Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.
"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.
"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.
"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.
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Tuesday, 15 January 2013
A practical way to reduce investment risk: averaging
If you read The Intelligent Investor by Ben Graham, the author speaks of the merits of dollar cost averaging.
You may wonder why I speak so often about The Intelligent Investor. There are two reasons: the first is that I've read it a thousand times and the other is that it's the second finest book on investment ever written after my 2012 book Get a Financial Grip. OK, apologies, I’m British - we tend to use hyperbole and sarcasm…we can’t help it, it’s what we do.
The fact is, if Ben Graham speaks highly of an investment strategy it is likely to be well worthy of consideration, so let’s take a closer look.
The tide turns against averaging?
About a decade ago or so, if you asked people about whether dollar cost averaging was smart, it suddenly seemed to be the case that you were a figure of fun, a genuine loser to be mocked, a moron, an uneducated investor who “lacked financial intelligence”.
Okaay. For a while I wondered what the heck was going on. Why was this time-tested strategy being so openly sneered at? I asked a few questions in return. Why is it such a bad strategy? What would you do instead? Can you explain to me what it actually is?
The responses were invariably the same: “Dollar cost averaging is dumb. Mutual funds are dumb. I'm gonna buy real estate and hoard silver coins because we gotta fiat currency and the US (?!) has loads of debt…we're gonna experience hyperinflation! Dollar cost averaging is for people who lack financial intelligence. Slow money is for the poor and fast money wins!”
Eventually it clicked. Why, of course. They had all read Rich Dad Poor Dad and were on their merry way to "financial intelligence". Silly me!
What is dollar cost averaging?
As usual, the one minor problem with the advice was that if you asked people to explain to you what dollar cost averaging actually was, they just said “it’s what financial advisers and mutuals tell you to do…and it’s dumb.”
In the most basic terms dollar cost averaging (DCA) is the practice of investing equal monetary amounts regularly and periodically over specific time periods in a particular investment or portfolio – for example, you could invest $500 every month into an index of shares.
The idea is that, simply enough, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The effect of so doing is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.
The benefits can include that the investor gets great piece of mind because in accepting that they are not trying to “beat the market”, they are instead ensuring that over time the average cost remains reasonably low and, in a market with a long-term upward trend they will finish with a good result.
The downsides can include that many of us don’t have the same amount of money available to invest each month and sometimes we need to withdraw funds for an emergency.
The reason DCA got a bad press, I suppose, is that financial advisers urged investors to persist with the strategy through the financial crisis but some investors lost their nerve and sold out at the bottom of the market (whereas they should have continued to buy safe in the knowledge that they were lowering their average cost).
Kiyosaki insists in Rich Dad Poor Dad book that the strategy is dumb because investors acknowledge that are not trying to beat the market. Of course, they should buy low and sell high, he said. The problem is that most average investors do precisely the opposite.
But remember what Buffett said: “when dumb money acknowledges its limitations, paradoxically it ceases to be dumb”.
The greatest benefit to my mind of DCA is that investors are granted freedom from worrying about the vagaries of the market and psychologically this makes them more likely to succeed. Thus dropping regular dollar amounts into an index fund – or better still the industrials index – can be a very effective strategy.
“More great news as markets plummet…”
The psychology of investing is endlessly fascinating. It is constantly assumed by the news bulletins that markets moving up are a good thing and markets moving down are bad. But why?
And why does the Dow “plummet” by 200 points? At today’s market levels that is only a 1.5% movement, yet nobody ever suggests that the temperature has “plummeted” from 30 degrees to 29.5 degrees, do they?
If you are someone who is earning money and planning to invest more money in the future why would a market moving downwards be bad? You can buy more investments at a cheap price. After all, the value hasn’t changed, only the price has. Imagine if the news read like this:
“More great news for investors today as markets dropped by another 5%. Delighted investors poured more money into the market to capitalise on the bargain prices. Better news still may lie ahead as analysts suggested that prices could drop by a further 15% which would see bargain-hunters able to pick up yet more cheap shares.”
This is why Graham says that most share investors would someimtes be better served if there was no daily stock market for their investments after they had bought them. Prices may fall because of others’ mistakes rather than your investment decisions being poor, yet investors often seem to react in panic.
Instead he says share investors should sometimes think like homeowners who only consider the price of their property on the day they sell (I wonder if the daily home value index today will shift homeowners’ perception?).
Averaging in property
Mathematically, averaging works in the same manner in any market. If prices move down then investors buy at a cheaper price thereby reducing their average cost.
Triumphant housing bears insists that “property is expensive and risky” but the statement is so loaded with generalisations it’s hard to know where to start in responding to it.
If you’d never invested in property in your life and suddenly pumped $5 million into the Melbourne CBD apartment market tomorrow, would property be a risky investment? Well, frankly, yes.
Yet if you’d invested in property steadily acquiring one property each year or two over the last 15 years, would property be risky? Your average entry cost would be very low, you would have very substantial equity and you would have the skills and experience to know that when property market prices retrace this represents an opportunity rather than a problem to be feared.
I touched on this the other day when I referenced my own portfolio. If you own property bought in the 1990s which has increased in value nearly fivefold against which you have a trivial mortgage, would you worry about a market correction? No way José.
Of course you wouldn’t, and after the “crash” from 2007 (well-located property eased moderately, and in London where hot foreign funds flowed, many markets continued to rise), opportunities were snapped up by counter-cyclical investors. I bought a property for 25% less than it had last changed hands for in 2005; and it’s so far positively geared it causes tax headaches.
Property investors are constantly being goaded by the threat of an imminent crash. I note that Professor Keen has warned that “prices could fall by 20% from peak to trough”. And, who knows, he might even be right (this time)?
Remember that the wealthy tend to think in a manner which is exactly opposite to the way in which the herd think. Falling prices are not to be feared – they represent an opportunity to pick up cheap quality assets when the herd is panicking and selling out. Continue to 'buy the dips' in a market with a long-term uptrend and you'll finish the race well ahead.