So often we hear people say that you should buy a few Australian Blue Chip stocks and hold them long term…  Well they’ve got it wrong!

Now I’m not saying a ‘buy and hold’ strategy is necessarily bad.  In fact, the way people will get their wealth is by saving and investing.  But that’s another story.  Here I want to challenge the traditional stockbroking strategy of ‘buying a few Aussie shares’.

Investors (and their stock brokers) tend to feel more comfortable investing in shares with which they are familiar.  That is, Australian shares that are often household names like the big banks, big retailers and big mining companies.

However, people forget that the Australian share market makes up only around 3% of the worlds shares.  That’s right… only 3%!  And yet they hold all their growth investments in one market, often in a handful of stocks dominated by a couple of sectors.  What this represents is a highly concentrated investment portfolio with a high level of risk.  Risk that is usually unrewarded.

So what’s the alternative I hear you ask?

A more prudent approach is to make sure that your portfolio has exposure to different shares in a variety of markets around the world.  This can be done without taking additional risk because you’re no longer holding ‘all your eggs in one basket’.

There are some years in which Australian shares perform better than the share markets of many other countries around the world.  But more often than not it helps to have exposure to shares globally.  Have a look at the table below.

Now this is, of course, just one year.  But it illustrates the fact that limiting one’s investments to a portfolio of Australian shares usually results in sub-optimum returns.  But as I said earlier, where do most Australians and most Australian stockbrokers invest?  Australian shares.

It may also come as a surprise that the unfamiliar International Shares, may not be so unfamiliar!  A global portfolio will often include names such as HSBC, Exxon Mobil, Apple, Coca Cola, Microsoft, Walt Disney, Volvo and Samsung to name a few.  Heard of them?  In fact, you have probably used their products in the last week.

So if you look at your investment portfolio and all you see is a group of Australian company names, perhaps it’s time to enhance your investments by broadening your exposure to the globalised world we now live in.

In journalism, this is known as the ‘silly season’. Lots of people are on holidays and the flow of news slows to a crawl. So the wide open spaces are filled with forecasts about the economy, markets and anything else you can think of.

Think back a year ago and politicians in Washington were in the grip of one of their now familiar “fiscal cliff” stand-offs. As has become the custom, the theatre of brinksmanship kept everyone guessing until a last-minute resolution.

For some, the excitement was just too much. The publication Financial News told its readers that “political storm clouds loom over the global economy. From Washington to Beijing, the financial markets are in thrall to seismic political events”.¹

In The Economist magazine, the tone about 2013′s prospects was equally skeptical, if not quite as florid. The magazine noted that while surveys showed investors were optimistic, the coming year was unlikely to be a bumper one.

This was because the past year’s gains partly reflected relief that the worst fears about the euro zone had failed to materialise, the magazine said, which meant that reality might intervene as investors judged shares as expensive.

“Although investors are not as complacent as they were heading into 2000 or 2007, say, it is still hard to believe this will be a bumper year for returns,” the columnist Buttonwood said in his column.²

The skepticism was universal. The Australian Financial Review quoted analysts as saying the prospect of rising bond yields and slowing profit growth did not augur well for a repeat of the performance of risky assets seen in 2012.

“Analysts are predicting no end to the volatility that has gripped markets over the New Year period, posing dilemmas for investors wondering how to invest in 2013,” the reporter concluded.³

It’s easier to see from all this that many investors might have taken fright at the developments around the turn of the year and sought to trim their exposures to risky assets because of what the media pundits were saying.

That would have been a shame because as of early December 2013, many global equity markets were notching up record-breaking years. In local currency terms, the US S&P-500 total return index, for instance, was up by just under 29% at time of writing, on track for its biggest annual gain in more than a decade.

In Japan, the Nikkei 225 total return index was 53% higher as of early December, heading for its best yearly gain since 1972. In the UK, the FTSE 100 total return index reached a 13-year peak in May this year. It has come off a little since then, but was still nearly 15% higher for the year by December.

Even in Australia, where an end to the mining boom and a strong local currency have triggered an economic slowdown, the local market as measured by the S&P/ASX 200 accumulation index was still up 15% by December, having hit 5-year highs in September. The New Zealand NZX 50 total return index was 16% higher, having set a record peak in November. These changes are in local currency terms.

