Buffett (1991): Invest in the company possessing characteristics of a 'franchise'.

In Warren Buffett's 1991 letter to shareholders, he threw some light on his concept of 'look-through' earnings and how one should build a long-term portfolio based on it. This week, let us see what further investment insight the master has up his sleeves in the remainder of the letter from the same year.

In the 1991 letter, while discussing his investments in the media sector, the master delivers yet another gem of an advice that can go a long way towards helping conduct a very good qualitative analyses of companies. Based on his enormous experience in analysing companies, the master classifies firms broadly into two main types, 

• a business and 
• a franchise 

and believes that many operations fall in some middle ground and can best be described as weak franchises or strong businesses. This is what he has to say on the characteristics of each of them:

"An economic franchise arises from a product or service that: 

• (1) is needed or desired, 
• (2) is thought by its customers to have no close substitute, and 
• (3) is not subject to price regulation. 

The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.

• Moreover, franchises can tolerate mismanagement. 
• Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage.

In contrast, "a business" earns exceptional profits only 

• if it is the low-cost operator or 
• if supply of its product or service is tight. Tightness in supply usually does not last long. 
• With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. 
• And a business, unlike a franchise, can be killed by poor management."

We believe equity investors can do themselves a world of good by taking the above advice to heart and using them in their analysis. If one were to visualise the financials of a company possessing characteristics of a 'franchise', the company that emerges is the one with a 

• consistent long-term growth in revenues (the master says that a 'franchise' should have a product or a service that is needed or desired with no close substitutes) and 
• high and stable margins, arising from the pricing power that the master mentioned, 
• thus leading to a similar rise in earnings as the topline.

On the other hand, a 'business' would be 

• an operation with erratic growth in earnings owing to frequent demand-supply imbalances or 
• a company with a continuous decline after a period of strong growth owing to the competition playing catching up.

Thus, if an investor approaches the analysis of a firm armed with these tools or with the characteristics firmly ingrained into their brains, then we believe he should be able to weed out a lot of bad companies by simply glancing through their financials of the past few years and save considerable time in the process. Further, as the master has said that since a bad management cannot permanently dent the profitability of a franchise, turbulent times in such firms could be used as an opportunity for entering at attractive levels. It should, however, be borne in mind that the master is also of the opinion that most companies lie between the two definitions and hence, one needs to exercise utmost caution before committing a substantial sum towards a so-called 'franchise'.

http://www.equitymaster.com/detail.asp?date=11/22/2007&story=3

PEG Ratio: Why It’s More Relevant than P/E for Stocks

by DARWIN on APRIL 6, 2010

While many individual investors are familiar with the conventional Price to Earnings (P/E) ratio, the PEG ratio isn’t cited nearly as often but it really puts a stock’s valuation in the proper context.  While a P/E ratio will tell you whether a stock is “highly priced” just based on a forward earnings expectations or trailing earnings reports, a PEG ratio is the P/E ratio divided by the stock’s long term annual growth rate.  Now, the problem is estimating just what that growth rate will be.  But for relatively mature companies with transparent investor updates, it’s not too tough to reasonably discern whether you’re in the right ballpark.

PEG Ratio vs. P/E Ratio:

Consider two stocks.

1) Mature industrial company with steady earnings year over year.  P/E = 10.
2) Nimble, fast growing company. P/E = 45.

Let’s say the broad market is trading at an aggregate Price to Earnings ratio of 12.  One investor may view stock 1 as a “value” and stock 2 as being absurdly overpriced.  However, when looking at each in terms of their projected growth rate, the pendulum swings the other way.  If stock 1  is a utility that’s expected to grow at about 5% per year and stock 2 is growing at 30% per year, in the context of future growth, the PEG ratios tell a different story:

1) Stock 1 PEG ratio = 10/5 = 2
2) Stock 2 PEG ratio = 50/25 = 1.5

Stock 2 now appears to be much more of a value.  Often times, stocks with high growth rates are more volatile and prone to massive price swings.  But if you’re able to hang on to a stock for a few years and the projected growth rate assumptions are reasonable, you’re often rewarded with a higher net return.  This is broadly reflected in the long term outperformance of tech stocks, biotech stocks, small caps and emerging market stocks vs. their counterparts.

When I provided my last portfolio update you will have noticed that many holdings fall into the stock 2 bucket since I’m young and have a long time horizon and my ultimate goal is to maximize investment returns.  Conversely, when I’m 55 and approaching retirement, I will likely be more focused on stability and income via high yield investments.  So, there’s no “right” way to invest, but it’s important to consider the context of your investments as well as your time horizon.

Do You Use the PEG Ratio in Evaluating Stock Purchases?

http://www.darwinsfinance.com/peg-ratio/

The Amazing 7% Annual Growth Rate

Granted, making the first million dollar is the most difficult.  I shan't dwell into this.  But for those who already have this $1 million, they should learn all about the amazing maths behind growing this amount at 7% per year.

