatility, are the same group of people who seem to be the least interested in it.

Probabilities Versus Predictions

Last week, South Korea stunned the football world by knocking out World Cup favourites Germany. In an astonishing finish, South Korea kicked two goals within minutes of the final whistle during extra time, in one of the biggest upsets in the sport’s history. Why? Because Germany were expected to take out the 2018 Fifa World Cup.

Here’s the 2 minute wrap up of the match courtesy of SBS:

It wasn’t only the football world who expected the German’s to take the cup home, it was also the expectation of UBS’ analytical team who ran complicated statistical models to place probabilities on all nations competing in the World Cup. Here’s the report if you’re curious.

Following Germany’s loss to South Korea, UBS have been copping criticism from journalists and social media trolls, about their inability to predict or forecast the future. Individuals’ and companies’ inability to forecast the future is well documented and certainly not news to anyone that studies the market, no matter how sophisticated they are or their technology is.

Let’s get one thing clear, UBS nor any of the other investment banks “predicted” Germany would win the World Cup. They simply applied a 24% probability of winning, in other words, a 76% probability of not winning – there is a huge difference.

“We are humble enough not to outright claim that Germany will win the tournament again, but our simulations indicate there is no other team with higher odds to lift the trophy than the defending champion.” – UBS (emphasis mine)

As nerdy and as absurd as this analysis may seem, what else do you have to rely on? Your gut feel? The tip your taxi driver gave you? Your “expert” football mate? I’ll take the odds thank you very much.

This is exactly how casino’s work. Their gaming systems are all designed to ensure the odds are firmly in their favour. Sure, you may win, and you may even win big, which is why you keep playing – but the odds are slim. And if you keep playing for long enough, you will eventually lose.

And when it comes to investing, investors seem to throw the odds out the window and prefer to play a very different game. One that is akin to the gambler at the roulette table. One where investment professionals try to outguess prices established by the collective wisdom of millions of different buyers and sellers each and every day.

Investors may be surprised by:

1) The number of investment funds that become obsolete over time, and

2) The low percentage of funds that are able to outperform their benchmark.

The chart below shows the sample number of funds that existed as at 31 December 2017, the number of funds that survived, and the number of funds that outperformed their benchmark. For example, 5 years ending 31 December 2017 (from 31 December 2012), there were 2,867 sample funds, of which 82% survived the 5 years, and only 26% were able to outperform their benchmark.

Source: Dimensional Fund Advisers (DFA)

Both survival and out-performance rates fall as the time horizon expands. For 15 years ending 31 December 2017, only 14% of funds survived and outperformed their benchmark. The odds of this game don’t seem very compelling if you ask me.

Let’s say you’ve found a manager who’s been able to outperform their benchmark for the last 3 years, and you’ve decided to hire them. Most investors and advisers use this method of manager selection, reasoning that a fund manager’s past success is likely to continue into the future – sack the poor performers, and hire the strong performers is how the narrative goes. The evidence suggests the contrary.

The chart below shows that among funds ranked in the top quartile (25%) based on previous three-year returns, most of them did not repeat their top-quartile ranking over the following. Over the periods studied, top-quartile persistence of three-year performers averaged 26%.

Source: DFA

The assumption that strong past performance will continue often proves faulty, leaving many investors disappointed. And despite all the evidence, investors continue to search for the winning investment – taking far greater risks than they ever expected.

Imagine for one second you could invest like the casinos. Putting the odds of success firmly in your favour the longer you play the game. As investors, we need to consider more than just a compelling story, and more than just good past performance. You may choose to ignore the evidence. You may choose to take on the odds. You may choose to ignore probabilities and make decisions based on predictions. Now that Paul the octopus is no longer with us, you may as well ask Achilles the cat for stock tips.

