US credit downgrade

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US credit downgrade: a timely wake-up call

The psychology of investing

Psyching up for retirement

Win a trip for two to Fiji

US credit downgrade: a timely wake-up call

By Bevan Graham, Chief Economist, AXA Global Investors

The downgrade of America’s sovereign rating by Standard & Poor’s on August 5th doesn’t tell us anything we didn’t already know. The US is in a weak and fragile recovery constrained by high household and sovereign debt. This has been the premise behind our expectations of many years of relatively weak economic growth in the US, and in much of the developed world.

The new part of the equation was the failure of politicians to develop, articulate and ultimately implement a credible long-term plan to achieve fiscal sustainability. Fiscal consolidation then becomes a series of short term measures that makes it difficult to achieve the important balance of achieving fiscal sustainability and supporting economic growth. Standard & Poor’s (‘S&P’s’) action was as much an indictment on the political process, than anything else. Perhaps in time we will look back on this as being a wake-up call?

Given the economic fundamentals of the US are well-known they are already, to a large degree, reflected in asset prices. The US Dollar is weak and much of that weakness is structural, reflecting the drop in relative living standards that is the primary legacy of the Global Financial Crisis.

Bond yields are low reflecting the low growth/benign inflation outlook and (still) safe-haven status of US Treasuries. If you’re going to sell Treasuries today, what are you going to buy? It has been our medium-term view, however, that US bond yields would rise over time as investors became increasingly focused on fiscal issues. That would be reflective of a rising US risk premium. S&P’s actions may well front-load some of that premium.

On the other hand there may be a downward impact on yields as investors take this opportunity to reassess the US growth outlook. The consensus view on medium-term US growth is still too high in our opinion. We think trend growth in the US is now about 2.5% and developments over the past couple of weeks haven’t changed that view.

None of that stopped the knee-jerk reaction to the credit rating downgrade as markets digested the news. Equity markets were already experiencing some weakness in the days leading up to the downgrade and this didn’t do anything to help sentiment. What’s cheap can always get cheaper.

One of the interesting things to watch in the weeks or months ahead will be how other countries, especially those who are still AAA rated, respond. It could be that some decide to take a harder austerity line to protect their rating. While that sounds admirable, it is the wrong way to think about it. It’s not about how fast fiscal consolidation occurs, it’s all about having a plan that is credible and gives markets confidence that there is commitment to achieve it. That is all that’s really missing in the US and Europe and should be an easy fix. Should be…. 

They psychology of investing

Question – What two words best describe why we do things the way we do?
Answer – Human nature.

Unfortunately, in the investment world, human nature is more often a hindrance than a blessing. As human beings, our emotions and psychological biases can often lead to poor or, at times, irrational decision-making. One area where your financial adviser can potentially add a lot of value for you is in preventing unwelcome behavioural reactions from dominating your decision-making process.

Some behavioural tendencies are so widespread that a number of eloquent new expressions have entered the financial lexicon. A few of the more colourful ones are as follows -

Fear of regret – this refers to the pain felt after making a bad decision. It is the fear of regret that causes an investor to hold on too long to a share that has dropped in price. The investor holds on to a losing share in the hope that its price will return at least to its original purchase price, at which point the share can be sold with no regret.

This tendency helps explain why professional money managers will often turn over their investments more regularly than private investors. A professional manager is less concerned about crystallising a loss on a poor performing investment if they have identified a better current opportunity in alternative share.

The snake-bite effect – refers to an investor’s reluctance to take risks after experiencing losses. It predicts that investors will avoid riskier shares once they have experienced a loss in the share market.

The snake-bite effect was very evident in NZ following the share market crash of 1987. From October 19th 1987, the NZ share market fell about 60% in two weeks and many local investors were ‘bitten’ so badly that they avoided investing in shares ever again.

Trying-to-break-even effect – is counter to the snake-bite effect. This refers to the desire by investors to recoup large losses in one quick long-shot (very high risk) investment. This form of behavioural bias predicts that investors who have lost money are more willing to take very high risks to try and recoup the loss immediately.

This might explain why some investors are prepared to invest in extremely high risk ventures without doing any real due diligence. However, in my opinion, this high risk approach is not investing at all, it is a form of speculation.

The endowment effect – refers to the tendency by people to place higher value on what they own than on identical items they do not own. This can also be viewed as the “do nothing” effect where investors make decisions with a preference to keeping their original investments, as if selling them will somehow elicit a feeling of loss.

This is seen quite often in local share market investors who seemingly take great comfort out of owning the shares of a particular company or companies.

Having an understanding of your own behavioural tendencies, particularly with respect to investment decision-making and markets, might help you (and will certainly help your adviser!) to plot your optimal investment strategy. Markets and investing are complex areas and, quite often, a decision which has a high level of emotional appeal may not be in your best long-term financial interests.

