Lessons Learnt From the GFC

I can hear an audible sigh of relief from many investors, particularly retirees, with the improvement on the share market in recent months.  It has been a long, arduous journey over the past 6 years and you can be forgiven for embracing the thoughts of many economic commentators that the worst may be behind us.

Before we consign the GFC to the history books (and I'm not sure this is wise as we are far from out of the woods yet), or endeavour to erase these memories, it is wise to reflect on what we have learnt from the GFC so we don’t repeat the mistakes.

                                                                                        Iman Mosaad

Lesson 1 The “This Time is Different” Syndrome

We as humans do evolve in so many ways, except when it comes to this.  Logic takes a back seat and we embrace the “new paradigm” where lessons learnt from the past don’t apply anymore.

But stretch the memory back and we can see that the world does move in cycles and bubbles form and they burst.  The GFC is just the more recent of many examples of this.

If you don’t accept the anecdotal evidence, have a read of a book by Reinhart and Rogoff (called you guessed it, “This Time is Different”) if you want the hard empirical and academic evidence.  It doesn’t read like a David Baldacci novel, so to save you some toil, here are some of the findings from this study:

Evidence of The Bubble forming

• Real estate prices are the initial element of many bubbles that form (the converse is they are a good predictor of future bubbles).
• From 1996 – 2006, cumulative real price increase in US house prices was about 92% - more than 3 x the whole period from 1890 – 1996.
• New markets are formed, new financial instruments are created (eg securitised lending) and new lenders are found.
• Massive increases in leveraging within the banking system around the world.  Borrowing money is dead easy.


What Can we Expect Following a Financial Crises?

• There have been 18 Bank centered financial crises since WWII.  These are not rare events (although this was one of the worst).
• Following a severe financial crises asset market collapses are deep and prolonged. The decline in real housing prices average 35% over 6 years and equity prices 56% over 3 ½ years.
• Economies suffer a decline in output and employment.
• Government debt explodes (can anyone please tell me what comes after a trillion and we will let the US Federal Reserve know?).

So there are common elements and conditions that lead to bubbles forming and we are not too good at predicting when bubbles are going to burst, despite evidence that will build and be presented before us, and then seem obvious after the event!

Lesson 2   Fear versus Greed

One of the basic tenements of investor psychology is the fear and greed factor and how it effects the decisions we make.  If we were unemotional, logical, patient types of beings, we would without question be far more successful investors.

So why do we get so carried away during periods like the dotcom boom and more recently, the GFC?  As Gordon Gecko famously pronounced in the movie Wall Street, "Greed is good!"

Contrary to what the great man said, greed is actually not so good.  It explains why the vast majority of investors clime on board and buy at the top of markets, rather than near the bottom.

So why do these cycles usually end so quickly and viciously?

Whatever the reason for the bubble being pricked, once it does, fear takes over.

Fear is what drives down markets as on mass,  people sell their investments. People have frequently bought investments blindly ignoring risk (the greed factor) and then suddenly they are far more risk averse than they realised.

Investing is counter-intuitive.  You should be buying when you don’t want to buy and selling when you don’t want to sell.  Recognise this, remember this and try to be less emotional when it comes to making major investment decisions.

Lesson 3.  DEBT – The “Dead Money” Myth

Any borrowing, leveraging or gearing (all means the same thing) means far greater risk.  As we saw with Storm Financial, it not only means a risk of losing money on your investment, but a risk of losing your house, or whatever other asset that has been used as security.

From a financial adviser viewpoint, it tends to be sold as a tax driven strategy, as the interest cost is tax deductible.  A certain level of gearing is not such a bad thing.  The massive amount of gearing, due to the easy money that has been available over the past 10 + years, is bad.

 Being able to borrow over 100% of the value of a property is not a good thing.  Having no savings history and then gearing heavily is not a good thing.  No income, no job, no asset loans (i.e. the NINJA loans emanating from the US and the low doc loans that were starting to gain a footing in Australia) are not a good thing.  Owning 10 properties in 12 months and being a paper multi-millionaire (well in assets anyway, lets conveniently ignore the debt), despite what the white shoe brigade on the Gold Coast tell you, is risky.

Lesson 4 Alternative Assets

I have used this term to describe the proliferation of products that invest in non-traditional asset classes.  i.e. assets other than shares, real estate, fixed interest, cash and commodities.

The best example of this, and will likely be featured in University texts and case studies for a long time to come, is the financial wizardry behind the packaging and selling of US sub-prime mortgages.

Billions of dollars of these securities were sold around the globe.  Some of the players knew they were a time bomb waiting to go off but still sold them.  As we have seen, house prices plummeted, the securities became virtually worthless and almost brought down the whole world financial system with it.

There is an old investment cliché, “don’t invest in something you don’t understand”.  If the investment is mostly based on investing in traditional assets, but use other financial instruments to reduce risk then it is probably worth further investigation.  If it's an investment in just financial derivatives promising a far superior return than what you can get in the “real” market, I would be very wary.  It is usually the bankers who are going to do well out of this, not you.


The GFC has been caused by an explosion in debt.  The solution from the economic guru’s has been to create more debt.  We do have short memories but I find it extraordinary a number of “experts” predict good times ahead.  I don't think we have learnt from the GFC at all, and it hasn’t finished yet!



Aaron McCracken
Private Client Adviser

Insurance: Inside or Outside of Super?

