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'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

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Wednesday, 9 January 2013

Opportunity cost will eventually fire up our investment markets

Opportunity cost

I blogged the other day about the concept of companies calculating their cost of their capital, for it would be nonsensical to undertake projects which return less than the cost of financing them. These ideas are intricately linked to the concept of opportunity cost.

A mining company might, for example, elect to invest $1 million in a new piece of crushing equipment which could increase its throughput rates. Before it does so, however, the company will generally need to look at what that money might be doing instead.

If the $1 million could be invested at a risk-free return of, say, 5% per annum, then the crushing equipment has an opportunity cost of $50,000 in year 1 and should therefore be increasing throughput sufficiently to return more than the equivalent of an extra $50,000 each year over its useful economic life.

Put another way, before you spend some money or invest it, it is first useful to know what you are foregoing or missing out on by so doing.

Opportunity cost is intuitive

It’s amazing how often you hear people say that they don’t have time to get started in investing.

You have 24 hours in a day and 7 days in a week the same as I do. Richard Branson and Bill Gates have the same number of hours in a day as us.

So it doesn’t really make sense to say that we “don’t have the time” to do something, for by definition we all have the same amount of time. What we are really talking about is how we prioritise our time.

Donald Trump takes the concept of opportunity cost to its ultimate extreme. He sees life as a competition as to who will be the richest and therefore only sleeps for four hours each night – sleep is seen as wasted time in the great competition of life.

I wouldn’t recommend such an extreme approach but it seems to work for Trump as he confesses that he loves the competition aspect.

While the concept of opportunity cost might induce stress, it need not. Whether or not we realise it, we all weigh up opportunity cost almost every time we make a decision.

Each time you elect to work overtime instead of going to the pub, or choose a slice of cake instead of going to the gym, you are effectively weighing up the costs and benefits of each decision.

Career opportunity cost

Over recent years a tough choice has faced many youngsters in Britain. 

With the introduction of expensive university tuition fees, would-be students must balance up the benefits of a university education which may see them incur considerable debt against the long-term benefits of attaining a degree.

By the time a student has graduated with a debt burden, his or her school-friend who shunned higher education may have worked for 5 years and saved a significant towards buying their first house. A graduate might earn a higher salary but they need to do so in order to pay off their student debts!

Of course, these can be impossibly difficult decisions to make at such a young age.

Opportunity cost in investment

It sometimes makes sense to employ the use of an expert in investment.

In fact, most employees actually do so by paying for a fund manager to manage their superannuation fund.

You don’t physically pay the cash; they simply deduct their fees from your fund each year, regardless of whether they have made money or lost you money.

Others of us deem the value to be added by fund managers as unacceptably low and thus elect to self-manage our balance via a self-managed super (SMSF).

Does that mean I would never pay for expert assistance in investment? Definitely not. Indeed, when I buy my next investment property I will probably pay a buyer’s agent to acquire it for me.

That might sound a little odd as I’m a licensed buyer’s agent in New South Wales myself, but I’m likely to be overseas and thus I’m likely to deem the cost of paying a buyer’s advocate as lower than the opportunity cost of what I might be doing with my time elsewhere instead.

Opportunity cost in today’s markets

And so to where our investment markets are headed today.

One of the problems facing investors and particularly retirees is that the slashing of the cash rate to just 3.00% has haemorrhaged returns on traditionally “safe” fixed-interest investments (with no capital appreciation these often bring risks of a different kind as inflation devalues capital values over time) such as term deposits, bonds and savings accounts.

Returns on some of the ‘safer’ or top-rated government bonds have been woeful, and returns on savings accounts and term deposits are dropping ever further.

This presents a difficulty for retirees who had grown accustomed to interest rates at close to double-digit levels or at times significantly higher rates than even this. A cash rate of just 3.00% was not expected.

When dividend returns on blue-chip stocks are higher than the equivalent returns from fixed-interest investments it is logical that the share market index might eventually start to rise.

And if your time horizon is a long one, quality dividend-paying stocks represent decent value at the moment.

One problem is that investors have very short memories and the almighty correction in stocks through the global financial crisis which scythed many retirement funds in half has scared many Australian investors away from equities for life.

In contrast almost every Australian who has been in the property market for the long haul has seen strong returns and therefore a perception exists that property is always safer than shares. 

The combination of historic low interest rates and the fanatical Australian love of bricks and mortar will eventually see confidence return to that sector.