What does growing at 7% per year look like?  It means doubling your money every 10 years.  Therefore, if you have $1 invested today, this $1 will grow thus:

00 year - 2010  $1

10 year - 2020  $2

20 year - 2030  $4

30 year - 2040  $8

40 year - 2050  $16

50 year - 2060  $32

60 year - 2070  $64

Study these numbers carefully.  Note the incremental amount of money grown in each of these 10 years period below:

00 year - 2010  $-

10 year - 2020  +$1

20 year - 2030  +$2

30 year - 2040  +$4

40 year - 2050  +$8

50 year - 2060  +$16

60 year - 2070  +$32

In particular, note that the incremental growth for each of the latest 10 year period, exceeds ALL the growth of the preceding years.  Therefore, the incremental growth of the 10 years from 2060 to 2070 exceeds ALL the growth of the previous 50 years from 2010 to 2060.  

Herein lies the power and magic of compounding.  Understanding this is very important to grow your wealth.  Starting early in your investing is extremely important.  Not losing money is important as a moderate growth rate in the absence of losses will translate to a large gain over many years.

Warren Buffett has been investing since his teenage years.  Now approaching his 80s soon, he has been investing for the last 60 years.  It is not surprising that he is one of the richest man in the world as he has been able to compound his money at phenomenal rates for so many years.  What is perhaps worth mentioning is that everytime his wealth doubles over a given period, the incremental wealth for that period exceeds ALL the sum of the incremental wealth for all his previous investing periods.

Now that you have your first $1 million, go forth and multiply.  You need not aim for too high a growth.  A modest 7% annual growth rate over many years can transform this figure into a large number.  Of course, you may be able to do better than this.   You will also be amazed by the numbers that come with an additional 1 or 2% additional growth per year.

Do not make mistakes.  Luck should play little part in your investing.  Investing is fun.  It is safe.  

Ref:

The Rule of 72

http://www.intmath.com/Money-Math/rule-of-72.php

The magic of exponential growth.  What does growing at 7% per year mean to you?

e Most IMPORTANT Video You'll Ever See (part 1 of 8)

Three most important personal factors to consider: Your Time Horizon, Risk Tolerance and Investment Objectives

The Math of House Buying

3. Math of House Buying

by M. Bourne

Disclaimer

This discussion is simplified so we don't get lost in complications. Also, interest rates are changing all the time - check your local banks for latest rates.
There is no need to really use the formulas in this section. You can easily use Excel to calculate the values or you can use the many on-line calculators to find the values.
This site does not contain investment advice.
Don't miss Flash mortgage calculator on this page.

Tom (see the chapter intro) wants to buy a house sometime soon. He knows that real estate is a reasonably safe way to build wealth. It is slow, but generally low risk.

He will come across a bewildering choice of mortgages. A mortgage is just a fancy word for the process of borrowing money for a house.
The bank actually buys the house and keeps the title deed. You agree to pay off the borrowed amount each month, usually over a period of 20 to 30 years. When you have finally paid it off, you get the title deed, meaning you now fully own the house.
If you stop paying for any reason, the bank has the right to sell the house. After all, they own most of it.

Mortgage Example

Tom's house will cost $300,000. He needs to pay a deposit of 10% and will pay the remaining 90% over 30 years at 8% per annum.
So he will need to pay a deposit of 10% of 300,000 = $30,000.
The remaining amount he owes is $270,000.

Monthly Payments

The formula for the amount Tom has to pay each month is

where

A = amount to pay each month
L = loan amount (or principal)
r = interest rate (per year as a decimal - or divide by 12 to get the rate per month)
n = number of payments

(This formula is based on the Sum of a Geometric Progression.)
So for our case, we have:

L = 270,000
r = 8% ÷ 12 = 0.0066667
n = 30 × 12 = 360

So the amount is

So Tom needs to find just under $2000 per month to buy his house. Of course, he won't be paying rent so the extra amount is not too bad, he figures.

Back of the Envelope Calculation

A reader asked if there is a reasonable approximation that we can use for this formula when we want to do "back of the envelope" calculations. It turns out there is.
("Back of the envelope" is an expression meaning we can work it out quickly and easily on a scrap of paper.)
Most mortgages are for less than 30 years. The following chart illustrates the value of the denominator for the above expression, for interest rates of 6% to 14% up to 30 years.
For example, the graph for lowest curve, 6%, is of the following form, where n is the number of years:

1 − (1 + 0.06/12)¹²ⁿ

We can use this graph as follows.
If the mortgage is 25 years and the interest rate is 10%, the graph tells us the denominator value is close to 0.91.
So a $100,000 loan would have a monthly payment of about

A check in the actual formula yields a value of $908.70. So the approximation is not bad.

Flash Interactive - Mortgage Payments Calculator

You can calculate any repayment here. Change any of the values for principal, interest or period and then click "Calculate". You can also see a graph of the equity (the amount you own) that has been built up in the property over time.

Note: These calculations do not take into account the bank fees and we are assuming a fixed rate of interest for the whole period of the loan. Actual amounts charged by lenders are sure to be higher than this.

