How To Spend

Reading media reports about Johnny Depp’s financial woes (he has allegedly come close to bankruptcy despite earning $650 million over the last decade or so thanks to a serious spending habit) it brings to mind a question we all ask, what’s the right way to spend money? Or to put it another way, What Would Johnny (Not) Do?

Have a budget

First up, be aware of your net monthly income and set monthly expenditure accordingly – which ideally means setting aside funds to invest for a rainy day (see How To Save). Johnny’s $2 million a month ‘allowance’ was clearly over budget (even for him).

Pay attention

Continually check your accounts to ensure you are keeping track of all outgoings. Set a spending limit and stick to it. Don’t expect someone else to tell you you’re spending too much (yes, I’m looking at you Johnny).

Be flexible

If your income varies then you must be ready to adjust spending habits. For most of us the income side of the equation is out of our control – at least Johnny can always do another Pirates of the Caribbean movie (‘Pirates 5’ out this Friday!).

Spend wisely (part 1)

Essential expenses are those necessary for basic living. Be conscious, perhaps ruthless, about what you consider ‘essential’. For example, for most of us one car is a necessity, but do we really need two cars, or forty-five (you know who)? Our home is undoubtedly a necessity, a second, or fourteenth (him again) is definitely non-essential.

Spend wisely (part 2)

Discretionary spending is everything non-essential – without doubt the area we can all ‘improve on’. For example, I would categorise a guitar, or seventy (uh-huh) as not essential. Did Johnny really need to spend $3 million blasting journalist Hunter S. Thompson’s ashes out of a cannon? I would say not.

Spend wisely (part 3)

And when it comes to discretionary spending, all the evidence suggests we get more happiness out of experiences rather than stuff (both before and after the purchase). So maybe don’t bother with the Hollywood memorabilia (for which Johnny needs 12 storage facilities) and instead enjoy a nice holiday.

 

Need help avoiding the temptation of splurging $30k a month on wine (like Johnny)?  You could call Money Smart on 01 276 0006 or email info@moneysmart.ie but maybe seek other help first!

 

All figures above are alleged in a lawsuit by Johnny Depp’s former business advisors.

What’s Your Financial Personality?

We all have very different ideas about what money means to us and we have many different, often damaging, psychological biases that impact how we make money decisions. Knowing our financial personality is the first step to making better decisions. So which one are you?

The Saver

= Values the security of cash much more than the fear of investment loss.

+ Rarely gets into any financial trouble of any kind as not all income is spent and no risk is ever taken.

May not enjoy life to the full if money is always hoarded. And being too risk averse, such as keeping all your money in the bank, will never make you rich.

The Spender

= Prefers the thrill of spending to the security of saving.

+ Gets full value out of the joy of spending money and amassing ‘stuff’.

May not think of the future and end up living beyond their means and in debt.

The Gambler

= Happy to speculate with their money. “If you’re not in, you can’t win”.

+ Big risks can occasionally mean big investment wins.

Often driven more by optimism and gut feeling than by research and analysis. Can lose it all with if just one big bet goes sour.

The Procrastinator

= Would rather bury their head in the sand than organise their finances.

+ I’m afraid there is no positive to this one!

Not engaging with personal finances leads to anxiety and stress.

 

Need help making better money decisions? Just call Money Smart on 01 276 0006 or email info@moneysmart.ie.

Stay Invested

globe-europeThe U.K. votes on Thursday on whether to leave or remain in the European Union. With the two sides neck and neck in the polls, markets are extremely volatile. A vote to leave will undoubtedly cause market disruption. So what should investors do? We say, as always, stay invested. Here’s why…

Cash is not the answer. Moving to cash does not eliminate risk. Yes it may help you sleep at night but it exposes you to the very real risk that inflation will drastically reduce the future purchasing power of your money.

Trading kills returns. Think you can outsmart the market and avoid the down days? Think again. Most investors are terrible at trading/guessing. JP Morgan calculated that those fully invested in the S+P 500 between 1995 and 2015 earned a 10% annualised return but those who missed the 10 best days earned only 6% – and 6 of those 10 best days were within 2 weeks of the 10 worst days.

Don’t miss the bounce back. Volatility is inevitable but stock market history teaches us that every bear market has been followed by a recovery. Staying invested has always rewarded patient investors, particularly those who continue to invest year in, year out.

Avoid emotional biases. Doing nothing in periods of market stress may be difficult in the face of constant media headlines but staying invested, switching off the noise and keeping your emotions out of the investment process is the best way to stick to a financial plan.

A diversified portfolio is for life. That’s why we spend so much time considering client circumstances and objectives. We recommend multi-asset portfolios designed to withstand market cycles. Your financial goals are long term – your investment behaviour should match that.

Money Smart can design your diversified long term investment portfolio. Call 01 276 0006 or email info@moneysmart.ie.

