Don't let the investing 'fast lane' fool you
August 27, 2015 | Robin Bowerman, Vanguard Investments Australia
We've all been there: stuck in crawling, grid-locked traffic, when all of a sudden the lane next to you starts moving and the car beside you surges ahead and disappears from view.
Your first instinct is probably to work out how quickly you can get into that fast moving lane and shave minutes off your travel time. You carefully time your move so you slip into an emerging gap in the traffic, then power past the other motorists who don't possess your superior driving and anticipation skills.
Only that's not how it works.
Some time-tested research from North America suggests the phenomenon of identifying a 'faster lane' in traffic is generally an illusion. That is, if you see cars moving in the next lane while you are stationary, your mind will perceive that the next lane is moving faster, when in fact the average speed of both lanes is the same.
The work from the University of Toronto instead says that, while changing lanes can give you a short burst of acceleration, you won't necessarily get there any faster. A car you overtook a few minutes ago might come puttering up beside you further along the road.
With investing lane changing is akin to performance chasing. You might see certain shares or asset classes surge ahead in the performance fast lane, while the value of your investments seem stuck in first gear. A friend or colleague might have shared a winning investment that leaves you having feelings of regret.
But just like driving in congested traffic, investors who aim to time the market and make their move to beat all the other 'slow moving' investors have the odds stacked against them. Tomes of investment research show that there are no sure-fire 'fast lanes' that will deliver you to your investment destination in a shorter amount of time than if you stick to an asset allocation designed to meet your long term goals.
Consider well-reported research into the decisions of more than 3000 US institutional pension plans who fired under-performing managers and switched to higher performing managers.
Remember these are large, sophisticated investors with plenty of technical decision-making support.
Yet the research by academics Amit Goyal and Sunil Wahal published in 2008 found that following termination the fired managers actually outperformed the managers hired to replace them by 49 basis points in the first year, 88 basis points over first two years and 103 basis points over three years.
So your best bet is to focus more on your destination than your journey and take a long term view of your investments. Stay in the same lane, stick to your investment strategy, and you are likely get there in your own time.
And just as changing lanes can involve an element of higher risk so too can looking for a 'faster' investment option present new risks not least of all the costs that come with changes to your investments, whether it be brokerage fees, buy/sell spreads, capital gains tax, etc.
The more you change 'lanes' when investing, the more of these costs you incur, and the more likely you are to make a human error, miss your timing and end up in a worse position.
It doesn't matter if you're sitting in traffic or investing: sit tight, stick to your chosen lane and remember that you're not missing out on a faster course to your destination.
Good (investor) behaviour
August 27, 2015 | Robin Bowerman, Vanguard Investments Australia
An understandable challenge for investors during periods of higher sharemarket volatility is to keep making rational, considered investment decisions and to keep focusing on their long-term goals.
As behavioural economists remind us, investors often act irrationally - particularly when markets are rising or falling sharply. And their common behavioural biases can become significant barriers to investment success.
Several of the undesirable biases identified by behavioural economists over the past 25 years or so are worth thinking about during the prevailing sharemarket volatility. These include what is known as "narrow framing".
Narrow framing is the tendency for investors to concentrate much of their attention on a single aspect of their overall investment portfolios. In turn, this may result in overreacting to short-term falls in share prices in the context of current market volatility.
The Journal of Portfolio Management in the US recently published a timely article, Bad habits and good practices, emphasising that investors falling into trap of narrow framing tend not to fully appreciate the benefits of portfolio diversification.
"It is easier to delve into one attention-grabbing investment than into its interactions with the rest of the portfolio," write the article's authors, Amit Goyal, a professor at the University of Lausanne, and Anitti Ilmanen, a London investment funds manager.
"Fortunately," Goyal and Ilmanen add, "each bad habit has a flip side: a good investment practice". They explain that good practice involves investing in a "consistent, disciplined and patient manner" following a strategic, long-term strategy.
Five years ago, Vanguard published a research paper - headed Understanding how the mind can help or hinder investment success - to provide a succinct explanation of behavioural finance including the investor bias of narrow framing.
Investors taking a narrow frame, the Vanguard paper explains, have a tendency to "fret over the performance" of a single investment or investment sector, increasing their sensitivity to loss.