Mortgage Calculator

You can use this calculator to get a rough idea of how much you can borrow, how long you will need to pay it off, what interest rate or the amount per month.

Loan Calculator
	Gadgets powered by Google

Six Months Later

Tom has been paying off his pride and joy for 6 months. He has paid a total of $1981.16 x 6 = $11886.96.
He gets the first statement from the bank and expects to see a reasonable dent in the amount he owes. He is shocked to find that he still owes $268,894.74. How is this possible? He has paid $12000 but only $1000 has come off the balance.
The formula for the balance is:

where

L = the loan amount
r = interest rate per month as a decimal
p = number of payments already made
n = total number of payments to be made

In our example, the balance will be:

With mortgages, the amount you are paying early in the loan period is mostly interest, and very little is coming off the principal. Towards the end of the loan, the interest amount is less and the principal starts to disappear more quickly.

Amount ($) still owing after p months.

The mistake a lot of people make is to sell the house quickly. The average mortgage is only 7 years. They own very little of the house by then because they have mostly been paying interest to the bank. If house prices have gone up a lot, they are ahead. But if house prices level off, or decline, then you lose a lot of money.

Money Maths Lesson Plan Suggestion - House Buying

Simulate a house buying scenario in your district. Use actual advertisements for houses and for housing loans. Get students to find the best loan deals. Which is best - fixed or variable interest? What will they pay in total for the house? What will it be worth at the end of the loan period? How much will they have paid after 10 years and how much will they own by then?

Footnote

It may not always be best to buy a house compared to renting. In Japan, house prices have still not recovered to where they were 16 years ago. Sure, interest rates are low there, but negative equity has been a huge problem for years. (This is when the amount that you owe on a house is more than what the house is worth.)

House prices, Japan. Index = 100 in 1975.

This means that house prices more than doubled at the peak in 1991 and have dropped back to 1975 levels since. In 2005/2006 there has been a modest increase.
Interestingly, house prices in US, Australia, UK, and most industrialised economies have shot up in recent years due to low interest rates. One wonders what the future holds for house prices in these countries...
If rents are low in your area, it may be better to rent a place and invest (not spend) the difference.

http://www.intmath.com/Money-Math/3_Math-of-House-Buying.php

Here is a technique to learn more about your buying and selling decision making.

You may separate all the months the market went up from the months the market went down.  Do this from the year 2005 to now, which includes the 2008 severe bear market.

From your CDS account statements, you can find out whether you were a net buyer or a net seller during these various months.

• If you were a net buyer during the months the stock market declined, you are more likely to be a contrarian.  
• But if you were a net buyer when the stock market did well, you may have a herd mentality.

Isaac Newton loses his fortune

Isaac Newton loses his fortune

8.7.2007

There is an increasing amount of concern about the protracted bull market in world equity markets. Since March 2003, almost every stock market has increased in value (and on average, world markets have almost doubled).

Memories of the “Dotcom Wreck” starting in 2000 are still fresh. The Nasdaq index is a good proxy for this financial disaster:



The graph shows the dramatic growth in share prices that started late in 1998. The hype about the potential of the Net was being pushed daily in all the media. “This time it’s different” was the mantra of the TV commentators.

• If you had invested in 1998 (when the Nasdaq was around 1400), your money would have more than tripled by the time the Nasdaq peaked at over 5000 in March 2000.
• Three years of misery followed where investors (those that hung on) lost 80% of their money (in October 2002 the Nasdaq was at around 1100.) 
• In the following 5 years, the Nasdaq has more than doubled.

South Sea Bubble

Flashback to the early 1700s. England was in a spot of bother having sent itself broke fighting a war involving the French, Spanish and money. The government approached the South Sea Company to help them out, and put conditions in place to attract investors. People always want to make a quick buck, and the investors enthusiastically invested – in droves. From the story in stock market crash.net:

Speculation became rampant as the share price kept skyrocketing. It was thought that this company “could never fail”.

One of the main money-making ventures of the South Sea Company was trading African slaves for the Americans.

Isaac Newton

Even Isaac Newton got caught up in the South Sea mania and invested a big chunk of his fortune. Interestingly, he pulled out early (after making a respectable 7000 pounds) then went back in after the bubble continued to inflate. The inevitable bust happened and he lost 20,000 pounds – a considerable sum at the time.

As a result of this crisis, he stated “I can calculate the motions of heavenly bodies, but not the madness of people”.

Footnote 1: Some of the Dotcom mania was well founded. Google, YouTube, Yahoo and others have gone on to develop highly successful Web-based businesses, worth billions. The problem in the late 1990s was that investors were happy to fund companies with no business plan and no hope of profits. The “madness of people” indeed.

Footnote 2: I don’t wish to imply that investing in stocks is dangerous – quite the opposite. If you don’t invest, you are setting yourself up for later poverty. But what you need to do is be careful to avoid hype and to be able to spot a bubble.