Money and Happiness

happy jumpDoes more money make us happier? How exactly? And what can we learn from all the research on this topic? Here’s my slightly tongue-in-cheek summary of what psychologists are telling us.

 

Fact: People around the world exhibit a happiness U curve. We tend to be saddest between the ages of 45 and 55 – possibly due to the perfect storm of teenage children, elderly parents, and the sense that retirement needs funding.

Lesson: Avoid kids, parents and retirement?? Or seek independent financial advice?

 

Fact: Younger people are happier as they don’t have to worry about these things but the happiest age group is the 65 to 75s.

Lesson:  A nice pension pot solves a lot of problems.

 

Fact: We generally become happier as we get richer. Being unemployed makes us miserable.

Lesson: Work, save, invest. Yes it’s boring but have you got a better idea?

 

Fact: Money has less impact on our happiness once we’re ‘comfortably off’ – after that health, lifestyle and relationships are much more important to our wellbeing.

Lesson: Once you’ve got enough income/capital, start focussing on how to use your money to maximise your wellbeing.

 

Fact: Money spent on experiences (and on others) makes us happier than money spent on ‘stuff’.

Lesson: If money doesn’t make you happy, maybe you’re not spending it right?

 

To talk to Money Smart about your money worries call 01 276 0006 or email info@moneysmart.ie

5 Bad Habits To Give Up For Lent

Easter Eggs… and forever after.

1. Counting your pennies.

Much better to forget about the pennies and think long and hard about the pounds. Or in other words, spend much more time choosing a pension provider than a utility provider.

2. Expensive credit card debt.

Credit cards can be really useful as long as you pay off the balance in full every month. If you don’t they are dangerously expensive so try to cut out minimum repayments.

3. Spending what’s leftover.

Don’t fritter away surplus cash or allow it to depreciate in a bank account. Instead, start a regular investing habit. It’s the easiest way to end both unnecessary spending and hoarding cash at zero rates of return.

4. Listening to the experts.

They know as much about the future as you do. So stop listening to them or reading (yesterday’s) financial news. This era of information overload is not helping us make good decisions.

5. Worrying about money.

It’s simple. Stop procrastinating and begin thinking seriously about budgeting and planning. Or better still, let an independent financial planner do it all for you.

 

Talk to Money Smart about the single good habit you need to concentrate on, long term investing made possible by forward planning. Call 01 276 0006 or email info@moneysmart.ie.

Don’t Get Stuck In Default Mode

too many choicesDo you think you have free will? How often do you exercise it? You may need to think twice about your answers because every time we make a decision there are powerful behavioural forces hampering our ability to choose.

The dominant force I want to talk about is inertia, our deep psychological resistance to change. In many situations we seek to minimise the effort or cost of thinking. For example, as Nobel Prize winning author Daniel Kahneman points out in “Thinking Fast And Slow”, 12% of Germans are organ donors versus 99% of Austrians. The reason why? Inertia. Germans (like us Irish) have to opt-in but Austrians have to opt-out. It’s easier to do nothing than to do something. Default settings are therefore powerful tools in framing our choices.

Whether it be a pension plan, a privacy setting or a car rental agreement, any change to the default requires effort on our part. This may be a good thing if product providers are acting in our best interests but as Cass Sunstein notes, “Choosing Not To Choose”  is often not the right decision. For example, we end up with some unwanted and expensive holiday insurance when all we actually wanted was to book a budget flight online.

In my business I see a lot of people whose pension details are not just buried in a dusty shoebox, they are also stuck in an inappropriate asset class. Because pensions are boring/complicated/opaque, no great effort is made to match asset allocation to the clients’ circumstances. Some surveys show that up to 85% chose the default option – which in my experience is often too conservative for a lifetime investment strategy. Similarly, I know of many instances where fear and loss aversion has driven money into cash after the 2008 crash but inertia has resulted in many years since of low/no performance.

The solution? In the case of pensions, ensure your financial advisor has an ongoing hands-on approach to your pension investments. If you don’t have an advisor you will need to make a little bit of effort to rescue your pension from the doldrums.

More generally we have to hope that governments and corporations take more responsibility so that our pre-wired inertia bias is no longer used against us when it comes to product sales.

Talk to Money Smart about maintaining a pension portfolio appropriate to your needs by calling 01 276 0006 or emailing info@moneysmart.ie.

5 Reasons To Never, Ever Buy Individual Shares

Lehman Brothers Share CertificateWe’ve all thought about it, most of us have done it, some of us have made big gains, many of us have been burned. Many ‘experts’ endorse it as a perfectly sound investment strategy. Not me. Here’s why you should never buy an individual share…

1.   Going to Las Vegas

It’s nothing short of legalised gambling. Why? Because picking out a single company share from among thousands makes it a game of chance, not a game of skill. Be honest. Do you really think yours is a skilful choice, made from an in-depth analysis of every aspect of this company’s business (and every aspect of competing businesses, as you are choosing not to buy those shares) and an in-depth analysis of this particular industry versus all the other sectors you could have chosen? Isn’t it time to leave Las Vegas?

