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November update: news, opinion and comment for your financial wellbeing
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How the market rewards good behaviour
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We've discussed the impact of our behaviour on investing outcomes before in this newsletter, but an instinctive reaction to each movement of the markets isn't the only way to wreck returns.
Inbuilt biases and prejudices conspire to knock us off track at the best of times. We can't help it - we're hardwired to think and react in certain ways.
American financial theorist William J Bernstein reckoned these biases or behavioural quirks made human nature, "a virtual petri dish of financially pathologic behaviour.”
But it's useful to understand this and recognise that a more detached view (as provided by a trusted financial planner) can help mitigate the effects.
So what do we need to look out for? Here are just three of the many biases investors need to keep in check.
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Overconfidence
Unlike weather forecasters, we can't predict what is going to happen in the future. But too many of us are confident that we can predict the markets, even though the overwhelming evidence is that we can't.
Hindsight
This is the other side of overconfidence. We often believe we predicted past events, but the fact is we can't remember what we thought on a specific day five years ago unless we keep a detailed diary.
We don't like to lose
In fact we don't like to lose more than we like to win. The thought of losing out is more powerful than the prospect of winning - so we often play it too safe when the evidence says we should be be taking more risks.
We'll reveal some more of the tricks our brain plays on us next month.
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Why am I here?
Have you ever pondered how you ended up where you are now? Not in the sense of forgetting why you went up the stairs - although that happens more and more as we get older - but in a existential, 'meaning of life' way? Without getting too heavy, we found this article a fascinating read. Take a look and see if you agree! |
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Elections... wars.... pandemics: what factors actually drive the stock market?
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Last month we touched on the then-upcoming US presidential election and what effect the outcome would have on stock markets in the US and around the world.
As we write, the world (the vast majority of it, at least) awaits the new Joe Biden era. It's too early to know for sure if his presidency and any new economic approach will affect the performance of the stock markets - but history would imply otherwise, as the chart below shows.
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This begs the question: if massive political events - however significant they may appear to a particular region or market sector - don't drive the market, what does?
1. Economic growth - more demand for services boosts company profits, dividends and share prices.
2. Interest rates - if interest rates are low, more money flows into the stock market in pursuit of better returns than can be found in bank savings or bonds.
3. Stability - the market doesn't like shocks or political instability that could threaten economic stability and future growth
4. Confidence - if investors are optimistic, they buy more shares. If they receive bad news they will sell.
5. The bandwagon effect - people follow the mood. Some stock market movements seemingly come from nowhere but escalate because no-one wants to be the investor who got it wrong when everyone else got it right
6. Related markets - some markets zig when others zag. If investors decide bonds are overpriced and likely to fall, they may move into shares, boosting the stock market.
7. Price to earnings ratios - if share prices rise significantly above historical averages, they're becoming overvalued and a correction is likely.
(from Economics Help)
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Research by Dimensional Fund Advisors has revealed that clients measure the value of their advisor in terms of the security and peace of mind they help them achieve, not in monetary terms.
With more and more automated investment solutions available, it's heartening to know that investors still appreciate the importance of the human touch.
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The case of 'Mr and Mrs Got Too Much’
Andy and Sarah were in their mid 60′s and happily enjoying their retirement. It was March, and they were referred to us as they were interested in using up their annual investment allowance in ISAs.
Andy had worked long and hard in a company that he had helped to grow over many years. He had benefited from his share options and had accumulated some real wealth.
They had plenty of income in retirement; from their personal pensions, interest off their savings and dividends off their shares and ISAs.
They had accumulated a 'big number' - and they were enjoying it. As ‘empty nesters’, they were about to downscale to a smaller, more manageable property, which would soon see a significant amount going from bricks and mortar into savings.
But what did all this mean for their wealth? And what about Inheritance Tax?
We spent some time really getting to know Andy and Sarah. We took the focus off ISAs - or any form of investment - and talked about the life they’d had, and the life they’d got. We wanted to understand their plans for their own future, and that of their children and grandchildren..
We helped them to identify the cost of the lifestyle they wanted to continue to enjoy, showing them how much they would need to spend to achieve it.
We also got them to think about what else they might like to do in their lifetime in order to really enjoy their remaining years, gathering the facts about what they had accumulated; their capital position, their assets, their liabilities and their many sources of income.
After ‘crunching their number’, this is what we found: based on the prudent assumptions they had made, after allowing for inflation and the potential cost of long term nursing care, Andy and Sarah would NEVER run out of money.
In fact their wealth would continue to increase, even after allowing for extra expenditure. Instead of running out of money, they were well on course to die with too much in the bank.
Why is that a problem?
After having paid tax throughout their whole life - on everything they’d ever earned and spent - Andy and Sarah were about to pay another slug of tax when they downsized their house.
We helped them realise the size of their problem, and just who was going to be the single, largest beneficiary of their hard earned estate: the Chancellor of the Exchequer!
If both Andy and Sarah died now, the Inheritance Tax bill would be well over £500,000. And it was going to get far worse.
So we helped Andy and Sarah work out just how much more they could afford to spend - and how much they could confidently afford to pass on to their children NOW and over the next ten years - without fear of them ever running out of money.
Effectively, with the help of our financial planning software, we helped Andy and Sarah confidently create a ‘spending and gifting programme’.
Andy and Sarah are now on course to eliminate their Inheritance Tax liability. They have certainty. They are on course to manage their wealth to give them the life they want whilst gradually passing on wealth down to their children and grandchildren so the Chancellor does not benefit.
They can do this, because Andy and Sarah now know – and more importantly understand – their number.
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Evidence-based investing insights - part seven
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We hope you're enjoying Evidence-based Investing Insights - a twelve-part series which distils the key principles for a successful investing experience into an easy-to-read downloadable guide.
Part seven is called 'The Business of Investing' and goes back to basics, explaining how the market works and how we build a portfolio designed to capture its returns. We hope you find it both informative and enjoyable to read. Let us know what you think!
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