30 Facts About The Stock Market

My son turned 4 years of age the other week and it was a weekend full of parties and eating. One of my son’s favourite toy is Lego. His imagination and creativity runs wild. I’m one of those dad’s that keeps the instruction manuals in a folder – I mean c’mon, how else will you know how to build the original toy Lego had designed with all those parts? Although I did recently find out that Lego’s website stores all the instructions. Maybe I’m just a little old fashioned…at 35 haha!

Anyway, this got me thinking about how often we, as investors, deviate from what the stock was always designed to do. We seem to lose the instruction manual too often and our imagination and creativity seems to run wild like my 4 year old son with his Lego.

So I decided to take the liberty and list 30 facts about the stock market. What it was designed to do, how it operates, it’s performance and behaviour, and some of the facts that many folk in our industry seem to ignore:

  1. Stock markets exist and were conceived in order to allow companies to raise equity from the public in exchange for shares in that company.
  2. For every seller of a company, there is a buyer.
  3. For every buyer of a company, there is a seller.
  4. Over the long-term, the Australian share market has returned 8.5% pa.
  5. On average, the number of times the stock market moves up or down 1% within a day is 57 times over one year. In 2017 we witnessed 20 +/-1% days, and in 2018 so far we’ve witnessed 6.
  6. Australia makes up 2.1% of the world’s stock market. The US makes up 52.2%.
  7. The Australian stock market is made up of 40% in banks, and 18% in mining.
  8. Since 1926, we’ve witnessed 10 bear markets (declines of 20% or more). On average, the decline has been 45% and lasted for just over 2 years. The shortest was 3 months, and the longest was 5 years.
  9. Since 1926, we’ve witnessed 11 bull markets (including the current). On average, the climb has been 159% and lasted for 3.5 years. The shortest was 13 months, and the longest 9.5 years.
  10. Since 1926, we’ve experienced 15 recessions. That’s 1 in every 6 years.
  11. The average recession lasts 15 months, and the average expansion lasts 47 months.
  12. Over long periods of time, small company stocks beat large company stocks.
  13. Over long periods of time, the average investor under performs the stock market by a about 5% pa.
  14. Over long periods of time, professional investors under perform the stock market 77% of the time.
  15. Over a rolling 10 year period, the stock market has not lost money.
  16. The biggest gains in stocks are made while the company is on the way to the top, not after the gains are made.
  17. The stock market returns double digit gains or losses in 70% of all calendar years.
  18. The stock market lost almost 90% of it’s value during the great depression.
  19. The Japanese stock market has done nothing since 1989.
  20. Dividends make up about 42% of an investor’s return.
  21. If you missed the best 10 days in the stock market over the last 20 years, your portfolio would have returned 67% less than the market. If you missed the best 40 days, your portfolio would have returned 114% less than the market.
  22. If you missed the worst 10 days in the stock market over the last 20 years, your portfolio would have returned 150% more than the market. If you missed the worst 40 days, your portfolio would have returned 952% more than the market.
  23. 90 days of the year generates around 95% of all the year’s gains.
  24. The US stock market rose 22% last year. 25% of that return came from 5 companies. 10 companies made up 35% of the return. 23 companies accounted for half the return. Apple’s return alone was responsible for of the index’s total return then the bottom 321 (of the S&P 500) companies combined.
  25. From 1980-2014, 40% of all the Russell 3000 stocks lost at least 70% of their value and never recovered.
  26. The stock market has experienced an average intra-year decline of 13.8% every year since 1980.
  27. The average return of stock markets are between 8-12%, yet stock markets see gains within this range only 5% of the time.
  28. The stock market produces a positive return 3 in every 4 years.
  29. The stock market produces a negative return 1 in every 4 years.
  30. Stocks go up most of the time.

The stock market needs to be looked at as owning a piece of a company, a business. The ownership or worth of a business represents it’s futures earnings power. I strongly believe that as technology progresses, as we become more innovative and efficient, profitability should increase, and therefore businesses become more profitable, and businesses become more valuable – on the whole. During this process, we’ll witness and many of us will experience default. But I believe this is part of the evolution and progress.

