All posts by Robert Wright

Nine bad habits of ineffective investors: common mistakes investors make

By Robert Wright /November 20,2024/

Introduction

In the confusing and often seemingly illogical world of investing, investors often make various mistakes that keep them from reaching their financial  goals. This note takes a look at the nine most common mistakes.

Mistake #1 Crowd support indicates a sure thing

“I will tell you how to become rich…Be fearful when others are greedy. Be greedy when others are fearful”. Warren Buffett, Investor and CEO

It’s normal to feel safer investing in an asset when your friends and neighbours are doing the same and media commentary is reinforcing the message that it’s the place to be. But “safety in numbers” is often doomed to failure. The trouble is that when everyone is bullish and has bought into an investment with general euphoria about it, it gets to a point where there is no one left to buy in the face of more positive supporting news but instead there are lots of people who can sell if the news turns sour. Of course, the opposite applies when everyone is pessimistic and bearish and have sold – it only takes a bit of good news to turn the value of the asset back up. So, the point of maximum opportunity is when the crowd is pessimistic (or fearful) and the point of maximum risk is when the crowd is euphoric (and greedy).

Mistake #2 Current returns are a guide to the future

“Past performance is not a reliable indicator of future performance”. Standard disclaimer

Faced with lots of information, investors often use simplifying assumptions, or rules, in order to process it. A common one of these is that “recent returns or the current state of the economy and investment markets are a guide to the future”. So tough economic conditions and recent poor returns are expected to continue and vice versa for good returns and good economic conditions. The problem with this is that when it’s combined with the “safety in numbers” mistake, it results in investors getting in at the wrong time (e.g. after an asset has already had strong gains) or getting out at the wrong time (e.g. when it is bottoming). In other words, buying high and selling low.

This is pertinent now with shares providing strong gains over the last two years – with US shares up 56%, global shares up 49% and Australian shares up 25% – despite lots of worries about interest rates, recession, commercial property and US banks, wars, elections, etc. This has brought with it a temptation to conclude we are in a “new era” where macro problems don’t matter and that even if they do central banks will protect us by slashing rates and pumping money in (the so-called “central bank put” which morphed from the “Greenspan put” many years ago) and governments will do the same with government spending.

Unfortunately, we have heard the “this time is different” argument many times before only to find out that it’s not – usually when we are most complacent! The reality is that shares have done well over the last two years because they came off a big cyclical fall in 2022 and the threats have not proved that serious economically. For instance, the much feared recession has failed to appear and the war in the Middle East has not disrupted global oil supplies (so far). And the “central bank put” did not prevent the tech wreck and the GFC (both saw US shares fall around 50%) and various other share market plunges. Just because shares have had strong returns over the last two years, despite lots of worries, doesn’t mean that the cycle has been abolished and that there is nothing at all to worry about.

Mistake #3 “Experts” will tell you what will happen

“Economists put decimal points in their forecasts to show that they have a sense of humour”. William Gillmore Simms, Novelist and Politician

The reality is that no one has a perfect crystal ball. It’s well known that forecasts as to where the share market, property market and currencies will be at a particular time have a dismal track record, so they need to be treated with care. Usually the grander the forecast, calls for “new eras of permanent prosperity” or for “great crashes ahead”, the greater the need for scepticism as either they get the timing wrong or it’s dead wrong.

Market prognosticators suffer from the same psychological biases as everyone else. And sometimes forecasts themselves can set in motion policy changes that make sure they don’t happen – such as rate cuts heading off sharp house price falls in the pandemic in 2020. The key value of investment experts is to provide an understanding of the issues around an investment and to put things in context. This can provide valuable information in terms of understanding the potential for an investment. But if forecasting was so easy, the forecasters would be rich and so would have retired!

Mistake #4 Shares can’t go up in a recession…

“It’s so good it’s bad, it’s so bad it’s good”. Anon

A common lament around in second half 2020, after share markets rebounded from their late March 2020 pandemic low, was that, “the share market is crazy as the economy is in deep recession and earnings are collapsing!” Of course, shares kept rising into 2022, economies recovered, and earnings rebounded. The reality is that share markets are forward looking, so when economic data and profits are really weak, the market has already factored it in.

History tells us that the best gains in stocks are usually made when the economic news is still poor, as stocks rebound from being undervalued and unloved, helped by falling interest rates. In other words, things are so bad they are actually good for investors! Of course, the opposite applies at market tops after a sustained economic recovery has left the economy overheated with no spare capacity and rising inflation and so the share market frets about rising rates. Hence things are so good they become bad! This seemingly perverse logic often trips up many investors.