2.   Known and Unknown Unknowns

Without going all Donald Rumsfeld, when it comes to stock markets there are many knowns, in fact information overload is the problem. I believe that stock market prices are an accurate reflection of all known information. So why do you think you know the unknowns? Do you honestly think you can predict the future for any single company? Did Tullow Oil investors anticipate that oil prices (and their shares) would drop by 60%? Did Tesco investors (including Warren Buffett) expect profits to plummet, resulting in a 50% share price decline? Did Anglo Irish investors expect their bank to go bust?

3.   Mind Games

Arguably the biggest single argument against buying individual shares is that in doing so, we invite our flawed emotional brains to play havoc with our money. For example, we often buy a company stock because we prefer the simple story constructed by ourselves (or a friend, or a TV ‘expert’) rather than do the time-consuming analysis that’s required, we seek confirmation of why we are right (and ignore signs we may be wrong), we are overly confident of our own investing abilities, we are over-optimistic about future outcomes, and we are pre-wired to sit on (rather than cut) losses. But apart from that…

4.   Basket Case

We know that diversification reduces risk. We know what happens when we cram too many eggs into one basket. We know we cannot predict which companies, or industries, or countries, or currencies will be the winners in any one year. Yet many investors, who should know better, believe in their own ability to stock pick their way to beating the market.

5.   Average = Above Average

The final reason not to buy individual shares is that there is a much better alternative – global index funds. These funds track the whole market return by investing, pretty much, in the whole market, rather than taking individual single company risk. So your money earns the long term average equity market return of around 8% versus the average equity investor return of around 4%. Which average return would you prefer?

 

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How The Rich Get Richer

large yacht with blue sea and skyThomas Piketty’s Capital in the Twenty-First Century is the bestselling book that policymakers the world over are talking about. The French economist states that wealth inequality is heading back to levels last seen a century ago, the gilded age era of Carnegie, Rockefeller and Vanderbilt. Piketty believes that the inequality gap is growing worldwide because the return on capital is exceeding economic growth.  In other words capitalism is flawed because its returns are unfairly distributed, resulting in a world controlled not by talented individuals but by family dynasties who just need to harvest their capital returns and their tax breaks to maintain their lofty positions.

The fortunes of Ireland’s 250 wealthiest people are now equivalent to 35 per cent of our gross domestic product.

The wealth of the UK 1,000 richest is also equivalent to about a third of its gross domestic product.

According to a recent report by Oxfam, the richest eighty-five people in the world – the likes of Bill Gates, Warren Buffett, and Carlos Slim – own more wealth than the roughly 3.5 billion people who make up the poorest half of the world’s population.

While there may be some argument about the extent of inequality (the FT says some of Piketty’s analysis is flawed), its social policy implications, and whether absolute poverty should be our only benchmark, it is worth considering, on a micro rather than macro level, how the rich grow richer. Apart from inheritance, what do they do differently than us that makes them, and keeps them so much richer than the rest of us?

1.   They all have financial advisors. Their myriad affairs often require advisors in various specialities (tax, accounting, etc) and jurisdictions but many will use their financial advisor to oversee all these strands. They are also ruthless in dispensing with the services of advisors they don’t rate.

2.   They fully embrace financial planning. It goes without saying that they expect their advisors to have the tools and expertise to plan their financial futures.

3.   They also employ tax advisors and carefully plan their tax strategy, managing both profits and losses efficiently.

4.   They tend to have very diversified portfolios, across all geographies and including all asset classes.

5.   They take more risk. Firstly, by including exposures to higher risk asset classes such as hedge funds, venture capital and private equity. Secondly, by skewing their portfolios towards their area of expertise, often in the form of own business or related business direct investments.

6.   They tend to buy and hold – but re-balance regularly, arguably the cheapest and most effective form of market-timing.

7.   They aim to pass on their capital intact (at least) to the next generation and employ the latest estate planning strategies.

Piketty may well be correct that the inequality gap will continue to widen unless governments implement aggressive wealth and income taxes. However, there is plenty we can do ourselves to mimic the capital growth of the super-rich, albeit on a much smaller scale!

Beware Your Inner Chimp

Chimp sticking his tongue outWhat do Ronnie O’Sullivan, Bradley Wiggins and Liverpool football team have in common? They have all benefited from the sports psychology coaching of Dr Steve Peters, author of The Chimp Paradox. The inner chimp is the primitive part of the brain that is impulsive and emotional by nature. If we allow our inner chimp to control us, our decision-making will be irrational and, most likely, detrimental.

