Six rules how to manage investment uncertainties

Six rules how to manage investment uncertainties

This is an updated version of a post originally published in 2012.

Perception is realer than reality.

Also, as long as the information is frequently repeated and rotated, the perception doesn’t verify the quality of ‘expertise’ it’s been fed with and created by.

Our lives are saturated with information lava erupted daily by a financial world volcanos with the spotlight on variables beyond our control - platforms, products, investment managers, interest rates, managed funds, direct shares, ETFs, investment performance, share market, Europe, China, Bora Bora...

However, they only cause noise and a blinding perception that they should be a centre of investor attention and concentration.

People just need to know the truth.

These variables have very little to do with real life investment outcomes. People simply do not experience the investment returns published in the magazines they read. The dominant determinant of real life investment results is something we can actually control and anticipate (in some people) – investment behaviour.

Therefore, if people want to experience quantum changes in their investment outcomes they need to hire a behavioural coach. A passionate coach will ensure that they stick to their plan and follow the below rules.

Six rules how to manage uncertainties and be a successful investor:

 1. Invest in your future – have a plan and a hire a coach

Good advice is worth paying for. The important detail is to hire someone who will talk to you about you, your attitude towards investing, your experiences, your plans, your values. If the conversation starts about ‘a great investment scheme’ or ‘guaranteed high returns’, you need to run! And run fast.

2. Believe in the future – things always get better

You will never be a successful investor with a negative outlook for the future. If you are constantly worried about what can happen and you cannot sleep at night after seeing a scary business ‘news’, maybe investing is not for you.

3. Realise your time frame – invest for life

The decision to invest should be more about an educated choice and changing your attitude about money in general. Seeing money more as a value and less as a currency. Understand that the main reason people invest is to enhance the purchasing value of money. Once you make that decision (and you only have to make it once), you are in much better position when it comes to selecting a time frame for your investment. Once you are in the know here, the most likely time frame you choose is ‘the rest of your life.’

4. Diversify  – never make a killing, never get killed

This must be the most talked about investment rule and the most ignored at the same time. Spreading your money across a number of options will decrease your chances to make huge gains. Yes, unfortunate, I know. But at the same time, it will decrease your chances of your portfolio suffering huge loses, which believe it or not, would hurt much more.

5. Look for value – never chase prices, always chase value

This is a difference between an investor and a speculator. It’s all in the understanding of basic investment fundamentals:

-          Price and Value are in a negative correlation

-          Price and Risk are in a positive correlation

What does it mean?

If price of a share is going down, its value is increasing (assuming it is a quality blue chip company, with healthy balance sheet etc.) and investors know it is a better investment now. The speculators that always chase prices panic at this point. They think the value of it is reducing and they flee it.

On the other hand, if the price of a share is increasing, its value is decreasing. The investors know this, but the speculators think it is a much better investment now and they keep buying more.

What speculators never seem to know is that if the price of something is increasing the risk of it is increasing. And vice versa, if the price of something is going down, the risk of investing in it is in fact decreasing.

6. Be patient and disciplined – do not react to noise

I always say to my clients that investing is simple. But it is not easy. Mostly because people get very emotionally attached to their investments. The more attached they get, the less patient and disciplined they become.

The environment surrounding us is not helping either. We are constantly bombarded with headlines like ‘Look at the latest investment trends’ or ‘ The shares to buy in 2013’ or ‘How you should re-act to…’. This noise is making people very nervous, they often stop believing in what they’re doing and they tend to switch to something else. Of course, that new investment will become old the very next year and they switch to something else again, etc.

Investing is about something else. It is about constructing a portfolio which is perfectly in tune with your long term plan and values. Once it is put together, you don’t reconsider appropriateness of it based on the latest market performance. You buy it and you hold it. And if you can’t cope with the latest ‘end of the world news’, you call your adviser for re-assurance. 

Investing has a very little to do with products, trends or financial magazines you read. Most people would say it’s not too exciting, not too much fun. And that they can do it themselves. Well, they can’t. Not unless they have an empathising and caring coach standing by their side. Everything else is noise.

If you are looking for excitement, take $1,000 and go to Vegas.

by Michal Bodi

Email me if you want to know more – mbodi@sydneyfinancialplanning.com.au

 
 Images courtesy of pakorn & renjith krishnan / Freedigitalphotos.net

2012: The Year Pessimism Got Skunked…Again

With the kind permission of Nick Murray whom I consider to be my mentor, I am posting one of his articles he published in his newsletter of January 2013.