Mistake #5 Letting a strongly held view get in the way

“The aim is to make money, not to be right”. Ned Davis, Investment Analyst

Many let their blind faith in a strongly held, often bearish view – “there is too much debt”, “aging populations will destroy returns”, “a house price crash is imminent”, “a Trump victory will see shares crash”, etc. – drive their investment decisions. This is easy to do as the human brain is wired to focus on the downside more than the upside, so we are easily attracted to doomsayers. They could be right one day but lose a lot of money in the interim. Giving too much attention to pessimists doesn’t pay for investors.

Mistake #6 Looking at your investments too much

“Investing should be like watching paint dry or watching grass grow. If you want excitement…go to Las Vegas”. Paul Samuelson, Economist

Checking up on how your investments are doing is a good thing, surely? But the danger is that the more investors are exposed to news around their investments, the more they may see them falling. Whereas share markets have historically generated positive returns more than 60% of the time on a monthly basis and more than 70% of the time on a calendar year basis, day to day it’s close to 50/50 as to whether the share market will be up or down.

 

 

 

 

 

Daily & monthly data from 1995, data for years and decades from 1900. Source: Bloomberg, AMP

Being exposed to this very short term “noise” and the chatter around it can cause investors to have a greater exposure to lower returning but safer investments that won’t grow wealth. The trick is to turn down the noise and have patience. Evidence shows that patient people make better investors because they can look beyond short-term noise and are less inclined to jump into one investment after another after they have already had their run.

Mistake #7 Making investing too complex

“There seems to be a perverse human characteristic that makes easy things difficult”. Warren Buffett

With the increasing ease of access to investment options, ways to put them together and information and processes to assess them, investing is getting more complex. But when you overcomplicate your investments, it can mean that you can’t see the wood for the trees. You can spend so much time focusing on this stock or ETF versus that stock or ETF or this fund manager versus that fund manager, that you ignore the key driver of your portfolio’s risk and return which is how much you have in shares, bonds, real assets, cash, onshore versus offshore, etc. Or that you end up in things you don’t understand. Instead, it’s best to avoid the clutter, don’t fret the small stuff, keep it simple and don’t invest in things you don’t understand.

Mistake #8 Too conservative early in life

“Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it”. Albert Einstein, Theoretical Physicist

Cash and bank deposits are low risk and fine for near term spending requirements and emergency funds, but they won’t build wealth over time. The following chart shows the value of $1 invested in various Australian assets since 1900 allowing for the reinvestment of interest and dividends along the way. That $1 would have grown to $955,656 if invested in shares but only to $263 if invested in cash. Despite periodic setbacks, shown with arrows (such as WWI, the Great Depression, WWII, stagflation in the 1970s, the 1987 share crash and the GFC), shares and other growth assets grow to much higher values over time thanks to their higher returns over the long term than cash and bonds and thanks to the magic of compound interest where higher returns build on higher returns through time.

 

 

 

 

 

Source: ASX. Bloomberg, RBA, AMP

Not having enough in growth assets early in their career can be a problem for investors as it can make it harder to adequately fund retirement later in life as they miss out on the magic of compounding higher returns on higher returns through time in growth assets like shares and property. Fortunately, compulsory superannuation in Australia helps manage this, although early super withdrawal for various purposes (through the pandemic, for medical needs and as proposed for housing) may set this back for some. For example, a 30 year old who withdraws $20,000 from their super could have around $184,000 (or $74,000 in today’s dollars) less when they retire at age 67 based on assumptions in the ASIC MoneySmart Super Calculator.

Mistake #9 Trying to time the market

“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves”. Peter Lynch, Fund Manager

In the absence of a tried and tested process, trying to time the market, i.e. selling before falls and buying ahead of gains is very difficult. Many of the mistakes referred to above kick in and it can be a sure way to destroy wealth. Perhaps the best example of this is a comparison of returns if the investor is fully invested in shares versus missing out on the best days. Of course, if you can avoid the worst days during a given period you will boost your returns. But this is very hard and many investors only get out after the bad returns occur, just in time to miss out on some of the best days and so hurt their returns. If you were fully invested in Australian shares from January 1995, you would have returned 9.5% p.a. (including dividends but not allowing for franking credits). But if by trying to time the market you miss the 10 best days the return falls to 7.5% p.a. If you miss the 40 best days, it drops to just 3.5% p.a. Hence, it’s time in the market that’s the key, not timing the market. The last two years provide a classic example of how hard it is to time markets – there has been a long worry list, so it’s been easy to be gloomy but timing markets on the back of this has been a loser as shares put in strong gains.