We all know that insurance is an important part of your financial well-being; it is a matter of providing money or replacing lost income at a time of financial difficulty.  However, the question I am always asked is; should I arrange for my insurances to be held inside or outside of super?

Having appropriate insurance in place will give you and your family financial peace of mind in the unfortunate event should you die, become sick or are injured and are unable to work.  When it comes to life insurance, Australia is one of the most under-insured countries in the world [1].   Put simply; only 4% of Australians with children have a sufficient level of insurance coverage.

What are the different types of insurance?

Life insurance provides financial protection in the event of death and in some cases, terminal illness.

Total and Permanent Disability (TPD) pays a lump sum if you become Totally and Permanently Disabled as the result of an injury or illness that will prevent you from ever being able to resume either your own or any occupation.

Income Protection policy will pay you a regular income in the event you are unable to work due to illness or injury.  Income Protection insurance generally replaces up to 75% of your monthly income.

Trauma Protection or Critical Illness insurance provides a cash lump sum on the diagnosis of a medical condition. The number of conditions covered (benefits) varies widely.


As a financial adviser, it is one of my objectives to create wealth for my clients and part of that is to ensure I protect it as well.  This will ensure my clients families are looked after in the event of the unexpected.  Deciding whether to hold insurances inside or outside of super involves assessing the tax implications, benefit access implications (social security) and the best option for each individual’s ability to; a) pay the premium and b) ensure that the proceeds are received by the intended persons in the most tax effective way. There are pros and cons with relying on your super for all your insurance needs.   Here are some of the major ones to consider:


PROS

• No medical examinations are required to take out basic/default level of cover inside super.
• Super policies often include total and permanent disablement (TPD) and Income Protection in a default superannuation offering.
• It is tax effective.  The premiums are paid out of SG contributions made by your employer or from personal contributions (for the self-employed) or are paid from pre-tax income, in the case of salary sacrifice contributions.
• Premiums can be deducted from super contributions.

CONS

• Default levels of cover are minimum and do not take into account your earnings and lifestyle.
• There can be delays with life insurance benefits being paid as payment initially is made to the super fund.  This can be a lengthy and frustrating process for your loved ones.
• If you have not made a binding beneficiary nomination, you can’t be 100% certain your benefit will be given to the intended recipients.
• Trauma insurance is not available through your fund.
• Income protection benefit payments are paid to the super fund which will then need to be sent to you as the recipient, adding delays to receiving your payment.

It’s always better to have some insurance in place rather than none, but it’s wise to know exactly what your insurance will or won’t pay and in what circumstances. Remember, there is nothing to stop you from taking out cover from both inside and outside of your super fund. We at LJ Financial are able to help you structure your insurances to ensure you are maximising your benefits.

Silvia Infante
Financial Adviser

[1] Investment and Financial Services Association of Australia (IFSA)

Precious Metals: Why the Bull-Market Is Not Over

                                                                          digitalmoneyworld

The start of 2013 has shown some interesting market dynamics. The equity markets have risen, and precious metals prices have fallen. There is mixed data about house prices, and expectations as to where the markets will go this calendar year. This week we look at Precious Metals start to the year, and why we believe investors should still consider this as an asset class in a well-diversified portfolio.

Gold is currently trading around USD $1575, a fall of around 5% in 30 days. Whilst the fall has been disappointing for investors in precious metals, there remains no fundamental reason to believe the bull-market in precious markets is over.

The fall in price for Gold has been attributed to a handful of arguments, including:

• Gold has gone up for 12 years in a row, so the bull market ‘must be over’.
• The World economy is improving hence there is no need for people to own ‘safe-haven’ assets like gold.
• The Federal Reserve has said it ‘might stop printing money’.

Whilst sentiment and short term market moves are being influenced by this thinking, we would point out the following.

The point about Gold going up for many years is correct, but it doesn't prove in any way that the bull market is over. Bull markets in any asset class don’t function to a strict timeline, but rather tend to end only when the fundamental factors driving that bull market are over-stretched, and valuations are extreme. This was the case with gold all the way back in 1980, but it’s far from the case when it comes to precious metals today.

Secondly, the world economy is not improving significantly. In Q4 of 2012, the GDP figures for the Eurozone and the United States were negative, despite the deficits being run to stimulate growth. Last week Wal-Mart was in the news in the US after February sales figures were internally reported as a ‘total disaster’. It's hard to believe the economy is improving if a company like Wal-Mart is experiencing its worst sales figures in nearly a decade.

The final argument, that the Federal Reserve might stop printing money and that this will cause gold to fall also needs to be addressed. It was only in December 2012 that the Fed decided to more than double the amount of money it was printing (from $40 billion a month to $85 billion). Since then, economic data has deteriorated, so it’s hard to see why they would stop printing money any time soon, especially with continued threats of tax rises and/or spending cuts from Washington.

We believe strongly that the Fed, and indeed all major central banks around the globe will maintain negative real interest rates (i.e. where the inflation rate is above the cash-rate), and continue printing money to prop up their economies for many years to come. Despite what they might say to the media, they know any attempt to stop the printing, or to raise interest rates will lead to a huge fall in economic activity.

These key factors are why we believe that the price of precious metals will increase steadily over the following decade. Prices may move into negative territory at some points in the cycle, but until there is a shift in the debt crisis and key economic indicators (such as higher real interest rates). Precious metals will remain a part of the LJ Financial Investment philosophy.