Client's Corner - 2012: The Year Pessimism Got Skunked…Again

The election. The fiscal cliff. The national debt. The federal deficit. Slow (to nonexistent) economic growth. Chronically high unemployment. Superstorm Sandy, the east coast's Katrina. Impending tax increases. The euro plague, leapfrogging from Greece to Spain, next perhaps to Italy and even France. The weak dollar. The Federal Reserve continuing to push on a string. The China slowdown. The LIBOR scandal. The Facebook IPO fiasco. Yet another new strain of flu virus. The end of the world foretold by the Mayan calendar. Two thousand twelve was certainly a banner year for catastrophe, was it not?

How very odd, then, that the broad equity market—which started the year at 1277 on the S&P 500 and has flirted with 1450 as I write on the winter solstice—so signally failed to get the message. With dividends, it seems to be on track to have returned something like fourteen percent in this seemingly most relentlessly dismal of years. How shall we account to ourselves for this dichotomy, which seems on its face not merely inexplicable but downright weird? Well, I can think of two possible explanations.

The first and most obvious is that the stock market is just dead wrong: that it has recklessly ignored the plethora of real and impending disasters that are bearing down on us with each passing day, and which will surely swamp our economy and precipitate a market meltdown…any day now. For simplicity's sake, let's call this Door Number One: Pessimists Right, Market Wrong.

But then there's that other possibility. Which is, of course, that the pessimists have not just been momentarily wrong: they've been fundamentally—and perhaps fatally—wrong about the whole equation. They have, in short, been focusing entirely on the fiscal, monetary and economic mistakes of countries. But the equity market—as is its wont—has been much more narrowly focused on the variables which always ultimately drive it: the healthy, growing (and by some measures record-breaking) earnings, cash flows, dividends and cash positions of companies. We'll call this, as I'm sure you've already anticipated, Door Number Two: Market Right, Pessimists Wrong.

This is just one armchair observer's opinion, you understand, but—as I have all along—I'm going with Door Number Two. And thereby hangs a tale.

It is fashionable in pessimist circles to note that the equity market as denominated in the Standard & Poor's 500-Stock Index is closing out 2012 just about exactly where it ended 1999, in the mid 1400s—having all these years “done nothing.” This observation, narrowly correct as it clearly is, misses a couple of important things.

The first of these is, of course, that at the close of 1999 the market was within weeks of the bitter end of its greatest two-decade run of all time, during which the Index had gone up quite a bit more than ten times. It was at that point, by any and perhaps every measure, way ahead of itself.

The second and to me even more telling point is that while the Index has been, on net, treading water for these unlucky thirteen years, the earnings and dividends of its five hundred component companies have essentially doubled. (As the late American philosopher Charles Dillon Stengel always said: “You could look it up.”) OK, technically the earnings have a tad more than doubled, and the dividends a tad less, but the point is made: the prices of the great companies in America and the world relative to their earnings and dividends have to all intents and purposes halved, lo these thirteen years past.

One may therefore suggest, not unreasonably, the possibility that the market may in these thirteen years have gotten almost as far behind itself as it was ahead of itself in 1999. And that what it has been doing in 2012 is playing catch-up.

And there is perhaps more to this thesis than most investors may suspect. At the end of 1999, the S&P 500 was completing a year in which it earned about $50. Dividing those earnings by 1450, the Index's earnings yield stood at 3.5%—at a moment when the yield on the 10-year U.S. Treasury bond (though falling rapidly) was still around 5%. It could have been argued (and in fact this thesis turned out to be the correct one) that the bond was a better value, or at least a very competitive safe haven.

Today near 1450, with earnings in excess of $100, the S&P 500's earnings yield is about 6.7%, while the 10-year Treasury's is 1.8%, suggesting that the relative values of stocks and bonds have very sharply reversed since 1999. And that's not all.

Dig a little deeper, and we discover a couple of very intriguing facts about dividends. The more obvious of these is that—for only the second time since 1958—the current dividend yield of the S&P 500, at slightly higher than 2%, is greater than that of the 10-year Treasury. (The only other time this has happened was during the Great Panic of 2008-09.)

More obscurely but perhaps more importantly in the longer run, since 1871 the average dividend payout ratio—the percentage of their earnings that companies paid to shareholders as dividends—has been 53%. It's currently 29%. This certainly doesn't insure that companies will be significantly raising their dividends anytime soon. But it tells us that, at least historically, they have a lot of room to do so—or to buy back stock, which is simply enhancing shareholder value by another means.