Footnote 3: For another speculative bubble (involving Japanese real estate), see Math of House Buying.

http://www.squarecirclez.com/blog/isaac-newton-loses-his-fortune/688

Choosing the Right Share through Fundamental Analysis and Comparative Quantitative Analysis of the Figures

We have chosen SingTel, Starhub and MobileOne as companies for comparison.

COMPARING THE FIGURES

Let us apply the concepts.

Table 1 shows the ROE, ROA, PE, NAV and dividend yield of the 3 companies. 

• In comparison, StarHub has the highest ROE as it is highly leveraged with debt whereas MobileOne has the highest ROA. 
• In terms of PE and dividend yield, MobileOne offers an attractive PE of 10.1x and StarHub gives out the highest yield. 
• As service provider companies, all 3 telcos offer a NAV lower than their traded share price due to their low asset investment.

OUR PREFERRED CHOICE

Based on the findings, we would choose MobileOne as our preferred choice of investment. 

Mobile One

• MobileOne also has the lowest PE while giving out a healthy 5.5% dividend yield. 
• The low PE indicates that MobileOne’s share price can still rise higher to between 14-15x PE to catch up with its peers. 

StarHub

• StarHub may have the highest ROE but it depends too much on debt to fund its operations. 
• Even though StarHub offers a higher dividend yield, its PE shows downside risk as the share may slide to match its competitors.

SingTel

• SingTel’s dividend yield, ROE and ROA are the lowest among the 3 companies but it has the highest share capital and NAV. 
• High volume of transactions involving large number of shares are required for SingTel’s share price to appreciate. 
• SingTel is a good choice to invest in times of uncertainty due to its huge share capital and strong business foundation but its share price is the highest among the 3 telcos and could be an expensive choice to invest.

MobileOne, being the smallest player in the market, still has a lot to offer and would benefit the most from the Next Generation National Broadband project (NGN) as it would be provided with the necessary infrastructure to compete with the other big boys in the network industry once the project is completed. The high-barrier industry prevent others from jumping into the bandwagon and the expertise of MobileOne in the local market would encourage foreign partners to tie up with it.

CHOOSING THE RIGHT SHARE

Choosing a share to invest requires a lot of research on the background of the company and its potential to expand further. 

• Always compare companies from the same industry and in a similar business as you can never compare apples with oranges. 
• If you are looking for a share for long-term investment, always look for one with a stable dividend payout that adheres to your requirement. 
• Both fundamental and quantitative analysis are basic means to fully understand the potential of a company. 
• Remember to use the various forms of fundamental analysis before choosing your next rewarding share.

Read:

Understanding Fundamental Analysis (Part 4)

Understanding Fundamental Analysis

Understanding Fundamental Analysis

Understanding Fundamental Analysis

Understanding Fundamental Analysis (Part 2)

Understanding Fundamental Analysis (Part 3)

Understanding Fundamental Analysis (Part 4)

Understanding Fundamental Analysis (Part 5)

Understanding Fundamental Analysis (Part 6)

Stock Market Timeline

Stock Market Timeline


By franklin on September 20th, 2009

The stock market time line is more extended that most people realize. The Frankfurt Stock Exchange in Germany dates back as far as the 9th century.

Back in the 13th century, merchants and financiers traded government securities and other investments. Most major European cities followed this trend, selling debt-based securities to investors to assist their own economic growth.

However it wasn’t until 1602 with the Dutch East India Company released the first stocks in a privately owned company and listed them on the Amsterdam Stock Exchange that the stock market as we know it today was formed.

Many other company owners realized that selling shares in a company was a great way to expand and grow and the stock market came alive.

It wasn’t until 1792 that a group of New York stockbrokers formally created the New York Stock Exchange board in order to formalize the rules for trading stocks. They agreed to meet daily to trade stocks and bonds.

The New York Stock Exchange expanded dramatically to include investors outside of New York in 1844 when telegraph messages, send via Morse code, were successfully transmitted, enabling investors to send and receive stock market quotes. This eventually was replaced by the stock ticker in 1867.

During 1866 the first transatlantic communications cable was completed between New York and London. This allowed the stock markets from both countries to communicate instantly, however it wasn’t until 1878 that telephones were installed on the trading floor of the New York stock exchange.

The Wall Street Journal announced in 1896 the creation of the Dow Jones industrial stock average and by 1934 the Securities and Exchange Commission (SEC) was formed in order to regulate the stocks and bonds markets. The SEC helped to oversee the requirements for companies wanting to issue stock to the public. It also oversees the daily actions of market exchanges, ensuring compliance.

The NASDAQ (National Association of Securities Dealers Automated Quotation) began trading in 1971, which officially became the world’s first electronic stock market. It wasn’t until 1994 that the first stock trade was placed via the Internet.

Timeline of Infamous Stock Market Crashes

With such a long and diverse history, the stock market has weathered through many periods of economic downturn and investor panic and has seen some spectacular recoveries too. When you consider that stock market declines are not as unusual or rare as many investors seem to think, it helps to restore a little faith in the ability of stock markets to recover even after the worst possible crashes.

Back in 1637, the Dutch stock market collapsed with prices falling almost 90%.