As the year comes to an end again, there are still plenty of gloomy stories to fill the newspapers – including ongoing speculation of what happens when the US Federal Reserve begins tapering its monetary stimulus program.

This isn’t to say these stories are necessarily incorrect. Most of them accurately reflect the sentiment prevailing at the time they were written and the uncertainty about the future as expressed in prices.

But as an individual investor, there is not much you can do about that. These expectations and uncertainties are already built into the market. Investing is about what happens next. We don’t know what happens next. That’s why we diversify.

And think about this. If any of the gurus who regularly appear on financial television or the newspaper really had a crystal clear view of the future, why would they bother sharing it with the world?

It makes more sense to focus on what’s in your own control.

In the meantime, many happy returns!

By Jim Parker

1. Financial News, Jan 7, 2013

2. ‘Hope Springs Eternal’, The Economist, Jan 5, 2013

3. ‘Shares, Bonds Brace for Volatility, The Australian Financial Review, Jan 5, 2013

‘Want the flexibility to maximise gains and minimise losses?’

‘Take advantage of rising markets and protect the downside’

‘High income with a capital guarantee’

Whenever I see these sorts of headlines or slogans, I get a shiver down my spine… and any prudent investor should run for cover.  Why?  Because there is always a catch.

Firstly, we need to acknowledge that there is nowhere an investor can put their money with 100% certainty of no risk.  There are always risks of some kind and we simply need to understand what the risks are and make sure we are comfortable with them, even if they are very unlikely.  A couple of extreme examples are:

• One of the risks of putting money under the bed is that you could get robbed.
• One of the risks of running your own business is that the business is not successful.
• One of the risks of buying US Treasuries (considered the safest investment in the world) is that the US defaults.

This does not mean we don’t take any risks; it just means we need to be comfortable with the risks we are going to take.

We see ‘headlines’ such as those above in the newspaper, on the internet, on television and unfortunately sometimes recommended by advisers; whether they be financial advisers, accountants, lawyers or your know-it-all brother-in-law.  Often the real risks of the investments being promoted are not fully disclosed (or are in the fine print) and they make it sound like you can’t lose right? WRONG!

These are some key things to look out for.

1.  Return OF capital (not just return on capital)

It doesn’t matter what return you get, if you don’t get your initial money back!  Many people forget this when they see investments that makes big promises and ‘guarantees’.  It is critical to understand WHO is giving the guarantee and what the UNDERLYING investments are.  An example of this going wrong in the last five years has been with Mortgage Funds and High Yield Funds.  Investors were promised income returns higher than cash.  But the problem was that the invested money was going into high risk areas with a low likelihood of the money being returned.  This led to a lot of people’s money becoming frozen or investor’s losing their money.

2.  ‘Downside protection’ when investing in shares

The important thing when you see products like these is to understand HOW the protection is being obtained.  This is done using ‘derivative’ instruments such as futures and options.  There is nothing fundamentally wrong with this, however there are costs associated with using such instruments.  This means that these products come with very high fees and ultimately can negate much of the long term returns you might achieve.

The solution to this is only investing in shares for a long term strategy, which removes the impact of temporary drops in the market.  Well diversified share portfolios will remove the risk of permanent capital loss.

3.  Understand the risk of security

If you are fortunate enough to have more than enough money to provide the cash flow you need for the rest of your life, then you may be able to afford to ignore returns, which means you can hold everything in highly secure investments.  However, for most of us it is very important that our income increases over time, to cover our increasing expenses such as bills, utilities and groceries.  In this instance it can actually be risky to hold your money in cash, where the investment will not grow at a rate higher than inflation.  Sure we might have security, but we won’t have enough money to live.

This is when it is ok to take some ‘volatility risk’ with a portion of our money to provide some longer term capital growth.  This is a risk that can be understood and therefore managed.

In Conclusion

At the end of the day, we need to be aware of the ‘marketing’ that is out there.  Marketing that is intended to lure investors into products potentially for the benefit of someone else.  The key is to understand any investment being considered.  And the best way to do this is to seek professional advice from someone that is working in your best interests.

