Tuesday, August 25, 2015

The Patience Principle

Jim Parker, Vice President, Dimensional Australia

Global markets are providing investors a rough ride at the moment, as the focus turns to China's economic outlook. But while falling markets can be worrisome, maintaining a longer-term perspective makes the volatility easier to handle.

A typical response to unsettling markets is an emotional one. We quit risky assets when prices are down and wait for more "certainty".
These timing strategies can take a few forms. One is to use forecasting to get out when the market is judged as "over-bought" and then to buy back in when the signals tell you it is "over-sold".
A second strategy might be to undertake a comprehensive macro-economic analysis of the Chinese economy, its monetary policy, global trade and investment linkages and how the various scenarios around these issues might play out in global markets.
In the first instance, there is very little evidence that these forecast-based timing decisions work with any consistency. And even if people manage to luck their way out of the market at the right time, they still have to decide when to get back in.
In the second instance, you can be the world's best economist and make an accurate assessment of the growth trajectory of China, together with the policy response. But that still doesn't mean the markets will react as you assume.
A third way is to reflect on how markets price risk. Over the long term, we know there is a return on capital. But those returns are rarely delivered in an even pattern. There are periods when markets fall precipitously and others where they rise inexorably.
The only way of getting that "average" return is to go with the flow. Think about it this way. A sign at the river's edge reads: "Average depth: one metre". Reading the sign, the hiker thinks: "OK, I can wade across". But he soon discovers the "average" masks a range of everything from 50 centimetres to five metres.
Likewise, financial products are frequently advertised as offering "average" returns of, say, 8%, without the promoters acknowledging in a prominent way that individual year returns can be many multiples of that average in either direction.
Now there may be nothing wrong with that sort of volatility if the individual can stomach it. But others can feel uncomfortable. And that's OK too. The important point is being prepared about possible outcomes from your investment choices.
Markets rarely move in one direction for long. If they did, there would be little risk in investing. And in the absence of risk, there would be no return. One element of risk, although not the whole story, is the volatility of an investment.
Look at Australian share market's benchmark S&P/ASX 300 accumulation index. In the 35 years from 1980 to 2014, the index has registered annual gains of as high as 66.8% (in 1983) and losses of as much as 38.9% (in 2008).
But over that full period, the index delivered an annualised rate of return of 11.6%. To earn that return, you had to remain fully invested, taking the unsettling down periods with the heartening up markets, but also rebalancing each year to return your desired asset allocation back to where you want it to be.
Timing your exit and entry successfully is a tough ask. Look at 2008, the year of the global financial crisis and the worst single year in our sample. Yet, the Australian market in the following year registered one of its best-ever gains.
Now, none of this is to imply that the market is due for a rebound anytime soon. It might. It might not. The fact is no-one can be sure. But we do know that whenever there is a great deal of uncertainty, there will be a great deal of volatility.
Second-guessing markets means second-guessing news. What has happened is already priced in. What happens next is what we don't know, so we diversify and spread our risk to match our own appetite and expectations.
Spreading risk can mean diversifying within equities across different stocks, sectors, industries and countries. It also means diversifying across asset classes. For instance, while shares have been performing poorly, bonds have been doing well.
Markets are constantly adjusting to news. A fall in prices means investors are collectively demanding an additional return for the risk of owning equities. But for the individual investor, the price decline only matters if they need the money today.
If your horizon is five, 10, 15 or 20 years, the uncertainty will soon fade and the markets will go onto worrying about something else. Ultimately what drives your return is how you allocate your capital across different assets, how much you invest over time and the power of compounding.
But in the short-term, the greatest contribution you can make to your long-term wealth is exercising patience. And that's where your advisor comes in.

Market Meltdown, Bloodbath and Armageddon Headlines

Jim Parker, from Dimensional, has put together a special one-off edition of the Coffee Break brings together some useful perspectives on current market volatility. 

Coffee Break: Avoiding Meltdown

It’s one of those rare times when financial news moves from the business pages to the front page. “Market meltdown” makes for a great headline. But for individual long-term investors the biggest danger is an emotional meltdown. [Click on headings or use links below.]
Deep economic and market analysis are not really what most investors need at times like this. Instead, the most useful attributes are discipline, diversification, patience and self-knowledge. Veteran journalist Jason Zweig, who’s seen it all before, lists five things you shouldn’t do now.

Market volatility can be hard to take, but the more attention you pay to day-to-day fluctuations the more your emotions take over. If you need the money tomorrow, you might have cause to worry. But for most of us, there will be many more market cycles to come. So don’t watch.