In 1720 the London stock market crashed, leading the government to take control of all National Debt.

In 1869, two American investors attempted to corner the gold market, beginning a gold-price crash and set in motion the events of the first Black Friday on Wall Street.

By 1873 America’s most reputable stock brokerage company collapsed and began a panicked stock sell off. This led to 37 banks and two major brokerage houses collapsing.

In 1884, yet another large stock brokering company collapses, which instigated another panic. This panicked sell off led to the failure of 15 other major brokering companies.

By 1893 the stock market crashed again, throwing America into a deep economic Depression.

1903 saw the ‘Rich Man’s Panic’ crash, and the financial world spiraled into yet another panic as news of the troubles hounding a major New York bank were released and 1907 saw yet another period of sharp downturn in the markets.

The notorious 1929 Black Thursday, followed only four days later by Black Monday saw the largest one-day fall in prices in the US stock market’s history at that time. One day later, Black Tuesday saw prices fall even further. Stock market prices around the world declined in response, but the bottom of the market wasn’t reached until 1932.

The Black Monday one-day percentage fall in stock market pricing was overshadowed by the stock market crash in 1987, when the Dow Jones lost 22.61% during one day.

In 2008, the Dow Jones once again saw the largest one-day pricing decline in history, falling 777 points.

http://www.personalfinancialtimes.com/articles/stock-trading/stock-market-timeline



Important Events Of The Stock Market Timeline


By franklin on April 6th, 2010

A comprehensive stock market timeline would probably need to be done in volumes. In the next several hundred words I will attempt to outline important events of the stock market timeline you might wish to know as a general curiosity.

Our stock market timeline begins in 1790, with the federal government issuance of $80 million in U.S. bonds.

In 1792, there are two government bonds and three bank stocks traded for a total of five securities.

Our stock market timeline moves into the 1800s with government bonds, bank stocks, and insurance stocks trading after the War of 1812.

In 1817, a constitution and rules are developed for doing stock trade. At this time, the New York Stock and Exchange Board is formally organized.

Our stock market timeline now moves us to the opening of the Erie Canal in 1825, when New York State bonds are issued to fund the construction.

In 1850 the shares volume reaches 8500, which represents a fifty-fold increase in only seven years.

In 1836, the NYS&EB prohibits it membership from trading stocks in the street.

During the panic of 1857, the Ohio Life Insurance and trust Company collapses and the market realizes a 45% since the start of the year.

In 1863, the New York Stock and Exchange Board becomes the New York Stock Exchange.

In 1903, the New York Stock Exchange and our stock market timeline move into the twentieth century. The stock market celebrates this by moving to its current residence at 18 Broad Street.

One of the most noteworthy occurrences of our stock market timeline is the panic of 1907, during which problems at Knickerbocker Trust cause a run on all the city banks. J. P. Morgan jumps in and shores up funds and ends the run on the banks.

The Federal Reserve is established in 1913.

The stock market timeline sees Wall Street become the investment capital of the world, supplanting London at the end of World War I.

http://www.personalfinancialtimes.com/articles/stock-trading/important-events-of-the-stock-market-timeline

How To Start Investing In The Stock Market

How To Start Investing In The Stock Market


By franklin on April 7th, 2010

The best way to start investing in the stock market is to pick an area of expertise. When you start investing in the stock market, you want to pick from corporations who do business in a field with which you are already familiar, or that deal in a product or service about which you have knowledge.

A lot of people think that how to start investing in the stock market is to learn about businesses unfamiliar to them. It is actually best to start investing in the stock market with businesses you know. For instance, if you have a preference for a certain computer manufacturer over another, the chances are that other people have that preference as well. This is a good point from which to start investing in the stock market.

Take that computer manufacturer you prefer, and do a little research on them. Chances are that you probably know a good deal about them, because you chose them over similar companies for your desktop or laptop, or both. This makes them a good opportunity for you to start investing in the stock market.

So, start investing in the stock market by taking a look at this companies performance. You should be able to get free investment tools on the Internet that will help you do this, or get the advice of a stockbroker, if you are choosing not to use a discount broker. Discount brokers do not offer advice on stock like standard brokerage houses do, it’s one of the reasons they give discounts.

However you get the information, start investing in the stock market by gaining an insight on this computer company’s performance. Then, find out how much their shares cost. If this seems like an affordable investment to you, buy some stock. It’s really no harder than that to start investing in the stock market.

It doesn’t need to be difficult to start investing in the stock market, as this example proves. Be aware that the stock market is a long-term investment and do not be afraid to watch the prices of your stock rise and fall. Better yet, don’t watch the prices of your stock rise and fall. When people start investing in the stock market, they often get too tied to the day-by-day rise and fall of their stock prices. They get free stock market tickers for their computers and sit and watch them like a tennis match. This can cause a lot of indigestion and stress, not to mention a sore neck.