Concluding comment

I know it sounds kind of boring and like a cliché, but the easiest way to overcome many of these mistakes is to have a long-term investment plan that allows for your goals and risk tolerance and then stick to it.

 

Source: AMP

What is a distribution?

By Robert Wright /November 20,2024/

A managed fund generates income from its investments – for example, through share dividends, interest on cash or fixed interest investments in the fund, or any gains made when fund investments (like shares) are sold. So in short, a distribution is profit or income made by a fund and paid to investors.

How are distributions paid?

Managed investment funds are required to pay all realised income and capital gains to investors for the financial year. Income can be paid monthly, quarterly, half yearly or yearly, depending on the fund. You may receive your distribution as a cash payment, for instance as a payment to your designated bank account, or as an amount that is reinvested back into the fund. As an investor, you should also receive a statement that outlines the amounts and types of income generated by the fund and distributed to you, which may be helpful at tax time.

How are distributions calculated?

• The income of all individual investments in a fund for a given time period is calculated taking into account things like share dividends or interest payments.
• The fund’s deductible expenses (things like management fees and other payables) are then subtracted, leaving the total amount of income that can be paid out.
• That amount is then divided by the total number of units in the fund to provide an amount of distribution per unit. For example, if the distribution for a fund was $1 per unit and an investor owned 100 units in the fund, they would receive a distribution of $100.

What does the unit price have to do with distributions?

When you invest in a fund, you’re pooling your money with other investors to access a professionally managed portfolio of investments overseen by skilled investment managers. In exchange, you’re allocated a number of units that correspond to how much money you’ve invested – based on the fund’s unit price at the time of investment.

Why does the unit price fall after a distribution?

When you receive a distribution for the income generated by a fund’s investments, the value of the fund reduces by the amount of the total distribution. This results in a lower unit price because income from the fund’s investments is being paid from the fund to investors, reducing the total value of the fund’s assets – a figure that is divided by the total number of units owned in the fund to determine the unit price. This doesn’t mean you’ve lost money on your investment or that your investment in a particular fund has changed – rather, you retain the same number of units in the fund, which has simply decreased in value by the amount of the distribution paid to you. Distributions that are reinvested back into a fund are used to acquire more units in it. This means the value of your investment should not fall as you will be allocated additional units.

Why aren’t distributions paid to super funds?

While managed investment options (funds) outside of super pay distributions to investors, investment options within super do not. That’s because there is a different structure and purpose for super, which members can’t access until retirement. Generally, super balances fluctuate higher and lower over time depending on the contributions members make and the performance of the funds their super is invested in. Investment options within super contribute to super balances through the unit price, which changes daily based on the performance of each fund’s investments. Effectively, the distribution amount is retained in your super and forms part of your super balance, which over time can be used to acquire more investments in the options your super is invested in.

 

Source: Colonial First State

Ever thought of investing in essential services?

By Robert Wright /November 20,2024/

Ever thought of investing in essential services?

Investing in infrastructure is about investing in the companies that provide essential services to society and earning predictable, reliable returns in the process.

More than 350 infrastructure and utility companies are listed on global stock markets, with the sector having a combined market capitalisation in excess of US$4 trillion; about three times the market value of the Australian stock market[1]. The services provided by these companies are essential to the efficient function of communities, providing assets that have reliable earnings growth and stable income streams in times of market declines. As investments, infrastructure stocks exhibit unique characteristics, including reliable cash generation, inflation protection, defensiveness in declining markets, and low correlations with other asset classes creating a compelling case to include the sector in a diversified portfolio.

As it is traditionally defined, infrastructure typically refers to large, tangible assets that deliver essential services. While utilities, highways and pipelines are widely regarded as infrastructure, the status of other assets, including car parks, data centres, and satellites attracts debate. Notwithstanding this complexity, the case for investing in infrastructure is clearly demonstrated by an examination of the sector’s attributes.

Why invest in listed infrastructure? 

As an asset class, infrastructure exhibits four distinctive characteristics:

• Infrastructure generates reliable cash flows – The vast majority of infrastructure assets exhibit predictable demand, limited competition and a stable regulatory environment. Infrastructure is thus well positioned to generate reliable cash flows and solid and stable earnings growth, no matter what economic conditions prevail.
• Infrastructure offers inflation protection – Infrastructure comes with built-in protection against inflation because regulators allow these companies to raise their prices to protect their earnings when their costs rise.
• Infrastructure has lower risk of capital loss – Assets that have reliable earnings growth and stable income streams are typically havens in periods when equity benchmarks decline.
• Infrastructure exhibits low correlations with other asset classes – Because the earnings of infrastructure companies exhibit low levels of sensitivity to economic conditions, the returns of infrastructure investments typically exhibit low correlation with other asset classes, offering diversification benefits for investors.