1. Once the accommodation bond is paid, it won’t be returned
The accommodation bond paid to an aged care facility can range from as little as $50,000 to the largest I have seen of $1.5 million.  It is commonly thought that this is a non-refundable ‘entry fee’ of going into aged care.  However, in reality  it is more like an interest-free loan that is either returned to the resident when they exit the facility, or to the resident’s estate upon their passing.

As long as the facility is Government regulated, the accommodation bond is guaranteed by the Government and must be used for the maintenance and development of the facilities.

2. The ongoing fees are an unreasonable amount
There are a number of fees that can apply on an ongoing basis in aged care including the basic daily fee, income-tested fee, extra services fee and an accommodation charge for high-level care.  These can add up to a substantial amount and cash flow becomes an important factor that needs to be carefully managed.

However, when one considers the services being provided by a facility, the fees have to be kept in perspective.  A facility provides a whole host of services and benefits including personal accommodation, often a room with an ensuite, communal facilities, three main meals a day organised activities and 24-hour care by qualified carers.

So what are the costs?  The most a resident can pay for the basic daily fee is $50.57 per day, which is actually not very much for the services provided.  This equates to $18,458.05 per annum.

If a resident has a high income (sometimes due to having significant assets) they might be asked to pay the income-tested fee. This can be up to an additional $70.74 per day ($25,820.10 per annum), which is a lot of money.  However, put into perspective, it is only charged to those that have high income and can therefore afford it.  It is still very reasonable for the services being provided.

3. The ongoing fees cannot be reduced
The costs of age care are based on standard rules set by the Government, with some having set formulas and others based on guidelines.  There are two types of costs in particular, that can range dramatically.

• Accommodation bond which is agreed between the resident and the aged care provider.  The Government allows an aged care facility to charge a maximum bond based on the assets of the resident.  However, often the bond may be far below the maximum.  The main thing to ensure is that the bond being charged is reasonable and not ‘above par’ for that facility.
• ‘Income-tested fee’ this can be variable and is calculated based on the resident’s income as calculated by the Centrelink income test.  It is important to know that whether one is entering care or already in care, there are clever financial strategies that can be implemented to reduce the income-tested fee.  If you are paying an income-tested fee, it is important to speak with your financial adviser about strategies to try and reduce it.

Clearly, there are many facets to the aged care system and it is certainly not a simple exercise going through it. That’s why it is important to seek advice from experts that are there to help, including Centrelink Financial Information Services Officers, Aged Care Placement Agencies and your financial adviser.

The cut to 2.50% is a fresh historic low and represented the eighth reduction this cycle.

While this has various implications for businesses, exchange rates, residential property and our economy overall, the impact on households is direct through mortgage rates.  And the big question is how much of the cut will be passed onto borrowers by the banks.

So what has your bank done following the central bank’s rate cut?  And what interest rate are you paying now compared to others?

Remember that the standard variable rate is just that… their standard.  This means that in most cases you can ask your bank manager for a discount and get a better deal.

One of the benefits of holding insurance through a large group superannuation fund is that members often benefit from features such as automatic acceptance, no underwriting and low cost cover.  These characteristics sound great, but members need to be aware that there may be potential traps.  Here I discuss just a couple of things to look out for before you can rest easy that your insurance cover is adequate.

 1.  Unitised Cover

One of the biggest traps is that super funds often offer members unitised cover, with ‘units’ costing $xxx per unit.  Members may be offered a certain number of units of cover without needing to undergo underwriting.  This is great while you are young and you can obtain a lot of cover at low cost.

However, with a unitised structure, often what happens is the amount of cover per unit reduces with age automatically.  The issue is that reducing cover may not be appropriate for your situation with the amount of insurance you have reducing at a time when you may need it the most… that is, when you’re ageing and health issues start cropping up.

The reason the unitised structure works for the super funds and the insurance companies is that when their members are older (and more risky), the amount of cover they are exposed to reduces.  But this is not usually the best outcome for members.