The key element you need to have when you start investing in the stock market is patience. Your money, like your children, will grow over time. Your kids don’t just sprout up to six foot tall their first year on earth. Your stock market investments are most likely not going to sprout to full potential their first year out either. When you start investing in the stock market, it is an exciting time, but you have to curb that enthusiasm and make it last along the course of the years your investment will run.

When you start investing in the stock market, realize that it will take years for your investments to mature.

http://www.personalfinancialtimes.com/articles/stock-trading/how-to-start-investing-in-the-stock-market

Curb irrational behaviour: Be aware of ANCHORING, a common mind trap when investing.

Curb irrational behaviour

Annette Sampson
April 7, 2010

The strategy To avoid common mind traps when investing.

You're talking about fear and greed, right? There's no doubt fear and greed are behind a lot of investor behaviour - much of it is irrational. But a school of study, known as "behavioural finance", has demonstrated our minds are hard-wired to react in certain ways. Even if we make concerted efforts to avoid fear and greed, our thought patterns may lead us to make investment decisions that could prove costly.


Such as? There are many aspects to behavioural finance but one area Tyndall Investment Management's Australian equities team believes may be influencing investor behaviour at the moment is "anchoring".  In simple terms, this is the tendency we have to base our judgment on a piece of initial information then stick with it even if other information becomes available.

To show how it works, Tyndall looked at research by two behavioural finance experts, Amos Tversky and Daniel Kahneman. They asked two groups of people what percentage of the United Nations comprised African countries. 

• The first group was asked whether it was above or below 10 per cent; 
• the second whether it was above or below 65 per cent. 

The numbers were supposedly chosen randomly (the groups didn't know the "random" spin of the wheel was rigged) but it still influenced their estimates.

• The first group, having a lower "random" figure estimated an average 25 per cent of African countries; 
• the second 45 per cent.

In the absence of real information, the test groups tended to "anchor" their estimates on any information available rather than thinking independently.

In another study, psychologist Ward Edwards asked people to imagine 100 bags of poker chips. Each bag contained 1000 chips but 45 contained 700 black chips and 300 red while 55 contained 300 black and 700 red.

• When asked what the probability was of selecting a bag with mostly black chips, most of the test subjects got it right. 
• The answer was 45 per cent.

But he then asked them to imagine 12 chips were randomly selected from the bag - eight black and four red. The chips were put back and the respondents were asked whether they would change their first answer in response to the new information.

• Many said the probability of the bag containing mostly black chips was unchanged at 45 per cent. 
• Most said the likelihood was less than 75 per cent. 
• But calculated mathematically, the bag was 96.04 per cent likely to contain mostly black chips. 
• The respondents didn't take account of the new information.

But how does that relate to my reactions to investment markets? Tyndall says the same research has been conducted on analysts' reactions to company earnings announcements.

• They often don't revise their estimates enough when they receive new information, resulting in a string of earnings "surprises". 
• It says the recent rally has resulted in largely favourable earnings forecasts but if the numbers don't live up to expectations and investors haven't factored in changing circumstances to their thinking, the market could fall sharply.

It says basing future investment performance on past returns is another common example of anchoring.

• After shares fell more than 38 per cent in 2008, most investors expected a dud 2009. 
• Certainly no one was predicting a rise of 37 per cent. Investors who switched money out of shares paid dearly.

So how do I avoid this trap?

• Understanding these behaviours and being aware of them can help you make more informed and rational decisions. 
• Even better, Tyndall says, it can give you an edge, allowing you to identify, and make money from, mispricing opportunities that come about because of other people's irrational behaviour.

Old favourites, such as having a diversified portfolio, getting good professional help and looking to the long term can help.

http://www.smh.com.au/news/business/money/investment/curb-irrational-behaviour/2010/04/06/1270374188426.html?page=fullpage#contentSwap1

Decisions over aged care for loved ones are both emotional and financial

Don't gamble on the future

Family decision...Dianne Douglas (right) with her parents Hilda and Tony.
Photo: Craig Sillitoe

April 6, 2010 - 12:19PM

Decisions over aged care for loved ones are both emotional and financial, writes Bina Brown.

Aged care facilities have come under fire lately with reports of mistreatment of residents and poor practices. This adds stress to the already challenging process of finding the best nursing home or hostel for loved ones who can no longer care for themselves at home.

While the system is under pressure, there are good facilities around.

To find the most suitable residence and secure a position, you need to be armed with the right information.
No one likes to think about living in an aged care facility but the reality is that one-third of all men and half of all women aged 65 or over can expect to go into permanent residential care later in their lives.

The federal government regulates the aged care industry by allocating the number of places, setting funding levels and controlling fees.

The underlying position is that every Australian is entitled to aged care, irrespective of their financial circumstances. In practice, most people have to pay for their preferred choice and extra services they may need or want.

There is a distinction between retirement villages and aged care facilities. The former is considered a lifestyle decision people make when they feel it is appropriate, considering their health and other personal and social factors.

A move into aged care accommodation is generally involuntary. Three-quarters of people enter aged care from hospital following an accident or illness.

Aged care facilities are categorised as low care (hostel), high care (nursing home) and high care with extra services.

