Each of our clients works with Lorica Partners for different reasons. During the year, clients have told me engaging with their children or sending regular updates on progress against specific goals is valuable for them. So, based on your feedback and a little research we have done, where do we think we make the biggest difference in your life?
Research shows that building wealth is normally a mindset problem, not a money problem. Our job is to set you on the path of best behaviours to achieve what you want.
A US colleague, Morgan Housel, wrote a wonderful article about a humble secretary, Grace Groner, who left $7 million to charity when she died in 2010 through a lifetime of disciplined saving. In contrast, a high-earning vice chairman of Merrill Lynch filed for bankruptcy just weeks after her death.
There is no industry other than finance where this story is possible. How does a woman with no training or connections so comprehensively outperform a Harvard educated Merrill Lynch guy?
The best financial outcomes are not necessarily about what you know and how sophisticated you are, but rather how you behave and your relationship with fear and greed. Below we discuss some areas where working with Lorica Partners may benefit you and your family.
Time is a valuable resource. It helps you create better relationships, have greater success at work and more memorable moments. But it never feels like you have enough of it.
According to research, people who value time more than money are happier and more productive in life. The study suggests that if you want to become a happier person — and you already make enough money to provide the essentials — you should start placing more value on time.
You should budget time carefully — as carefully as you would money. The graph below reminds us just how precious time is.
Avoid Behavioural Mistakes
Russell Investments recently published a report to quantify the value of working with an adviser[i]. They calculated an adviser can add at least 5.3% per annum in monetary value to clients even (or perhaps especially) in difficult investing climates. Contrary to some popular perceptions, Russell believes the value of good advice goes “beyond investment management”. Let’s consider the four key areas Russell identified and quantified an adviser can add value.
A full 2.3% of the 5.3% expected gain from advice comes from helping investors avoid bad decisions. An example would be avoiding a selldown of stocks in February and March 2020 during the pandemic outbreak – the following quarter was one of the strongest in history.
US research firm Dalbar has long produced an annual report quantifying the cost of behavioural mistakes. Their study shows there is a difference between the average return an investment generates, and what the average investor in that investment receives. The results of their December 2019 U.S focused report showing 20-year market returns compared to the return of the average investor are shown below:
The Behaviour Gap for equities was 1.81% pa and for bonds was 4.56% pa – this gap occurred each year for 20 years. For a $1 million portfolio invested in a 60% growth portfolio in 2000, the cost to the average investor was almost $60,000 per year – or $1.2M over 20 years. This outcome is consistent with Russell Investments’ own calculations.
Managing investor behaviour seems so simple, but simple should never be confused with easy. We can point to health and diet as an example. We all know what we should do but doing it can be quite hard.
Many people don’t hire a financial adviser because they don’t know what to do. People certainly don’t engage an adviser because they’re dumb. You hire a financial adviser to be the thing between you and poor behaviour. You can have an optimal investment portfolio, but one behavioural mistake each decade and you may as well have been invested in cash.
We find people who do-it-yourself naturally tend to become emotionally invested in their own portfolios, meaning they ride the losers south and never want to give up the winners. The reasons for these attitudes are well documented by behavioural economics.
The key to earning strong long-term returns is diversification and discipline. The stock market will have more good years than bad, we know that. But there will be bad years, so a plan needs to accommodate those by including bonds and other defensive assets. We make sure when the time comes to buy, you buy. That’s the discipline of our process.
The second biggest contributor in the Russell report was advice that maximises tax efficiencies when investing, expected to add 2.3% pa. This gain is generated by advisers recommending tax strategies such as salary sacrifice to top up superannuation and managing capital gains tax. The process we use to manage clients’ portfolios means every rebalancing decision factors in capital gains tax. This benefit is not available if you use an industry super fund for example, which is designed as a Master Trust and thus factors the collective member capital gains tax situation into the entry and exit unit price each day.
