Assumptions

September 21, 2012, 11:28 am Marcus Padley Yahoo!7

Assumptions are the mother of all stuff ups and here are ten. Let's start with the basics.

Everyone else is making money


One of the most glorious financial marketing conveniences is that winners stay and crow and losers go. The stock market is fantastic at raising up its winners and forgetting its losers. That’s why people write and buy books like “How I made $2 million in the stock market” not “How I blew my kids education trading CFDs”. You need to know, which you probably already do, that you are only going to hear one side of the success story in finance which is a shame, because as any Motorcyclist will tell you, you learn far more from other people’s accidents than you will ever learn from their stories of glories.

It’s not my fault


When I first joined the broking industry 30 years ago the senior partner took new dealers aside and told them the facts of life for brokers. They included the fact that one of the services we were to provide, implicit in a commission, was that we always took the blame. “The blame comes to us, the credit goes to the client. Don’t fight it just accept it. In the long run it will benefit your relationships, the well being of your clients and the longevity of the firm.” I’m not sure that 30 years later in a more litigation abundant environment that brokers would still hand out the same advice today but it is certainly a fact of life that everybody wants someone to blame. But it won’t get you anywhere. Blaming someone else for your financial outcomes is simply a placation of your lack of responsibility which is always after the fact and therefore, too late. On top of that, if you don’t accept the blame it perpetuates the lack of responsibility and the lack of attention with the end result being that nobody learns anything or changes anything for the better. You don’t progress. You, as the person with the money at risk, have to decide what advice to take, what structure to enter and what responsibility to give to others or accept yourself. It is your choice and your responsibility, no-one else’s.

The stock market is about fear and greed


Emotion is a killer for investors, it perverts the investment process. Loving or hating stocks, being loyal, respectful, polite, proud, fearful or greedy, being envious of others, regretting not selling or buying, referencing (anchoring) your decisions to past prices (if it gets back there I’ll sell) and any other emotion that creeps into the investment process is not healthy unless you are the person on the other side taking advantage of it. Yes the market is fearful and greedy but it is those emotions in other people you need to exploit. Selling a bubble at the top. Buying a depression at the bottom. Anything that is not quantitative that is affecting a share price is to be exploited by you, by unemotional, cold calculating people who deal objectively with the facts. If you “love” or “hate” are “fearful” or “greedy” you’re on the wrong side of the equation.

The stock market always goes up


The property market always goes up. Many retirees built great nest eggs on the property and stock market booms in the last 30 years and the assumption is that you will too. But the stock market has gone down 9.6% pa for the last 5 years and it’ll take another five years going up at 12% pa to get back to square one. Dispelling the assumption that the market always goes up is perhaps the most constructive legacy of the GFC. The baby boomers rode a 30 year wave of asset price appreciation, that’s how they built their nest eggs and their current job is to preserve them. Everyone else is going to have to build their nest eggs on their wits and with effort because mere participation doesn’t cut it any more. Far better we accept the reality that making money effortlessly was not “normal” it was great. Now maybe we’ll appreciate, rejoice in and exploit a bull market when it returns, rather than think we’re owed it.

Making money is about predicting share prices


Not really. Making money is about entering an investment (a stock) with as high a probability of getting the direction right. You can narrow the odds in a million ways but ultimately the best you can do is narrow the odds of getting it right rather than wrong. The game is about doing your best not predicting the future and when, a split second after you invest, everything changes, you simply accept it. There’s no “mistake” there is simply an outcome you have to deal with. If you narrow the odds you will win more than you lose and that’s about as good as it gets.

What goes up must come down


Definitely wrong. What goes up is more likely to keep going up and what goes down is more likely to keep going down. They say the best technical analysts are kids. Show a five year old a chart and ask them if the stock is going up or down and they will tell you the obvious truth, not concoct some miraculous pivot point out of nothing. The trend is more likely to be your friend which challenges the idea of catching the knife or averaging down. What is more likely, that a stock that falls 10% is going to miraculously turn on a sixpence and go up for ever more, or that its more likely that something is wrong and it is going to trend down?

Diversification is good


The argument for diversification is based on the mathematical truth that if you combine risky assets you reduce overall risk. But the reality is that you also reduce return. If you diversify you are committing yourself to the average return and accepting average market fortunes. Diversification negates the whole idea of the equity market which is to take more risk to make better returns. You don’t do that by avoiding risk. You do it by embracing it, controlling it and winning at it.

History repeats


This is one of the weakest tenets of financial research. If you add up the performance of the All Ordinaries index in every month of the year for the last 100 years you will find that there is one month that is statistically the best month of the year and one month that it the worst. But it is just a statistic, it is not a prediction. You were bound to come up with a good month and a bad month. It adds no value at all. It is voodoo. Unless you can explain the reason a statistical phenomenon will repeat it is of no value. Who cares if the stock market goes up in an election year and down in October. What about this year? Some of the “Sun Spot” type predictions that lace the stock market are simply people with too much time and too much data on their hands. “Statistically 9 out of 10 statements that begin with the word ‘statistically’ are utter rubbish”.

Dividends are good


Not necessarily. This is a bit complicated but basically return on equity, the amount of money a company makes on the money you give them is far more important than how much money they give you back. Really good companies should have a yield of zero because it is far better for shareholders to have them keep the money and invest it in the business than return it to you. Why invest the money in the first place if they’re just going to give it back?! A high yield also suggests a mature, low growth company with few growth options to invest in, not the best investments. The dividend decision can also be driven by a lot of factors that do not reflect success. Like the CEO having a lot of shares. Yes income stocks are in favour in this rather unique income deprived moment in investment history but they will not be forever. It is a purple patch. The bottom line is that you need to look at the total return from an investment (capital plus income) not yield. The yield is a distraction, it will distract you from the share price which is far more volatile, far more important and can do you far more damage than a dividend will do you good.

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