They can vary enormously depending on who runs them, their age and the types of funding they receive from government and individual residents.

FINDING AND FUNDING AGED CARE


To get into an aged care facility, individuals must be assessed by an Aged Care Assessment Team, which will determine the level of care a prospective resident requires.

An assessment of the person's assets and income will determine whether they have to pay an income-tested fee on top of the basic daily care fee and the amount of an accommodation bond or charge.

The financial assessment is not compulsory but if the information is not provided, aged care fees will be charged at the highest rate.

People with assets valued at more than $37,500 who need low-care hostel accommodation are required to pay an accommodation bond, a daily care fee and potentially an extra income-tested fee.

The bond may be set by the facility and can be anywhere between $100,000 and $600,000 depending on its location, age or the types of services it offers; or it can be negotiated based on calculations of the level of assets held by the prospective resident.

The average bond is about $270,000 in Victoria and higher in NSW. The bond is like an interest-free loan to the hostel while the person is a resident there. The balance is refunded upon leaving.

Anyone entering a nursing home, which provides a higher level of care than a hostel, is required to pay an accommodation charge determined by the Department of Health and Ageing, rather than an accommodation bond.

The exception is where the high-care facility is recognised as offering extra services, such as daily newspaper delivery or a choice of meals, which are available for an additional cost to the resident.

In this case, the facility can charge an accommodation bond instead of an accommodation charge.

In addition to the accommodation charge, there is the daily care fee and, potentially, an income-tested fee.

The maximum total of these three fees could add up to about $123 a day or $45,000 a year, depending on an individual's financial circumstances and care needs.

A senior adviser at Partners' Retirement Planning and Investment Advisors, Patrick Barry, says that where an accommodation bond is to be paid by a resident in a low-care hostel or a nursing home offering extra services, the individual must be left with a minimum of $37,500 in assets.

From March 20, the basic daily care fee in low and high care was increased to $38.65 a day for everyone, whether they had $5 million in assets or 5¢ to their name.

Barry says the daily income-tested fees for low and high-care accommodation apply when someone's income exceeds $812.50 a fortnight. This fee may equal 41.67 per cent of any assessable income in excess of $812.50 up to a maximum of $62.11 a day.

SELLING THE FAMILY HOME


The prospect of having to sell the family home or another cherished property is one of the biggest fears for many people having to consider aged care, says Val Nigol, a director of specialist advice firm Financial Freedom Solutions and the co-author of Aged Care Homes, the Complete Australian Guide.
However, the family home doesn't always have to be sold.

"If it is low-care accommodation and you need to finance the bond, then quite often people assume they have to sell the family home, because it is a few hundred thousand dollars, but there are alternatives," Nigol says.

Passing the hat around the family is one option if the rest of the family want to retain the property for their own use in the future.

Borrowing against the property using a product such as a reverse mortgage is another; or there may be other investments such as shares that could be sold to finance the bond.

Nigol says the size of the accommodation bond and the way it is to be paid is generally negotiable with the facility. It may be possible to pay in instalments, for instance.

Of course, there are situations where it may make sense to sell a property. The beneficiaries may not want it and selling would eliminate questions over who would have to look after the property.

The marketing manager at Melbourne-based Lifetime Planning, Ken Mitchell, says people considering downsizing the family home need to be aware of the effects on the age pension. "If downsizing increases a couple's assessed assets by $500,000, the pension could reduce by $19,500," Mitchell says.

"The cost of moving could be as much as $50,000 and, for an elderly couple, the trauma of moving from the home of a lifetime could be significant."

Centrelink can provide information about how an individual's pension may be affected.

PLANNING AHEAD


Unfortunately, people can't always plan ahead for their aged care needs but, where possible, they should view them from short-term and long-term perspectives.


"In the short term, it is important for people to be well organised with powers of attorney, wills and good records of their assets and liabilities," Mitchell says.

"In trying to look ahead more than one or two years, the situation is more difficult because of the seemingly constant changing rules. For example, assets held in trust were previously excluded from personal assets and accommodation bonds have only recently become government-guaranteed.

"Changes like these have caused very significant changes to financial planning, which could not be anticipated with any great degree of certainty."

Perhaps the biggest factor making it hard to plan is that most people entering aged care come via a hospital following an accident or illness. All of a sudden, a person can go from living in their own home, possibly independently, to needing full-time care.

Although people can just "knock on the door of a facility and ask for a bed", such an approach is highly unlikely to produce the best solution, Mitchell says.

He recommends the use of a placement agency, which would be aware of the facilities that can cater for the person's specific requirements and can match those to other factors such as location, finance and psychosocial needs.

"It can be difficult for families in stressful circumstances to balance all the aspects of the drama of moving to aged care and the assistance of a placement agency can be a godsend," Mitchell says.

The executive manager of placement agency Tender Living Care, Denise Tomaras, says part of the service is working out with the prospective resident or their family how close they want to be to loved ones and what sort of lifestyle they want.

Lifestyle decisions include whether they want to be able to go out for dinner and whether they want a single room or would be happy to share.