Now despite recent hiccups (let’s not mention Mark Selby or Crystal Palace!), the sports stars mentioned have all converted better mind control into improved performances. So much so that Peters’ latest client is the England football team. Let’s see how that works out this summer, particularly in a penalty shoot-out situation!

The inner chimp theory is very much related to the arguably more scientific work of Nobel Prize winning behavioural economist Daniel Kahneman, most notably in his ‘bible’, Thinking, Fast and Slow. Both Peters and Kahneman agree that we are creatures of sub-optimal thinking, prey to impulsive, emotional, irrational ‘fast thinking’.

Now while most of us no longer need controlled minds for high pressure sports events, we do need to think rationally when making money decisions, and unfortunately, our default ‘fast thinking’ is very much in evidence in our financial lives. For example…

  1. Confirmation Bias. We tend to only use information that matches our existing beliefs and ignore data that suggest otherwise. For example, when we buy a house we tend to seek out only opinion that supports such an investment.
  2. Overconfidence. We think we’re better than average at almost everything, including investing. This leads to costly overtrading and is, perhaps not surprisingly, more prominent in the male of the (human and chimpanzee) species.
  3. Anchoring Bias. We rely too heavily on the first piece of information offered when making decisions. Advertisers use this flaw to nudge us, very successfully, into economically irrational choices.
  4. The Endowment Effect. We place a higher value than others would on things we own. Often as a result of our pre-wired Loss Aversion – we prefer avoiding losses to making gains. Four words. Bank of Ireland shares.

So how can we control our minds when making important financial decisions?

1.   Be Aware. Try to recognise situations where you may not be thinking rationally.
2.   Slow down. Disengage your fast thinking brain by delaying decisions.
3.   Outsource. In other words, use an (emotionally detached) independent advisor.
4.   Have a Plan and a Process. Make money decisions based on a Financial Plan and executed with reference to a rational consistent process.

 Investment and pension decisions are the key to your financial future. Silence your inner chimp and give Money Smart a call.

Are You Sure You’re Not A High-Frequency Trader?

Man celebrating on stock exchange trading floorMichael Lewis is a genius.  He has regularly turned what, on the face of it sound like boring subjects into entertaining stories.  That The Big Short’, a book about the credit default swap market, is about to be made into a movie is testament to his storytelling genius.  And now he has done it again with another fascinating read.  Flash Boys: A Wall Street Revolt’ examines high-frequency computerised trading in US stock markets, shining a light on yet another murky corner of the capitalist world.  High-frequency trading represents half, yes half, of all U.S. equity trading.  Lewis points out that everyone who owns equities is being victimised, in which the fastest traders figure out which stocks investors plan to buy, purchase them first and then sell them back at a higher price.  It’s such a lucrative practice that a technology firm spent $300 million to build a cable that would shave three  milliseconds off the time it takes to communicate between New Jersey and Chicago, then leased it out to securities companies for $10 million each.  And it’s just as prevalent on this side of the Atlantic, so much so that the EU is about to introduce restrictions.

As the debate about high-frequency trading rages on, it’s worth thinking about our own human propensity to trade stocks or funds far too frequently.

We humans suffer from a whole range of psychological flaws.  Two ‘failings’ of particular interest to this discussion are over-confidence and its investment offspring, over-trading.  We systematically overestimate our knowledge and our ability to predict.  This is evident when we pick single stocks and trade them too frequently, thinking we know more about the value of a security than everybody else. The average holding period for a stock on the NYSE is around six months. This is not investing. This is our own, very flawed, very human and much much less profitable version of high-frequency trading.

The famousBoys Will be Boys’ study carried out by behavioural finance experts Brad Barber and Terrance Odean found that men traded 45 per cent more often than women and earned 1.4 per cent less annually.  Single men traded 67 per cent more often than single women, and earned 2.3 per cent less annually! The reason?  Women outperform not because of superior stock-picking ability; they simply make fewer mistakes. Men take on too much risk and trade too much, partly out of overconfidence in their ability to divine market swings, and partly because of thrill-seeking desires.

Research has shown that women are less likely to break traffic lights, less likely to smoke, more likely to wear seat belts, more likely to floss their teeth – so it’s little surprise the same differences would manifest themselves in investment behaviour.

So I say to you (especially if you’re a man!), do not trade, do not speculate.  If you want entertainment, read a Michael Lewis book.  Leave your investment portfolio alone – allow it to be dull.  Take a leaf out of Michael Lewis’s book, who says “I’ve always been a boring and conservative investor … I own index funds … I don’t time the market … I put it away and I don’t look at it very much”.

James Montier in his excellent ‘Little Book of Behavioural Investing’ quotes the French philosopher Blaise Pascal; “All men’s miseries derive from not being able to sit in a quiet room alone”.