Damon O'Brien is an Authorised Financial Adviser. His disclosure statement is available on request and free of charge by calling  03 377 6675  or at spicers@spicers.co.nz

Psyching up for retirement 

There are said to be a number of “most stressful” events in one’s life: starting work, buying a home, getting married, loss of a close relative, getting divorced and so on. At least as stressful for many people is retirement. For those approaching retirement, in retirement, or with a spouse, friends, parent etc at retirement there are some key things to be aware of.

According to two psychologists from Monash University in Australia*, there are a number of factors which coincide at retirement to make it stressful:

• a dramatic reduction in income, usually by one half to two thirds
• a loss of identity in an occupational sense
• ceasing to be “productive” leading to lower self esteem
• a major change to marital “style” due to both partners often being at home
• boredom due to the increase in spare time yet to be reallocated

This stress manifests itself for most people in either anxiety or depression, both of which have physical symptoms (jumpiness and sweating are signs of anxiety, and sleepiness and indecisiveness are signs of depression).

According to the psychologists, who presented a paper at a conference for investment advisers and financial planners, those who are approaching retirement have a range of attitudes, with one third expecting to be happier in retirement, and one quarter at the other extreme who are overwhelmed by anxiety about their health, their personal finances, and simply the unknown: how will I be in retirement?

The first key message is this: according to their research, the more you look forward to retirement, the more likely you are to enjoy it more than you expected. The converse is also true. In other words, psyching yourself up is a good idea, and it pays not to retire until you really want to. That is one major reason why forced retirement is very difficult to adjust to.

After retirement a number of problems are reported by people:

• 20% say they are suffering from boredom
• 18% report significant marital tension
• 16% say they miss work
• 6% say that their finances are a major worry

No doubt there are others who feel these problems but did not say so. These things make people anxious and lead them to make poor decisions early in retirement. So the next key message is to check for symptoms of stress early in retirement and if they exist, defer any big decisions such as moving house, making major investment changes, taking that world trip or whatever.

The research conducted at Monash University showed that many people go through four stages early in their retirement.  These are as follows:

The first three stages are relatively self-explanatory. The fourth may take two forms, depending upon how one deals with the first three. The good outcome is where the retired person re-employs him - or herself in some way - be that through work in the traditional sense or some other “mission” in life: charity, family, sport etc. They experience a high level of wellbeing and go on to enjoy a long, healthy and happy retirement.

The poor outcome is where the retiree remains somewhat disenchanted and enters an ongoing (although not necessarily continuous) period of poor health and does not recover. Sadly the latter outcome is all too common.

The third key message then is to be aware of these stages, to expect to experience them and to work through them explicitly, with a view to coming out on the good “stability” path quickly and with the minimum of stress on the way.

The fourth message given at the address at the conference was to investment advisers: often when you see clients they will be going through the stresses of pre - and post-retirement, without the benefit of a counsellor who understands all of the above. If the investment adviser can help in that regard then he or she will be doing the client a great service, one which is at least as important as helping with their financial matters. So a good investment adviser should also be not just a financial planner but also a retirement counsellor.

* Effects of Age of Retirement, Reason for Retirement, and Pre-retirement Training on Psychological and Physical Health during Retirement Australian Psychologist Volume 33, Issue 2, pages 119–124, Christopher F. Sharpley, Renaty Leighton

Win a trip for two to Fiji

By Spicers Portfolio Management Limited

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• Travel insurance

To find out more about how to enter the competition and to download your free magazine go to ‘The Adviser’ magazine competition page here.

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Your feedback is welcome

Financial Update is a regular publication published by Spicers Portfolio Management Limited. It discusses topical investment and financial planning issues. A disclosure statement is available on request, and free of charge from you adviser by calling  0800 102 100.

The Spicers approach is to meet with a potential investor and ascertain what their individual needs are before making any recommendations. We believe that quality advice incorporating a robust planning process should be the foundation of any investment service provided.

The planning process starts with discussing what is important to clients. This may include achieving financial independence, repaying the mortgage, educating children, supporting ageing parents – all while enjoying a good lifestyle. We then review the overall financial position now and how it might unfold in the years ahead.

Once we know what is important and how the financial position looks, we can then work with our clients to tailor a financial plan to help make it happen. Importantly, once we understand what is important to our client, we can then provide a specific recommendation on the type of investment portfolio to support the plan.

Please provide feedback directly to your adviser or email: spicers@spicers.co.nz

Disclaimer

The information in this publication is of a general nature only. If you would like advice that takes into account your particular financial situation or goals, please contact your financial adviser.  A disclosure statement is available from your adviser on request and free of charge.

The information has been published in good faith and has been obtained from sources believed to be reliable and accurate at the time of preparation. The opinions contained in this document reflect a judgment at the date of publication by Spicers Portfolio Management and are subject to change without notice.  Past performance is not indicative of future performance and is not guaranteed by any party.