Set aside the staggering economic progress of the developing world—China, India, Brazil and the like—in these thirteen years. Set aside the fact that the cost of computing has fallen by something like 98% since 1999, thereby empowering the rise of a billion global smartphone users. Set aside the stunning reality that the United States has gone from the most abject dependence on foreign oil to a point where it will emerge as the world's leading oil producer by 2020.

And set aside, if you can, the inarguable fact that the fiscal conditions of the West's democracies are an unholy mess. Tocque­ville said it 170 years ago, and it's never been truer than it is today: “A democracy will always vote itself more benefits than it is prepared to produce.” Set this aside, I say, because as they become almost daily more genuinely global, the great companies become progressively less dependent on the economies of the older democracies on both sides of the Atlantic. At his confirmation hearings in 1953, President Eisenhower's nominee for secretary of defense could opine (if not in so many words) that what was good for General Motors was good for this country. In 2013, General Motors will sell as many cars in China as it does in the United States. This is not your father's Oldsmobile, and it isn't his stock market, either.

Especially if you have a personal predilection to pessimism, the turn of the year might be a good time to ask yourself—or, even better, to ask your financial advisor—whether, in fact, it might be the market that's right and the pessimists who are wrong. In terms of your own financial planning, and especially of your retirement income planning, this could turn out to be the single most important financial question you ask in 2013.

© January 2013 Nick Murray. All rights reserved. Reprinted by permission.

Image courtesy of digitalart / FreeDigitalPhotos.net

What to do with your savings before you buy the property

Question:

‘I'm interested in getting a high return on $250 000 with a low risk option for approximately 6 months to 9 months. Can you please advise which banking solution would suit best (I.e. long term deposit, savings account) or other options that would suit? I am wanting to purchase a property towards the end of the year but in the meantime want to make my money work for me.’

Taking part in the annual FPA (Financial Planning Association) 'Ask an Expert' initiative in which I participate every year, I was recently asked this question. I think it is a great question. Simply because it is a burning issue a lot of people want an answer to while saving for their dream property.

So, I thought it would also be beneficial to publish it in this blog.

Answer:

That is a great question, thank you for asking it.

You are asking about a high return and low risk and you also mention your time frame being not longer than a year. The role of a good financial adviser is to create realistic expectations. In that spirit I have to inform you that you will not be able to achieve high returns given your risk aversion and the time frame.

Historically, the big swings in returns come from growth assets like shares. In order to master investing in these assets successfully two main requirements need to be met:

- willingness to sit through temporary volatility (mostly an emotional issue), and

- appropriate amount of time (10 years +).

Given the fact that your situation doesn’t allow for any of these, it’s not recommended that you invest your deposit. What we can talk about, however, is 'parking your money' for a short period of time. This will mean that you are not going to make any amazing gains during the next 6 -12 months, but you can have your money working for you in the meantime.

You have three options to execute your strategy of 'have your money working for you' short term:

High interest savings accounts - don't get fooled by the name, again, there is nothing high in the sense of a possible interest you can gain on these accounts, however these accounts generally earn higher interest than an everyday bank account, they are flexible - money can be accessed anytime, the interest is often calculated on daily basis. They are often available online with no requirement to visit a branch.

Term deposits – basically represent a less flexible alternative to the previous option. The interest is guaranteed for the term selected, although you cannot access the funds until the end of the term. The interest is calculated at the end of the term. Also, unless instructed otherwise, the bank will renew your term automatically at the end of each term, so you want to be quick here.

Offset accounts - applicable after you purchase your property (assuming you will be borrowing more from the bank), you will be able to take advantage of the system banks use to make money - borrow for less and lend for more...this way you essentially 'earn' the same interest the bank charges you on your loan (which is generally higher than the interest offered in TDs or high interest saving accounts). Additionally, the amount in the offset account reduces the interest you pay on your mortgage.

Remember, the most important thing regarding your future is to have a plan in place. Neither investment nor a portfolio (on their own) represents a plan. They are only tools we use to implement our plan.

People with plans make it, people chasing performance as a substitute to planning never make it.

by Michal Bodi

 

Originally posted on FPA Difference website: http://askanexpert.fpadifference.com.au/questions/detail/im-interested-in-getting-a-high-return-on-250-000-with-a-low-risk-option

Image courtesy of Salvatore Vuono / FreeDigitalPhotos.net