With our exposure to China, Australia has been caught up in the market falls. Dipping into and out of the market may seem tempting at this time, but listen to another veteran financial journalist Michael Pascoe. People who panic only risk making it worse for themselves.

Monday, July 06, 2015

Jim Parker's Coffee Break

Each week Jim shares a few interesting links from the web and is happy for them to be posted here.
Before decimal currency, many of us remember our grandparents saying that if you take care of the pennies, the pounds will take care of themselves. These days we have dollars and cents, but the lesson is still the same.

Basically, the lesson is that little things count in building wealth. On their own, the details may seem unimportant, but paying attention to them pays off in the long term.

This week’s Coffee Break looks at ways of spending less and saving more. While we don’t necessarily endorse everything in these links, they may prove handy as conversation starters.

Do you ever look at your credit card statement and find yourself telling stories about your impulse purchases to make yourself feel better? It’s natural to want to rationalise our expenditure. But Carl Richards says we should focus on the numbers themselves as they don’t lie.

Saving money begins with understanding what you can and can’t control. Just sticking to essential purchases may work, but it’s also important you don’t put yourself in a straitjacket. In any case, it’s sometimes the little things that have the biggest impact.

Small changes in your spending patterns can make a big difference to your savings pile. It may be as simple as giving up buying coffee each day or locking up your credit card for a month. Check out this useful ready reckoner from the Australian Securities and Investment Commission.

Monday, March 23, 2015

Coffee Break: Beating the Market

Jim Parker's Interesting Links from the Web
Many investment gurus say they can 'beat' the market. But do they do it consistently, what risks are involved and what’s the result after costs?
In this week’s Coffee Break, we feature articles showing that investors are better off starting with the aim of getting the capital market rate of return.
Beating the Market
Some fund managers will always beat benchmarks in any year. But how many do it consistently? And when they do, how much is due to skill or plain good luck? A new survey, published in the NY Times, asks those questions.
Mission Impossible
Even Warren Buffett admits he doesn’t beat the market all the time. If he did, he would eventually “become” the market. This study shows the arithmetic behind the idea that no investor can outperform the market forever.
Never a Stock Picker’s Market
‘Alpha’ is the extra return an investor gets over a benchmark due to skill. The problem, says Noah Smith, is that what is identified as ‘alpha’ is often just ‘beta’ or the return the market would have given you anyway.

Jim Parker is a Vice President at DFA Australia Limited.

Monday, January 19, 2015

Mug's Games - This week's Coffee Break from Jim Parker

At the start of a New Year, the media is full of forecasts about the likely path of the economy and markets for the coming 12 months.

Most of these 'investment outlooks' are marketing exercises. The actual outcome of the forecasts doesn’t matter since few people recall them anyway. This week, Coffee Break looks at why so many market forecasts go awry.

Forecasts to Ignore
The famed US economist John Kenneth Galbraith once said that the only function of economic forecasting is to make astrology look respectable. Yet people keep on trying. In this article, Barry Ritholtz revisits some of the (now) embarrassing forecasts made this time a year ago.

Spotting Bad Forecasters
One characteristic of a bad forecaster is to make excuses when they are wrong. 'Oh, if the RBA had raised rates, I would have been right.' Another classic: 'It didn’t happen this year, but it will happen.' This writer argues that forecasters go wrong in assuming they control what they don’t.

Weasel Words
Media insiders will tell you that market pundits save their blushes when their forecasts prove to be wrong by using 'weasel words'—slippery phrases that provide an easy out. In this article, the writer lists 14 meaningless phrases that can make you sound like a market guru with actually saying much.

Jim Parker is a VP at DFA Australia Limited

Thursday, January 15, 2015

Jim Parker's Coffee Break - Keeping Resolutions

Making New Year’s resolutions, particularly when it comes to our finances, is easy. Keeping them is something else entirely.

This week’s Coffee Break provides links to helpful articles that show how you can increase your chances of success in keeping to a plan.

The Theory of Sunk Costs

Most people are reluctant to walk out on a bad movie. They may hate the film, but they subconsciously figure that having spent the money on the ticket, they need to sit it out. While this tendency to honour sunk costs can seem illogical, it can also help us keep New Year’s resolutions. More >

Beware the Loophole

So you’ve committed to the resolution and built a plan that makes it hard for you to change course. That’s good. But humans still have an amazing capacity to create loopholes. This article lists 10 common ones. Just being aware of the excuses may make it easier for you to resist them. More >

Why are Resolutions Hard to Follow?

When straying from a commitment, people will often say they lacked the willpower. The truth is the strength of our will is only part of the challenge. Often overlooked in keeping resolutions are the external factors that control our behaviour. This article highlights six steps to take back control. More >

Jim Parker

DFA Australia Limited