Monday, November 25, 2013

Mind over Matter -

Interesting Links from the web, from Jim Parker's Coffee Break newsletter. This week Jim observes that:

...when asked what makes a good investment, say they “just know”. They have a gut feel. 
Our tendency to equate exterior confidence with being right about a subject is the theme of this week’s Coffee Break. Put simply, we are very good at fooling ourselves about our investment skill.

According to Nobel Prize-winning psychologist Daniel Kahneman, human beings have two ways of thinking. System 1 is fast, intuitive and emotional. System 2 is slower, deliberative and logical. There are times when System 1 makes sense, like in choosing a piece of music to listen to. But in the world of investment, fast-thinking can be our enemy. This video explains.

Our biggest enemy in the world of money and investing is often ourselves. We exhibit what psychologists call “biases”. Among them is over-confidence, a view that we are more astute investors than everybody else. Another one is that we are typically more sensitive to potential losses than we are to gains. This article describes a few ways we fool ourselves.

We’re wired to think we can “do better” than what the market offers. That’s fine, but the record shows most investors end up with significantly less. And the gap between the market and our actual returns is often due to our own behaviour. In this short video, communicator Carl Richards shows how we can often stand in our own way.

Jim Parker, Vice President, DFA Australia Limited

Monday, November 11, 2013

Keep it Simple

From Jim Parker, VP, DFA Australia LTD

Interesting Links from the Web

In most areas of life, the harder we try and the more work we put in, the better the result. Success as a long-term investor is different.

Generally, in this area, the closer you study the form guide and the more active you are in monitoring your portfolio, the lesser your chances of success. So in this week we celebrate the virtues of simplicity.

These articles that reinforce a patient, disciplined approach to money.

This is a story of two individuals—one a poorly educated orphan who lived simply, bought a few stocks in her youth and then forgot about them; the other was a highly credentialed MBA, active investor and finance executive. Their respective investment outcomes tell us a lot about the link between advanced financial education and investment outcomes.

We’re overloaded with information in our lives. How are we supposed to keep up with it all? The simple answer is we shouldn’t even bother trying. Following the news is fine, but acting on headlines often leads us to responding to stale information. Better to focus on the underlying signal and ignore the noise. This article tells you how.

Legendary investor Warren Buffett has a way of cutting through much of the technical claptrap around investing to the underlying truths. In this article, the Berkshire Hathaway chairman boils down his accumulated wisdom to three simple ideas that anyone can apply.

Friday, October 18, 2013

Why You Should Know Gene Fama

from Carl Richards in Behavior Gap Newsletter

You may have seen the news earlier this week that Eugene "Gene" Fama was awarded the Nobel Prize in Economic Sciences. It wouldn't surprise me in the slightest if your reaction was, "Who is Gene Fama?" Unlike some of the other Nobels, the Economic Sciences prize tends to highlight the work of people who don't often land on magazine covers — until they win a Nobel Prize, anyway.

Dr. Fama is a professor at the University of Chicago, and he's often described as the "father of modern finance." Besides acknowledging his amazing accomplishment of winning a Nobel, I also want to talk about Dr. Fama for two other reasons:
  1. I really admire his work, and it's the foundation for much of what we do at the BAM ALLIANCE.
  2. He's about the research, not the sound bite.
Dr. Fama did something pretty amazing (which is why he won the Nobel): He demonstrated that markets are efficient. His findings eventually led to the development of stock index funds.

Beyond the potential of index funds, Dr. Fama's work also showed that it's highly improbable we can pick fund managers who will beat the market this year, let alone beat it the next year or the year after. His research has made a world of difference for the average investor, which leads me to reason No. 2.

Researchers like Dr. Fama don't spend their time coming up with sound bites. Instead they spend months and even years working on big ideas that have the potential to improve our understanding of wildly complex subjects. In short, their work often goes unrecognized by the wider world until something like the Nobel committee shines a light on their efforts.

I bring this up because it seems like we're inclined to give greater weight to the latest headline or cover story instead of time-tested knowledge. It's not surprising because I know that for most of us, we're looking for ways to reduce the complexity and answer our financial questions. Those goals are good ones to have, but if we aren't paying attention, they can lead us to overlook things like Dr. Fama's research in favor of the most recent list of the "10 Hottest Funds." 

To be clear, I'm not suggesting that we bury ourselves in financial research and work through every equation to answer our money questions. Instead, I think we need to challenge ourselves to ask questions about the latest "financial news." Does it really tell us something new and valuable, or does it simply recycle advice based on anecdotes instead of research?

The work of Dr. Fama offers us a reference point, a way to help us separate good advice from the questionable. As I mentioned before, we don't need to understand the research in detail. However, by taking the time to understand the principles and how they apply to us, we're increasing the odds that we won't be distracted from our primary goal of making smart financial decisions.


P.S. If you're curious and want to know more about Dr. Fama and his work, I suggest you read this piece by John Cochrane.

Monday, September 30, 2013

Jim Parker's Coffee Break links...

by Jim Parker, Vice President, DFA Australia Limited 

“All I want you to tell me is when will the market go up and when will it go down.” How often do we hear that cry? Perhaps the better question to ask is whether it is really in our best interests to trust predictions about something, like the financial markets, that is inherently unpredictable. This article from Carl Richards in the New York Times provides a useful perspective on the dangers of market timing.

