FYI | Jul 10 2013
By Peter Switzer, Switzer Super Report
Last week I got to thinking about sensible investing when conditions are really ‘iffy’ and as I thought about it, I realised that in most short-term stock market situations there are always Rumsfeldian moments, which explain why there is a seller when someone wants to be a buyer.
Last week, the European Central Bank president, Mario Draghi, was accused of being “semi-rude” to a well-known business reporter at a conference last week. It followed Draghi’s announcement that European interest rates would be kept “at present or lower levels for an extended period of time.” It came as the new Bank of England boss implied the same thing and stocks spiked big time as a consequence.
The FTSE in fact was up 3.1%, which was the best gain in 20 months. European bourses had smaller but still big gains as well. However, some economists were negative on him giving forward guidance on rates, on the basis that he is virtually saying “we’ve tried everything and so we have to stick to low rates.”
Unknown unknowns
That was the incident that got me thinking about the old US Secretary of Defence, Donald Rumsfeld. This is what he said: “There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.”
A lot of people laughed at his logic but I think there are lots of unknown unknowns in the world of investing and it’s why sometimes you have to be cautious. It’s why you would not be heavily invested in stocks if you couldn’t afford to ride out a crash of a 2007-2009 kind.
Historically, I would have argued younger people can afford to be fully invested as there would be plenty of cycles to get your money back from a crash. Known knowns tell us that stock markets gain in seven out of 10 years. Also, they tell us a market will pass its old high before crashing again.
Of course, history can change a rule of thumb or known known, but in the world of investing you have to have some basic rules that have stood the test of time.
Let’s face it, if we had $5 million in our SMSFs and we only needed $250,000 a year to be happy, then we could invest our money in a term deposit at 5% and sleep well at nights but this is hypothetical.
Longevity risk
Last week I did a speech with Bernard Salt, the KPMG demographer, and as it happens I met the CEO of the Actuaries Institute, Melinda Howes and both were emphasizing how long we are living.
Howes said if you make 65 there’s a good chance you will make 100 and the actuaries have a paper to prove it. Even if this is a stretch, the new known known is that many of us will outlive our super if we play the ‘too cautious’ game.
When I got into financial planning, 60-year olds were supposed to be investing conservatively but life expectancy was less than the low 80s. This is what we are telling clients now, but if Salt and Howes are right, we will be pushing up these figures over the next few years!
The great known unknown is that you will die but you don’t know when and it gets more complicated when you throw in your partner. These unknowns make the unknown unknowns that the stock market brings with it even more challenging, when it looks like we have to take on more risk with our investments, because ‘unluckily’ it looks like we are going to live longer!
The big plan
So, what’s my response to these unknowns? First is to have a plan to keep wealth growing for as long as I can. So, my stocks will be dividend payers, as half the historical return on stocks – which is about 10% per annum over a 10-year period – are from dividends. Second, I have an attitude to buy when share prices of great companies fall substantially, or as Roger Montgomery argues, when the intrinsic value of the company is greater than the share price. Third, I keep a cash-buffer for those times when the dividend flow does not pay what I want to live on. Fourth, I could be diversified but I am mindful that Warren Buffett has said “diversification is for wimps”! I believe as we get into the retirement zone we should add ‘wimpishness’ to our investing but we don’t go too long on it until our age-wealth relationship tells us we can. Fifth, it means you might need external eyes occasionally to ensure you are investing wisely, given this age-wealth equation, which is changing as we become longer-living.
If you have this attitude and plan, then crashes, which show up every seven to 10 years, become less of a freak-out experience and more of a chance to buy good companies at low prices, which eventually pushes up the yield you’re living on.
It takes guts but as the old saying goes – no guts no glory!
One final point, many who follow the above plan might keep 5 to 10% of their portfolio free for playing the market – speculating on miners, picking out small caps with real potential, etc. This can add some alpha or spice to your investment life but remember, it is for those who like a bit of risk and/or who think time is on their side!
That said, banks look good value at these levels for dividend chasers and even speculators.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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