Investors taking what could be described as a wider frame would tend to see a fall in the price of individual investments or an asset sector as just part of the expected movements within an appropriately-diversified portfolio. Indeed, diversified portfolios are specifically designed with the intention of having some assets rising in value to counter other assets falling in value.
In summary, investors determined to try to avoid the traps identified by behavioural economists typically:
- Set clear and appropriate investment goals.
- Develop a suitable long-term asset allocation for their portfolios, taking into account their goals, tolerance to risk and the need to diversify their risks and rewards.
- Remain committed to their appropriate long-term investment strategy through periods of market uncertainty and increased volatility.
Behavioural economists say investors should recognise that they are vulnerable to making irrational decisions and take such steps to keep undesirable behavioural biases in check.
What SMSF trustees really want
August 09, 2015 | Robin Bowerman, Vanguard Investments Australia
What are the hardest aspects of running your SMSF? And are there any areas where you would like financial advice but are not currently receiving it?
These are just two of the key questions asked in a comprehensive survey of almost 4000 SMSF trustees for the 2015 Self Managed Super Fund Report, recently published by Vanguard and specialist researcher Investment Trends.
The SMSF trustees' answers to the two questions provide an exceptional insight into the challenges of running Australia's 551,000-plus self-managed funds and into their unmet needs for professional guidance. (The survey is carefully structured so the answers reflect the views of the SMSF sector as a whole. Multiple answers were allowed.)
The five most-commonly cited difficulties of running an SMSF are not surprising. These are:
- Choosing what to invest in (32 per cent of funds).
- Keeping track of changes in SMSF rules and regulations (24 per cent).
- Dealing with paperwork and administration (23 per cent).
- Finding time to research investments (19 per cent).
- Understanding the rules (17 per cent).
These responses strongly confirm that in addition to perhaps receiving guidance regarding investment selection and fund administration, a large percentage of SMSF trustees acknowledge an unmet need for strategic financial advice. Indeed, almost 39 per cent or 213,000 of SMSFs have unmet needs for financial advice - much of this being strategic advice.
The key areas of unmet advice highlighted in the survey include: inheritance and estate planning (59,000 SMSFs), SMSF pension strategies (55,000), age pension and other social security entitlements (51,000) and offshore investing (41,000).
And other areas of unmet advice include: strategies for ensuring savings last for life (39,000) and transition-to-retirement strategies (38,000), borrowing within an SMSF (33,000), tax planning (33,000), investment strategy/portfolio review (33,000), ETFs (32,000) and investing for a regular income (30,000).
These responses clearly show that many SMSF trustees recognise the need for specialised, quality strategic advice that extends far beyond selecting investments.
Typically strategic advice includes such areas as long-term or target asset allocation and portfolio diversification, cost and tax efficiency, regular portfolio rebalancing and encouragement to invest in a disciplined, unemotional way.
Further, the 2015 Self Managed Super Fund Report, highlights the changing needs for strategic advice directed at an ageing of the Australian population. This is shown in the unmet need for advice in such areas as estate planning, SMSF pension strategies and how to plan for retirement savings to last for life.
In regard to strategic advice for older SMSF members, keep in mind that SMSFs hold more than half of the total superannuation money invested in retirement products (including transition-to-retirement pensions).
The gender gap in retirement
August 09, 2015 | Robin Bowerman, Vanguard Investments Australia
The word poverty evokes a stark picture of life in retirement. That is the reality facing a disproportionate number of women in Australia as a result of the ongoing inequality in our workplaces.
Given the advances feminism has brought to our society and the broad acceptance today of equal rights and equal pay it was confronting to read a research white paper compiled by ANZ on the barriers to achieving financial gender equity.
It is true that great strides forward have been made by women in terms of education - 42 per cent of women aged 25-29 hold a university degree versus 31 per cent of men - and that there are more women in the labour force now than ever before. But there remains a long way to go given that women in full-time roles earn, on average, $295 a week less.
Clearly there are a broad range of societal factors at play here and the chief executive of ANZ’s Global Wealth business, Joyce Phillips, used the launch of the research white paper to call for leadership on a range of issues that could shift the status quo and address the inequities that hold many women back.