Have you ever noticed the similarity between commercials for lottery tickets and those by investment managers promising market-beating returns? Just as you rarely see images of a mug punter tearing up is lottery ticket, you rarely will see ads with pictures of dejected investors realising ‘the sure thing’ was anything but. The good news is you don’t need to treat investment as a gamble.

Spending more than you earn, failing to have a cash emergency fund on hand and neglecting insurance. Those are three of the big 10 money mistakes cited by The Sydney Morning Herald as most common among Australian consumers. But perhaps the most dangerous one is the “hot tip”, the get-rich-quick idea based on a speculative gamble on a single security or scheme. As always, getting sound and independent advice is a good starting point

Monday, September 09, 2013

Coffee Break (from Jim Parker, DFA Australia)

Useful Articles from the Web

The biggest communications challenge for financial professionals these days is rarely lack of information. The challenge often is accessing the right information quickly and in a form that suits the market you are seeking to service.

This new regular item points to potentially useful links in communicating the principles of sound investment. How you use them is up to you – whether in a newsletter, blog, client meeting or just to spark your own ideas.

We don’t necessarily endorse everything in these links, but we’re sure there’s something you can use. And if you see something worth reading, let us know here.

In the popular 1990s US sitcom Seinfeld, the hapless George Costanza ponders that his fortunes might change if he stops giving way to his first impulse on everything and instead does the opposite. It’s a lesson we might heed in investment as the media pushes us toward “popular” stocks. Larry Swedroe of CBS News explores the Seinfeld connection.

We see them on the TV news every night. They are always making sage and convincing sounding forecasts about the outlook for growth, interest rates, currencies and shares. But economists actually have very little to teach us as investors, as blogger Barry Ritholtz explains.

The pubs of the world are full of people big noting about how they beat the market by getting in or out at just the right time. But the truth is even a well-orchestrated entry and exit will not guarantee you beating a diversified portfolio that is rebalanced periodically.

DFA Australia Limited | Level 43, 1 Macquarie Place, Sydney NSW 2000, Australia

Monday, July 15, 2013

Second Guessing

July 11, 2013

Markets recently have had a rocky time as investors in aggregate reassess prospects for monetary policy stimulus in the United States. Is this something to worry about?

The world's most closely watched central bank unsettled financial markets by flagging it may start later this year to scale back its bond purchases.

Under this program of so-called "quantitative easing", the Fed buys $85 billion a month in bonds as a way of keeping long-term borrowing costs down and helping to generate a self-sustaining economic recovery.
What spooked the markets was a comment by Fed chairman Ben Bernanke on May 22 that the central bank in its coming meetings may start to scale back those purchases.

The mere prospect of the monetary tap being turned down caused a reassessment of risk, leading to a retreat in developed and emerging economy equity markets, a broad-based rise in bond yields and a decline in some commodity markets and related currencies like the Australian dollar.

Gold, in particular, was hit hard by the Fed signals, the spot bullion price falling 23% over the second quarter on the view that rising bond yields and a strengthening US dollar would hurt its appeal as a perceived safe haven.

For the long-term investor, there are few ways of looking at these developments.

First, we are seeing a classic example of how markets efficiently price in new information. Prior to Bernanke's remarks, markets might have been positioned to expect a different message than what he delivered. So they adjusted accordingly.

Second, the reason the issue of the policy medicine being wound back has been raised is that the patient is showing signs of recovery. In other words, policymakers are seeing sufficient signs of growth to publicly countenance "taking away the punch bowl".

This is not to make any prediction about the course of the US or the global economy. It just tells you that policymakers and investors are reassessing the situation.

Third, for all the people quitting positions in risky assets like shares or corporate bonds, there are others who see long-term value in those assets at the lower prices. The idea that there are more sellers than buyers is just silly.

Fourth, the rise in bond yields is a signal that the market in aggregate thinks interest rates will soon begin to rise. That is what the market has already priced in. What happens next we don't know.
Keep in mind that when the Federal Reserve began its second round of quantitative easing in late 2010, there were dire warnings in an open letter to the central bank from a group of 23 economists about "currency debasement and inflation".1

Yet, US inflation is now broadly where it was and the US dollar higher than when those warnings were issued (see charts below), suggesting basing an investment strategy around supposedly expert forecasts is not always a good idea.

US Dollar Index
US Dollar Index

US CPI Year-on-Year (pct)
US CPI Year-on-Year (pct)
So it would pay to exercise scepticism with respect to predictions on the likely path of bond yields, interest rates and currencies in the wake of the Fed's latest signalling. Just because something sounds logical doesn't mean it's going to happen.

Fifth, a rise in bond yields equates to a fall in bond prices. Just as in equities, a fall in prices equates to a higher expected return. So selling bonds after prices have fallen echoes the habit some share market investors have for buying high and selling low.

Finally, keep in mind the volatility is usually most unnerving to those who pay the most attention to the daily noise. Those who take a longer-term, distanced perspective can see these events as just part of the process of markets doing their work.

After all, the individual investor is unlikely to have any particular insights on the course of global monetary policy or bond yields or emerging markets that have not already been considered by the market in aggregate and built into prices.

What individuals can do, with the assistance of a professional advisor, is to manage their emotions and to remain focused on their long-term agreed goals.

Otherwise, the risk is you react to something that others have already countenanced, priced into expectations and moved on from as further information emerges.

Inevitably, second guessing markets means second guessing yourself.

1. 'Predictions on Fed Strategy that Did Not Come to Pass', Floyd Norris, New York Times, June 28, 2013