"We show people up to eight facilities," Tomaras says. "Some of them may have waiting lists but we may be able to influence these depending on a person's needs and whether the facility has an appropriate bed.

"When we see people they are generally in crisis. My advice is: don't wait for a crisis. Try to narrow your preferred facilities down to even two places and be armed with some knowledge of how the system works.
"It is great to see people planning because their choices become wider. But if they are in a crisis, we can kick in pretty quickly."

CASE STUDY


Proximity and a high level of care were at the top of a long list of must-haves for Dianne Douglas and her family when they started the process of looking for an aged care facility for her father Tony.

Tony had been a fit man in his 80s before a series of strokes left him in need of full-time care.

"We had six weeks to find a high-care facility that was close to my mother and siblings. While we wanted to find a place with nice facilities, we also became very aware of the importance of the staff that worked there and how the place was run," Dianne says.

The checklist included how many staff a particular facility had, what their qualifications were and whether the staff members were mostly permanent or agency workers. This was to get a sense of whether people were floating through or full-time carers for the residents.

So daunting was the task of comparing about a dozen possibilities that Dianne engaged Melbourne-based Tender Living Care to assist in finding a bed and working through the financial and bureaucratic maze that goes with helping someone into aged care.

"People don't realise how extraordinarily stressful the whole process of finding somewhere and then moving someone you love in is until they have to do it. It is something you don't think about until it happens," she says.
"It is a combination of knowing that someone's whole lifestyle has changed and they have lost complete control of how they want to live."

http://www.smh.com.au/news/business/money/planning/dont-gamble-on-the-future/2010/04/06/1270374189659.html?page=fullpage#contentSwap2

Tickle yourself with these same questions

So you think you can save?

Jessica Gardner
March 28, 2010

What was your first job? Dancing at the age of seven on a telethon back in 1987 with So You Think You Can Dance judge Jason Coleman and choreographer Kelley Abbey.
What did you get paid? Oh, I can't remember but I'm sure it wasn't much.
Are you a saver or a spender? Thanks to my father, I'm a saver. Working as a child actor and dancer, I managed to save quite a bit of money growing up, which became the deposit for my first apartment when I was 20.
What was your biggest splurge? I have to say clothes. If I like something, I very rarely look at the price tag. I've gotta have it!
What was your best bargain? I got a pair of Nike high tops fairly recently for under $60. Score!
What was the best thing you've got free of charge? Since I started on the show, I've had so many wonderful things for free. My favourite would be the entire Rock Band set for Wii.
What is your greatest money-saving secret? Open an account that you can't touch for a long time, halve your wage and put it in there. You'll earn a bunch of interest and you'll be surprised how much you'll make.
What's the best piece of investment advice you have heard? Property is a pretty good investment. Just wait for the recession to be over.
What's the best piece of investment advice you've actually acted upon? Buy an investment property while owning the apartment I was living in. It paid for itself and was a dream.
Credit cards are: a) Great; b) Helpful; c) A poor investment; d) The work of the devil? Why? D. It's scary to spend money you don't have. The bills build up quickly. It scares the hell out of me.
If I were given $20,000 I would buy ... a brand new wardrobe. Labels and all.
If I were given $20,000, I would invest in ... property.
I wish I had $1 for every time ... someone asked if I had any hair under my hat.
I'd be a millionaire if I gave up ... nothing. It's going to take me a long time to get there ... if ever!
Source: The Sun-Herald

----

Best to grow with what you know

Jessica Gardner
April 6, 2010

What was your first job? Working in my dad's nursery when I was 10. I got to fill the boiler, weed, pot up and water plants and serve customers.

What did you get paid? I got the same pocket money that I would have got if I hadn't done anything. Which, if I remember that far back, was nothing.
Are you a saver or a spender? I see myself as a saver with no qualms if I see something that I really want.
What was your biggest splurge? Antique gardening books. I just love the look and feel of them and the fact that even if it was written in 1675 the advice is still pertinent to this day.
What was the best thing you've got free? The best freebie has to be the plants people gave back to me that I had lost after the Ash Wednesday fires.
What is your greatest money saving secret? Return everything organic to my garden — it saves on fertiliser.
What's the best piece of investment advice you have heard? Put your money into something that you know a lot about.
What's the best piece of investment advice you've actually acted upon? As above. I put my money into my passion for plants. I opened a nursery so my hobby and my income are one.
Credit Cards are:
a) great
b) helpful
c) a poor investment
d) work of the devil?
Why? They are helpful if used when needed and not all the time. They are so much better than travellers cheques when overseas.
If I were given $20,000 I would buy ... after I got up off the floor, I would book those tickets to Namibia.
If I were given $20,000 I would invest in ... antiques and art, as you get to live with your investment and enjoy it.
I wish I had $1 for every time ... someone apologised for asking me a gardening question over dinner but then asked it anyway.
I'd be a millionaire if I gave up ... trying to sell weird plants that only a nutter like me wants.

Knowledge is Power, Take Your Knowledge to the Next Level