Returns on the stock market are not promised to anyone, nor are they guaranteed. Having said this, the track record of the stock market is compelling. If you’re patient and disciplined enough, you too may be able to participate in what it has to offer.

Source:

Index Fund Advisers

JP Morgan – The Agony & The Ecstacy

JP Morgan – Guide to Markets (Australia)

Vanguard/Andex

Morgan Housel

Ben Carlson

SPIVA

The Tale of an Unsophisticated Millionaire

It was 1909, in a small Illinois farming community, a little girl by the name of Grace Groner was born. Orphaned at the age of 12, and like many people who grew up and lived through the great depression, Grace Groner was quite frugal with her money.

It’s understood she bought her clothes from garage sales, and rather than buying a car, she walked everywhere. Her one bedroom house in Lake Forest was minimalist to say the least. Grace Groner worked at a healthcare company as a secretary for 43 years. Although she was quite frugal during her working days, she traveled widely upon her retirement, volunteered for decades, and occasionally made anonymous donations to those in need.

Grace Groner died in 2010 with an estate worth $7,000,000 which was left to a foundation she established prior to her death. It’s estimated the estate would generate $300,000 pa in income each year. She instructed that the income would be used to benefit the students of Lake Forest College by funding internships, international study, projects, and grants.

During the time of Grace Groner’s death, Richard Fuscone, a former top Wall Street executive declared bankruptcy – fighting to save foreclosure on his 18,471 square foot, eleven bathroom mansion.

“I have been devastated by the financial crisis which came to a head in March 2008, I currently have no income.”

He writes in his bankruptcy filing.

Richard had an MBA from the University of Chicago, and attended Harvard Business School. Fuscone was viewed by company insiders as a “winner”. Upon his retirement, then-CEO (of Merrill Lynch) David Komansky praised him for his “business savvy, leadership skills, sound judgment and personal integrity.”

Money and finance is one of those industries where the humble 100 year old secretary will outperform a Wall Street titan. In no other industry can this happen. The 100 year old humble secretary couldn’t beat Tiger Woods at a game of golf. And would not be better at open hear surgery than a specialist heart surgeon.

The correlation between financial education and financial success is not guaranteed, as we have seen with Groner and Fuscone.

So what was Grace Groner’s secret sauce? She bough $180 worth of shares in the 1930’s. She never sold the shares, reinvested the dividends, and let the magic of compound interest do the work.

Simplicity unfortunately is not sexy, and investors are attracted to complexity. We seem to think that complex problems require complex solutions, when in fact the converse is true.

Investors’ time horizons are getting shorter, patience is being tested, and we seem to have a desire to over-complicate things unnecessarily. It’s as if the more information we have, the better educated we are, the smarter we think we become, the dumber the decisions we make.

The finance industry is living in a world of hype, false complexity, and over-confidence.

I’ll leave you with this great passage from a Walt Disney biography:

Long-term successful investing is simple, but not easy.

Do The Opposite

I sold my share portfolio last week. It’s just too risky – you know, Trump, China, interest rates, there’s just too much risk in the market at the moment. The whole lot I replied? Yep, the whole lot. I’ll get back in when it’s less risky.

This was the latest portfolio positioning for a (I think mid 40’s) gentlemen I met over the weekend through a mutual friend. What do you think he asks, you’re in finance, right?

I get this question all the time. As soon as people find out what I do – Where should I investment my money? Is the market going to crash? What do you think of the property market? I love discussing markets, so I’m happy to roll with the conversation. Financial history fascinates me, so too does the ongoing propensity of poor decision making by individuals.

People always want something to talk about. Whether it’s crypto-currency or trade-war, choose the rabbit hole you want to go down – you’re not short of them. As advisers, and in fact as investors, we need to be able to separate the conversation that is going on at kid’s birthday parties and bbqs, with what people are actually doing with their money.