 2.  Medical Definitions

This is something that is relevant for any insurance policies.  It might sounds like common sense, but you need to know what you are actually covered for.  More relevant for income protection, disability and trauma covers, it is imperative that one understands what the policy defines as ‘being disabled’ or ‘not able to work’.  In addition, there may be particular medical conditions that are not covered by a particular policy.  And as medical advances witness new conditions or ways to measure these conditions, you need to know if the insurance policies are being upgraded to capture these new changes.

And guess what? If the insurance policy does not cover a medical condition you suffer, you won’t get paid on a claim.

 3.  Customer Service and Payment of Claims

Although we all hope our insurance cover is a ‘waste of money’ (so that we don’t make a claim), when is your insurance at its most valuable?  When you make a claim… and it is at claim time that you value the benefits being paid to you in a timely fashion.  So, do you understand the claims history of the insurer?  And do you know what is involved to get paid a claim?

These are extremely important questions to ask because at the time of a claim, there are far bigger personal issues to manage than having to worry about dealing with an insurance company.  Far too often have we seen insurance companies and large super funds make life very difficult for families trying to access much needed funds in very unfortunate events.  This can be avoided by ensuring the insurance company you deal with is customer focused.  Another way to get around this is to have your financial adviser do all the legwork for you so that you don’t have to.

 4.  Increasing Costs

We are seeing a recent trend in large super funds of increasing insurance costs.  This is largely due to an increasing number of claims by members… and many of those who never underwent medical underwriting.  It is also the result of these large funds passing on much of the increasing costs of running the insurance part of the funds.  This is just something to keep a look out for as your insurance premiums may simply increase without you realising it.

The key message in all this is that insurance is not as simple as taking out the cheapest policy for the amount you receive automatically.  You need to think about whether or not you actually want to be paid what you need to be paid when something happens to you.  If you are not certain your family will be taken care of in an unforseen event, then you need to review your insurance position immediately.

Gold is frequently cited in the media as a safe haven asset that offers stability in a diversified portfolio and an anchor in uncertain times. The reality, however, frequently falls short of the billing.

By the end of 2012, after a dozen consecutive years of price gains by gold, many analysts were rewriting the record books and predicting stratospheric gains for the precious metal on expectations of perceived “safe haven” flows.

But that all changed in recent weeks when, in a two-day period, gold suffered its biggest correction since 1983, dropping 13% to around $1330 an ounce. Even seasoned traders expressed surprised at how fast it unraveled.

Three headlines covering a little over a six-month period tell the story:

• “Safe haven gold is tipped to run up to $3000.” Australian Financial review, Sept, 27, 2012
• “Gold has the strongest upside potential of all the precious metals in 2013, despite recent weakness, according to Barclays Capital.” Platts Metals Daily, Dec 31, 2012
• “Gold has suffered its biggest two-day drop in 30 years as investors flee most financial markets after disappointing Chinese economic data.” Reuters, April 15, 2013

While gold may suit some investors as a modest holding in a diversified portfolio, it is worth reflecting that this so-called safe haven is in fact a highly volatile and speculative asset which generates no cash flows.

Fans of gold point to its 12 consecutive years of gains through until the end of 2012, but the fact is gold delivered negative returns in the two decades prior to that

The chart below shows the inflation-adjusted returns of Australian shares, global shares and gold invested in 1980 up until February of 2013. For the purposes of the exercise, we are using common indices and the gold spot price in Australian dollars.

Shares Vs Gold

Source: Returns Program

So if you had invested $10,000 in the Australian share market in 1980, this would have grown to just under $100,000 today. The global share market, as measured by the MSCI World ex-Australia index, leaves you with a sum of $54,000.

Now, look at gold. Your net return after more than three decades of investing and after adjusting for inflation is zero, nil, zip. In fact, you are slightly out of pocket.

So by investing in gold, you have worn extraordinary volatility, sudden and unexplainable price drops and had no protection against inflation for no return whatsoever.

Some safe haven.

While this has various implications for businesses, exchange rates, residential property and our economy overall, the impact on households is direct through mortgage rates.  And the big question is how much of the cut will be passed onto borrowers by the banks.

So what has your bank done following the central bank’s rate cut?  And what interest rate are you paying now compared to others?

