Tag Archives: Investments

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

Decoding cognitive biases: what every investor needs to be aware of

By Robert Wright /August 23,2024/

Common human biases that investors should understand when it comes to investing is extremely important. These biases are ingrained in human nature, leading to tendencies to oversimplify, rely on quick thinking or exhibit excessive confidence in judgments, which may lead to investment mistakes. By gaining insight into these biases, investors may be able to make better decisions to help reduce risk and improve their investment outcomes in the long-term.

Numerous cognitive biases can affect how decisions are made. The key to mitigating these biases lies in recognising their presence, identifying when they might arise and then either making appropriate adjustments or obtaining help to moderate their impact.

Seven cognitive biases that might arise at various stages of an investor’s investing journey.

Herding: The tendency to follow and mimic the actions of a larger group.
Confirmation bias: The preference for information that confirms one’s existing beliefs or hypotheses.
Overconfidence effect: Excessive confidence in one’s own investment decisions and abilities.
Loss aversion: When the fear of loss is felt more intensely than the elation of gains.
Endowment effect: Overvaluing assets because they are owned.
Neglect of probability: Disregarding the actual likelihood of events and often overemphasising rare occurrences at the expense of more probable outcomes.
Anchoring bias: The tendency to rely too heavily on a past reference or a single piece of information when making decisions.

Herding

The herd mentality occurs when people find reassurance and comfort in a concept that is widely adopted or believed by many others. In recent times, we have seen the herd mentality with the events that surrounded the GameStop stock event. Where many people saw the rise in stock prices and without proper investment research followed the trend of many others and invested.

This impacted a lot of investors who bought the stock due to the fear of missing out and the hype it created. We believe, to be a successful investor, you must be able to analyse and think independently. Speculative bubbles are typically the result of herd mentality. Herd mentality in investing can overshadow rational decision making and could increase the risk of financial losses.

Investors need to recognise the feeling of pressure to conform to popular opinion or follow the crowd and instead consider conducting research and analysis before making decisions, as well as seeking alternative views to challenge the consensus.

Confirmation bias

Confirmation bias is the tendency to favour information that corroborates pre-existing beliefs or theories. In our view, confirmation bias can lead to significant errors in investing. Investors may develop an inflated sense of certainty when they encounter consistent evidence supporting their choices. This overconfidence can create an illusion of infallibility, with an expectation that nothing can go wrong.

Overconfidence bias

Overconfidence bias in investing is where investors overestimate their knowledge, intuition and predictive capabilities, often leading to poor financial decisions. This bias can present itself through various ways such as excessive trading, under-diversification and the general disregard for potential risks.

Investors with overconfidence bias tend to believe they can time the market or have the ability to pick the winning stocks better than most, which in turn may also result in overtrading and increased transaction costs. Overconfidence can also lead to a lack of proper risk assessment and analysis, as investors might underestimate the likelihood of negative events or industry dynamics affecting their investments.

An example of overconfidence bias occurred during the dot-com bubble of the late 1990s and early 2000s. Many investors were overly optimistic about the growth potential of internet related companies. This led to inflated stock prices as more and more people invested in these companies without proper evaluation of their actual worth.

Loss aversion

Loss aversion is where a real or potential loss is perceived as much more severe than an equivalent gain. The pain of losing is often far greater than the joy in gaining the same amount.

This overwhelming fear of loss can cause investors to behave irrationally and make bad decisions, such as holding onto a stock for too long or too little time. For example, an investor whose stock begins to tumble, despite clear signs that recovery is unlikely, may be unable to bring themselves to sell due to the fear of loss in the portfolio. On the flip side, when a stock in the portfolio surges, they may quickly cash out, not wanting to see the possibility of those profits disappearing.

When an investor clings onto failing stocks, departs with successful stocks too quicky and fear governs their investment decision, it’s known as the disposition effect. It’s a direct consequence of loss aversion, leading investors to make overly cautious choices that ultimately undermine their financial goals.

So, understanding this bias may help investors make rational decisions to grow their portfolios while managing risk effectively.

Endowment effect

Closely related to the concept of loss aversion is the endowment effect. This effect arises when individuals place a greater value to items because they own them, as opposed to identical items that they do not own. It’s a cognitive bias where ownership elevates the perceived value of an item beyond its objective market value.

For example, an investor may develop a strong attachment to a particular stock. It could be the very first stock they ever invested in, or they may favour the company for a particular personal reason such as aligning with their values. If this stock begins to fall and financial experts are advising to sell, because of the value bias this investor has they may be unwilling to sell. The investor perceives the stock’s value as greater than what the market dictates, purely because of ownership. It is a delicate balance that is needed to be able to determine between attachment and sound financial decision making and can be challenging for some investors.

To help mitigate the endowment effect, investors should regularly review their portfolios and consider the help of a financial adviser. Establish clear, predefined criteria for selling assets, aligned with financial goals. Develop a detailed investment plan with specific financial goals, a well defined investment strategy is crucial to prevent emotional decision making. Understanding and focusing on long-term investment goals can also help in maintaining objectivity.

Neglect of probability

Humans often overlook or misjudge probabilities when making decisions, including investment decisions. Instead of considering a range of possible outcomes, many people tend to simplify and focus on a single estimate. However, the reality is that any outcome an investor anticipates may just be their best guess or most likely scenario. Around this expected outcome, there’s a range of potential results, represented by a distribution curve.

This curve can vary widely depending on the specific characteristics of the business involved. For instance, companies which are well established and have strong competitive positions, tend to have a narrower range of potential outcomes compared to less mature or more volatile companies, which are more susceptible to economic cycles or competitive pressures.

Another error investors may make is to overestimate or misprice the risk of very low probability events. That does not mean that ‘black swan’ events cannot happen but that overcompensating for very low probability events can be costly for investors.

Anchoring bias

Anchoring bias is the inclination to excessively rely on a previous reference or a single piece of information when making decisions. Numerous academic studies have explored the impact of anchoring on decision making. Typically, these studies prompt individuals to fixate on a completely random number (such as their birth year or age) before asking them to assign a value to something. The findings consistently demonstrate that people’s responses are influenced by the random number they focused on prior to being asked the question.

Looking at a recent share price is a common way investors may anchor their decisions. Some people even use a method called technical analysis, which looks at past price movements to predict future ones. However, just because a stock’s price was high or low in the past doesn’t tell us if it’s a good deal now.

Source: Magellan