Including infrastructure in a diversified portfolio can enhance returns and reduce portfolio risk.

Infrastructure – always in demand

Investing in infrastructure is about investing in the companies that provide essential services to society. We are so used to these services in our lives that perhaps we underestimate the range of essential services that are provided the world over, every minute of every day.

Communication towers

The phenomenal growth of the Internet and mobile devices means that communication towers play an essential role in the efficient function of a modern community. The biggest tower operators have a large reach. American Tower, for example, has nearly 226,000 towers across 25 countries in five continents[2]. Other examples of telecommunication tower stocks include Cellnex Telecom, Vantage Towers and Crown Castle International.

Global mobile data traffic is expected to grow 20% p.a. over the six years to 2028.

Water

Water is perhaps the most essential of all infrastructure services. Australians consumed more than 13,800 gigalitres of water in FY2020-21[3], with the average household bill being $832 a year[4]. In 2020-2021, the total expenditure on distributed water by Australian households, businesses and other bodies was about $9.2 billion. Examples of global infrastructure water stocks include United Utilities of the UK and American Water Works.

Humans can use only about 0.3% of the world’s supply of water[5].

Natural gas

Natural gas is nearly as interwoven into our daily lives as electricity. In Australia, ~42,000 kilometres of natural gas transmission pipelines shift gas from where it is produced to demand centres[6]. Natural gas supplies ~27% of Australia’s energy needs[7].

Global natural gas consumption is expected to increase by more than 40% over the period to 2025[8].

Electricity

Electricity is integral to almost every aspect of our modern lives. In the US, the power grid is made up of over 7,300 power plants, nearly 160,000 miles of high-voltage power lines, and millions of miles of low-voltage power lines and distribution transformers, connecting 145 million customers throughout the country[9].

The average US household spends US$137 per month on power[10]. Examples of global infrastructure ‘electricity’ stocks include the National Grid of the UK, WEC Energy and Xcel Energy with service territories in the USA.

Electricity wasn’t ‘invented’ it was ‘discovered’ because it is present in nature.

Airports

In 2022, planes carried over 3.8 billion passengers worldwide through the world’s airports[11]. Airports within the global infrastructure sector include Zurich Airport, Paris Charles de Gaulle Airport, London Heathrow.

Airports play a vital role in economic growth, job creation and international trade and tourism.

Toll roads

Toll roads have been around for thousands of years, the history of toll roads in Australia dates back to 1811 when the first toll road (Sydney-Parramatta) was built. Today the US has more than 9,500 kms of toll roads and host more than five billion trips a year[12]. Examples of global infrastructure ‘toll road’ stocks include Transurban with operations in Australia and North America, Ferrovial with toll road assets in North America.

Sydney’s toll roads host an average of more 950,000 trips each day[13].

 

Source: Magellan Group

[1] https://www.ceicdata.com/en/indicator/australia/market-capitalization

[2] American Tower Overview – Q2 2023, Data as of June 30, 2023

[3] Australian Bureau of Statistics: 2020-21, total expenditure on distributed water by industry and households

[4] Canstar Blue research, January 2023.

[5] ngwa.org – https://www.ngwa.org/what-is-groundwater/About-groundwater/information-on-earths-water

[6] Australian Pipeline and Gas Association: https://www.apga.org.au/pipeline-facts-and-figures

[7] https://www.energy.gov.au/data/energy-consumption (2020- 2021)

[8] https://www.energy.gov/fecm/liquefied-natural-gas-lng

[9] https://www.epa.gov/green-power-markets/us-electricity-grid-markets

[10] https://www.eia.gov/todayinenergy/detail.php?id=56660#13

[11] https://centreforaviation.com/analysis/reports/the-worlds-airports-the-state-of-the-industry-in-jan-2023-in-11-numbers-635413

[12] IBTTA. https://www.ibtta.org/sites/default/files/documents/MAF/2015_FactsInBrief_Final.pdf

[13] https://www.parliament.nsw.gov.au/lcdocs/inquiries/2792/Report No. 16 – Road Tolling Regimes.pdf

Pros and cons of Self Managed Super Funds (SMSFs)

By Robert Wright /November 20,2024/

While self managed super funds are not for everyone, they do offer significant benefits. Running an SMSF successfully requires investment, legal, super and admin skills – or the ability to get help from people who have those skills.