The big surprise is that ANZ has made a cut to their standard variable rate that is HIGHER than the RBA cut!

Remember that the standard variable rate is just that… their standard.  This means that in most cases you can ask your bank manager for a discount and get a better deal.

Trying to correctly time your entry point to the market is never easy. Just ask the experts.

In early February, strategists at a global investment bank were becoming alarmed at political events in Europe, the sequestration “crisis” in the US Congress and what they saw as an unseemly rush into equities.

The word went out to their clients to put a tactical alert on stock investing over the next one to six months.

A month later, however, the bank strategists¹ decided to reverse course. The problems in Europe, they now discerned, were not systemic, and the likelihood was that continuing easy monetary policy would support investor sentiment globally.

As a result, the experts told clients to cautiously re-enter the market over a number of months.

That’s a shame for the clients, because at time of writing, the Global MSCI was up by 8.6% in US dollar terms this calendar year. The US S&P 500 was up 10.7%, the FTSE-100 9.9% and Australia’s S&P/ASX 300 10.7% in local currency terms.

The investment bank was not alone in changing its view. In December 2011, the veteran US newsletter writer Richard Russell (author of the Dow Theory Letters) told his clients in unequivocal terms to “get out of stocks”.

“I believe we’re going to see a brutal stock market that will shock the Fed and the bulls and the public — and all who insist on remaining in this bear market,” he said.²

But 15 months later, Russell has changed his tune, telling his clients to now buy stocks after a rally that has taken the broad US market to more than double the levels prevailing at its bottom in March, 2009.

“Yes, I know that this market is uncorrected during its long rise from the 2009 low, and I know that there are risks in buying an uncorrected advance that is becoming uncomfortably long in the tooth, but my suggestion is that my subscribers should take a chance (after all, Columbus took a chance),” Russell said in March, 2013.³

This sort of commentary isn’t just happening in the USA. In Australia, one of the most highly recognised market ‘gurus’, writer Alan Kohler, issued an ominous warning to his subscribers in a regular note in December 2011:

“The conditions are in place for a panic sell-off,” Kohler said. It is not certain that it will happen…but the risk is now such that you must take action. I will be significantly reducing my already reduced exposure to equities possibly to zero”.⁴

Explaining his mistake later, Kohler said he had not foreseen the extent to which central banks would continue to pump cheap money into the financial system.

That’s all very well. But the fact is anyone who followed his advice and went to term deposits has missed a rally in the Australian share market of more than 20%.

Providing reliable investment advice based on macro-economic, technical and political news is a tough gig. Having once worked for a newspaper, this writer knows well the dangers of splashing a front page story about markets that events overtake.

After a bleak session on Wall Street one Thursday, the Australian paper I worked on covered Friday’s local session and then threw forward for the Saturday edition with a doom-laden headline, trusting that US markets would stay down overnight.

Unfortunately, for us at least, Wall Street bounced back on the Friday, recovering all of the previous day’s losses and more. Our Saturday splash, along the lines of ‘No Respite from the Bears’, now looked a trifle silly, if not plain wrong.

For the everyday investor, the lesson is that the closer you are to media and market noise, the harder it is for you to pay attention to the bigger picture.

Markets are moving constantly as news and information is built into prices. Sentiment is buffeted one way, then the other. Millions of participants make buy and sell decisions based on news or their own individual requirements.

The job of media and market analysts frequently boils down to creating plausible narratives around often disconnected events so that it all appears seamless. Then the next day, you start all over again.

As a broker or a journalist, whose horizons are in minutes, this approach to markets makes sense. But for investors with long-term horizons, second and third guessing money decisions based on the news of the day is unlikely to deliver sound results.

A better approach is to work with a trusted advisor in building a diversified portfolio of assets tailored for your needs and risk appetite. The portfolio is rebalanced regularly to match your requirements, not according to what is happening in the markets. Tactical asset allocation can sound tempting, but there is always a risk that the news overtakes you. Then you are left having to change everything all over again.

As a wise man once said, running inside a moving bus won’t get you to your destination any quicker.