The three key drivers of financial gender inequality the research highlighted were:
- Fields of study/career choices and pay gaps
- The gendered nature of caring responsibilities
- Discrimination and structural bias
The conclusion was that those factors combine to prevent women from contributing to their superannuation and growing their retirement savings in the same way as men.
The impact on retirement incomes of women is clearly significant.
Women typically have about half as much in their super account as men and as a result 90 per cent of them will retire with inadequate super.
One quite chilling statistic in the research was that one in five women yet to retire has no superannuation at all. But of course in years past it was not uncommon to hear of young women cashing out their super when they were starting a family.
If women are in an enduring relationship they will have access to the combined retirement savings or income of their partner. Which is fine for women in that situation, but the report also says a significant proportion of women in Australia today choose to live alone. An additional factor at play of course is the high level of divorce which can be financially crippling regardless of gender.
The good news when it comes to retirement for women is that they will typically live longer. The downside is that because of their lower retirement savings/earnings they are much more likely to be totally dependent on the age pension.
The ANZ study highlights the issues facing women and the barriers they confront in achieving financial equality. While the problem is broader than just the superannuation system, part of the answer has to be getting women focussed on super and the value of long-term savings. In terms of equity measures, retaining the low income super contribution is one small step that could help redress the balance.
July 15, 2015 | Robin Bowerman, Vanguard Investments Australia
First the good news. Millions of Australians gain their life and disability insurance as well as income-protection insurance through their super funds' default cover. And the level of that default cover tends to be much more adequate than a decade ago. Now the not-so-good news. It can be a costly mistake to assume that your super fund's default insurance cover is adequate for your circumstances.
Underinsurance in Australia 2014, a 94-page report published over the past week by Rice Warner Actuaries, estimates that the median default cover provided by super funds cover meets 60 per cent of the life insurance needs for average households. However - and this is a big however - the funds' default death cover meets a much lower proportion of needs for families with children.
Young families with children are calculated to have a "basic level" life insurance need of about $680,000 - $400,000 more than the typical default coverage. (This calculation is based on certain assumptions including that the parents in these families are aged 30.)
Interestingly, half of the $14 billion collected annually in life insurance premiums each year is through super funds for their group insurance cover.
Rice Warner has gathered its superannuation insurance data from 45 industry funds, 14 public-sector funds and six employer master trusts. These funds have a total of 16.5 million members.
The Underinsurance in Australia report makes the crucial point that members' insurance needs "vary significantly" depending upon the composition of their families.
"This could be addressed by superannuation differentiating members' default cover by marital status and the number of independent children instead of just age," the report suggests.
A reality highlighted by the researchers is that the level of default life cover held by the youngest single members of super funds is "likely to be higher than their needs".
Yet the coverage of members as they grow older and form families and accumulate debt typically falls well short of needs.
Rice Warner says the key challenges for super funds in regard to improving the adequacy of insurance cover for their members are to:
- More closely tailor insurance cover for younger people to reduce the possibility of over-insurance given their typically more limited liabilities and responsibilities.
- Maintain insurance for older members. Many super funds' default covers "taper rapidly" as members grow older but their insurance needs may not reduce.
- Encourage members to report to their super funds "life events" such as having children, taking a home loan and older children becoming financially-independent. This would assist super funds to fine-tune insurance products to their members' circumstances.
While these particular pointers are directed at super funds, the report may prompt individuals - perhaps with the guidance of their financial planners - to take the initiative and make sure their insurance is adequate for their family's circumstances.
Perhaps as starting point, consider feeding your family's details into an online insurance calculator provided by large super funds. Also, ASIC's personal finance website MoneySmart has some valuable tips on gaining the right level of cover - inside or outside super. (See Insurance through super.)
One tip is that if you are considering switching super funds to first check whether you will get the same level of life, total and permanent disability and income-protection cover with the new fund - at the right price. This can be particularly critical if you have an existing medical condition.
A core message is not to jump to the assumption that your super fund's default cover is sufficient your circumstances.
Rice Warner's research confirms that the levels of underinsurance for permanent disability and income-protection cover are even greater than for life insurance.
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