Having control over how your retirement savings are invested is one of the many benefits of SMSFs.

On the flip side, the responsibilities and management skills required to run an SMSF are significant. This is because you’re accountable for your SMSFs regulatory compliance, not your accountant, financial adviser or solicitor.

What is an SMSF?

An SMSF is a private super fund you manage yourself, giving you more control over how your retirement savings are invested.

SMSF members must be trustees (or directors of the self managed super fund corporate trustee) and are beneficiaries of their SMSF. This means SMSF members are responsible for managing the fund’s investments and compliance with super and tax laws. This hands on approach sets SMSFs apart from public super funds, which are managed by financial institutions.

Benefits of SMSFs

1. Access to more investment options

Having an SMSF provides more choice and freedom to access investment options that would otherwise be unavailable through a public super fund. This includes assets like real property, art and collectibles (such as stamps and coins), as well as physical gold.

Unlike investing with an industry, bank or retail super fund, your SMSF can borrow to invest in property, using a Limited Recourse Borrowing Arrangement (LRBA).

This strategy is a good option to help expand your investment portfolio. However, there are restrictions and compliance requirements. The Australian Taxation Office (ATO) has warned investors of the dangers of over investing (and over borrowing) into property within SMSFs.

2. Control

If you’re a member of an SMSF, you have greater control over how your super’s invested while working, and how it’s paid when you retire.

This means you can invest in many of the products available to public super funds, as well as some products that aren’t. For example, SMSFs can invest directly in real estate, rather than being restricted to property trusts as many public funds are.

3. Tax benefits

You’re entitled to the same reduced tax rates that are available through super so your investment return is taxed at a maximum of 15% (provided that your SMSF is a complying fund) rather than your personal income tax rate which could be as high as 45%. In addition, any payments received after the age of 60 are tax free.

These tax benefits are common to all super funds, not just SMSFs. However, SMSFs have more flexibility to use tax strategies around capital gains, taxable income or franking credits.

4. More scale to access opportunities

Generally speaking, an SMSF can have up to six members. Bringing six investors’ money together, offers greater scale to access investment opportunities that may not be available to you as an individual investor.

Having scale may also help to keep fees down. This is because you can pool your assets and share expenses, leading to potential cost savings, which means you may have more funds available for investment growth.

5. Estate planning

One often overlooked advantage of an SMSF is that they can provide greater flexibility or control with estate planning, if a member was to pass away.

An SMSF trust deed may also provide how and to whom death benefits will be distributed as long as these align with super law. The deed may also allow for cascading death benefit nominations or the exclusion of certain beneficiaries. Benefits could also be distributed to beneficiaries in a tax effective way.

Considerations to be aware of with SMSFs

1. Responsibility

Managing an SMSF is not easy. As the trustee, you need to ensure the fund complies with all relevant regulations otherwise you could face severe consequences for getting it wrong.

If the fund is deemed to have breached its compliance responsibilities, penalties can include fines and civil or criminal proceedings. Depending on the offense, tax penalties could be increased, including fund returns being taxed at the top marginal tax rate as opposed to the concessional super rate of 15%.

2. Expertise

What investors often overlook is the financial and investment expertise required to run, or be involved in running an SMSF.

As a trustee, you’ll be responsible for creating and implementing your own investment strategy – one that will need to deliver enough returns to adequately fund your retirement.

This means you need to:

• Understand how investment markets work, including share markets.
• Record your investments and transactions.
• Ensure your fund is adequately diversified to help manage risk.

You’ll also need to remain up to date on any changes to legislation that affect SMSFs as these may have compliance requirements.

An understanding of how to manage legal documents, such as a trust deed, is also beneficial. However, a legal professional could help you with this.

3. Time

The administration and management of an SMSF is time intensive so if time is something you’re short of, an SMSF may not be a good option. On the other hand, many SMSF investors enjoy the sense of involvement and purpose that running their own fund brings.

4. Higher insurance costs

Public super funds can generally provide cheaper insurance to their members than SMSFs. This is because they have large memberships and can negotiate discounted bulk premiums with insurance providers.

5. Outsourcing your SMSF to professionals

If you find you don’t have the time or investment knowledge to manage your SMSF, you can outsource this to investment managers, financial advisers or other experts. This will come at an additional cost though.

6. Minimum amount required for SMSFs

There is a lot of controversy around what should be a reasonable amount to set up an SMSF.

There’s no minimum amount required to set up an SMSF but depending on the fund’s complexity and structure, set up costs, administration, reporting and legal fees, it can become expensive. It’s generally more cost effective if your SMSF has a higher balance.

 

Source: MLC