1. ‘Credit Suisse Reverses Cautious Stand on Equities’, Reuters, March 12, 2013

2. ‘Richard Russell: Get Out of Stocks’, Business Insider, Dec 15, 2011

3. ‘Another Bear Bites the Dust’, WSJ, March 13, 2013

4. ‘The Eureka Report’, Alan Kohler, Dec 19, 2011

What do the leading economists foresee in the financial indicators?

What are the stock analysts predicting for company forward earnings estimates?

What are the ‘gurus’ saying in the media about the best place to put your money?

In fact, none of these things is very relevant for most investors!  Yes, that’s right… you don’t need to ‘predict the future’ to know whether you should be buying shares… and which ones to buy.

There are 3 key things you need to think about when considering the question, “Is now the time to buy shares?”

1. Time Horizon – For how long do you intend to invest?
2. Long-term goals – What is the money ultimately for?
3. Cash Flow – What spending needs do you have?

1. Time Horizon – For how long do you intend to invest?

Too often I speak to people who ask me to invest their money in shares, so they can use it for a major purchase in two or three years.  That major purchase may be for a new home or renovation, for example… or even an aged care bond.  When I tell them I can’t do it I get mixed responses, including a couple of people who were quite angry that I would not ‘make them some money by investing in shares’.

The truth is that unless you are willing to invest capital for at least five years, you should not even consider buying shares.  I actually prefer my clients to invest their shares for a minimum of ten years.  Now, some of your capital might be needed in the short-term (see below), whilst the remainder can stay invested for the ten year period.

Younger people with superannuation, for example, have a forced long investment time horizon.  Under superannuation legislation, anyone under the age of 50 now cannot legally access their superannuation until they are aged 60.  Therefore, they automatically have the ten year investment time horizon, which means, unless they are already doing so, now is the time to buy shares.  Of course, if they were receiving good advice, they would have been buying shares for the last 5 years!

However, for anyone that might need their money in less than ten years, then the answer to the above questions is a resounding NO!

1. Long-term goals – What is the money ultimately for?

One thing that astounds me is the number of people and advisers that invest money without understanding clearly what their goals are… and what the money is actually for!  The reason for this very typical behaviour is our tendency as humans to want to ‘make a quick buck’, focus on returns and forget about risk.  Too many advisers (financial advisers, stockbrokers and even accountants) are too focused on short-term gains, rather than making sure clients investment strategies are suitably tailored to make sure they achieve their long-term goals.  That is, good, professional advice will ensure that a client doesn’t look back in 20 year time and wonder what went wrong!

So, the key to understanding whether now is a good time to be buying shares or not, is in understanding what the money is ultimately for.  And then you can work out to what level you need your capital to grow.  You (and anyone significant in your life) also need to spend some time asking yourself some of the hard questions such as

-          What is really important to us about money?

-          How much do we want to spend in retirement?

-          What do we want with the money when we are no longer here?

Only with consideration of these important questions will you be able to construct an investment strategy that will leave you looking back, fully satisfied with the outcomes.

1. Cash Flow – What spending needs to you have?

Particularly for those who are a bit wiser (read older!), the key to a sound investment strategy is cash flow… cash flow is KING!

Cash flow is one of the most important things to assist in meeting your long term goals (as discussed in the previous point).  In particular, if you are retired you are no longer able to meet your spending needs by going to work each day and receiving a pay cheque.  In fact, the transition involved in ceasing employment is very difficult mentally, as we now find that you have to rely on a ‘bucket of investments’ (often superannuation) to provide you with this cash flow.

So when designing a suitable investment strategy and your allocation to shares, we need to consider expected spending needs over the next ten years.  It is not just ‘cost of living’ that we need to think about, but also the one-off expenditure items such as holidays, new cars, large gifts etc.

With a good understanding of these cash flow requirements, you can then determine to what extent you are comfortable to have money invested in shares.  Remembering that it is a long-term investment and you need to be prepared to hold on for ten years.

With these important points in mind, you can see that you need not predict the future in order to determine when to buy and sell shares… in reality we know that no one can predict the future anyway! 

As Benjamin Graham (Warren Buffet’s mentor) once said, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework”.

So, is now the time to buy shares?  It depends!