The noise

People have been investing money for centuries. They’ve been doing so through good news and bad. This is one of my favourite charts. It plots the US stock market’s tumultuous history from 1896 to 2016 and highlights major events during this time – from the sinking of the Titanic to Brexit and everything in between. Notwithstanding the 121 major events, the chart proves once again that over the long-term, the stock market has risen as the drive for innovation and productivity trumps fear (click for larger image).

Source: Chris Kacher – MoKa Investors

It’s not the poor decision making by individuals that puzzles me, it’s seeing the evidence and proof that what you’re doing just doesn’t work, yet still doing it anyway is what puzzles me. It’s insanity as Albert Einstein once succinctly defined:

“The definition of insanity is doing the same thing over and over again, but expecting different results”

The average investor

There’s never one portfolio solution that will meet every investor’s objective. Whether you’re in your 70’s, seeking a regular and stable income, or whether you’re 45 trying to grow your asset base for your future, the two portfolio’s are going to look very different. The one thing that these two investors have in common however, is that (typically) they look for activity and complexity.

Staying the course, staying diversified, keeping your costs low is far too boring for these folk. And because it’s boring, they seek complexity and activity. Yet, the evidence suggests that because they’re doing the opposite of what they should, they lose money. And when I say they lose money, I mean they leave money on the table. They don’t generate the returns they should have generated should they have stayed the course. It’s as if you don’t even realise what you’re doing because you’re still generating some rate of return, albeit lower than what you should (but you never knew that).

Source: JP Morgan

Our industry thrives on these types of investors. And investors love hearing from the mouth piece that has a great story to tell. It’s a match made in heaven. For the most part of our industry (and I’m ashamed to say it), their job is to keep you as their investor/client, amused and entertained. It’s nothing more than dinner theater.

In the pursuit of trying to beat the market, the average investor falls short – by a huge margin.

You have to understand one important thing, about the market and that is for every buyer, there is a seller. And every seller, there is a buyer. So when transactions take place, the only winner, net, is the man in the middle. The croupier in the gambling casino.

– Jack Bogle

The perils of market timing

He sold his share portfolio because the market was too risky, and he’ll get back in when the market is less risky. He may get the first part of this call right, but he then needs to get the second part right too – when does he get back in?

The best investors in the world can’t get this right. They can’t pick the winning stocks, they can’t pick the manager who picks the stocks to beat the market. What makes you think you can?

I recently shared this chart, and I think it’s timely to share again. Harvard University’s endowment has trailed the S&P 500 index for the last 1, 3, 5, and 10 years. This is the largest university endowment fund in the US with some of the smartest people too, you’d think the fund’s investment returns would be out of this world. Yet even the biggest and the best can’t beat the market over the short, medium, & long-term.

Source: Bloomberg

It’s crazy but true.

If you’ve ever attempted to time the market, you don’t need me to tell you how difficult, stressful, and time consuming it is. To efficiently time the market, you need to be right twice – selling at the top, and getting back in at the bottom. Rarely anyone can predict either – it’s almost impossible as skill, more possible with luck. You may not have “lost” money, but allow me to show you what you left on the table.

Historical data clearly shows that staying invested and following a consistent strategy produces larger returns over time than letting current events or market valuations drive your investment approach.

Here’s the performance of $10,000 invested between 1 January 1997, and 30 December 2016. The chart shows the return of an investor who stayed the course (7.68% pa), the investor who missed the 10 best days in the market (4% pa), 20 best days (1.57% pa), and so on, you get the picture. Missing the 10, 20, 30 best days over a 20 year period makes all the difference in the end – the margin for error is so small!

Source: JP Morgan

In summary

I know how difficult it can be. It’ tempting – the excitement, the thrill, the belief that you’re smarter or different to the millions of other investors trading on the same day. Yet the evidence is clear. Unless, your Warren Buffett or Jim Simons, don’t risk your family’s future by gambling away your wealth.

Next time your find yourself itching to do what you normally do, pause for a moment and maybe do what George Costanza once did – do the opposite.