If our client invests $100,000 and leaves it untouched until they commence a pension, 100% of the unrealised capital gain will be tax free. In an industry super fund, part of this capital gain will be realised along the way. Quantifying the benefit here is difficult, but it is real.
Russell estimated asset allocation accounted for 0.9% pa of the 5.3% benefit, based on the all-too-common scenario where an investor is taking inappropriate risk in their portfolio because it is aligned with their objectives. The report showed 2 in 3 investors don’t know how their investments are allocated between shares and bonds.
Cost of Cash
Finally, 0.6% was attributed to the cost of cash. This is about optimising the return of your defensive asset portfolio whilst being mindful of not taking excessive risk. When people see their bond portfolio returns fall, they can be tempted to chase yield. We saw this prior to the GFC when many investors rushed into mortgage funds, only to discover these funds were subsequently frozen to redemptions (often for 5+ years) due to the illiquid nature of the underlying assets. More recently, we sadly saw many investors in November 2019 invest millions in Virgin Australia bonds, seduced by the promise of “guaranteed” 8% returns, only to lose 100% of their investment inside eight months.
Our role is to ensure you understand the role of defensive assets in your portfolio, so you don’t chase yield and end up in high-risk products. The focus for defensive assets should be capital preservation, portfolio volatility management and liability matching, not yield alone.
The costs paid to fund managers can be a significant drag on the returns you receive.
The funds we use to implement our philosophy have some on the lowest overall expenses in the industry due to their investment strategy, trading protocols and value-added trading techniques. Below we benchmark the costs of the primary asset class strategies we employ against the market average pricing for Australian investors[i]:
To provide context, the Perpetual Australian Wholesale Fund, which provides investors with exposure to approx. 50 listed Australian stocks, charges 0.99% per annum. After-tax, most of our clients pay less than this in total for Lorica Partners advice, custody and administration of their assets, tax reporting, and fund manager costs which provides exposure to over 8,000+ global securities. We think this outcome is compelling.
Some believe earning a high income or accumulating material wealth (often with significant debt) equates to Financial Wellbeing. Instead, we find the best predicator of Financial Wellbeing is financial security – knowing you have enough to pay for your desired lifestyle and being prepared for unexpected events. This is three times more important than income alone (Rath, Wellbeing 2010).
When you feel in control of your finances, you feel less stressed and anxious. A 2008 AP-AOL poll showed those with higher debt stress were more likely to have severe depression (23% versus 4%) and severe anxiety (29% versus 4%). Insomnia, difficulty concentrating, and anger management issues were also common among the indebted. A 2016 paper in Psychological Science even showed that financial stress causes physical pain. It cited six studies that found those with economic insecurity experienced far more pain and consumed a lot more pain medication.
Have a plan just for you
If you have no written plan for your future, you have no framework for what you are doing, thinking and why. Instead, you often bounce from one short term, ad hoc matter to the next, and are a slave to random commentary either on the TV or at dinner parties.
We typically find most new clients have never articulated their goals properly to know what their plan should be trying to achieve. If you’re not clear on your goals, how can you know how much risk is appropriate for you, what duration your investments should be, and what future liabilities you should plan for?
No plan is ever set and forget, for two reasons. First, markets are always changing, which can move your portfolio beyond the bounds of your risk appetite. Secondly, you are always changing. We are constantly helping you plan for major life transitions, and then help guide you through them when they arrive. This requires plans to be reassessed and, often, goals to be reset.
When outcomes disappoint
When it comes to investing, no one can consistently make the right calls. There is not a single person or trading system in the world that can do that. As Professor David Blake from City University in London noted, “most outperformance is due to luck, not skill. It takes a very long period of performance data to distinguish skilled managers and lucky ones”. One report quantified you may require 36 years of data to achieve 95% confidence that manager skill exists[i].
If you look at the Netflix share price, if you have held the stock since the 2002 listing, you have made a return of almost 500 times your initial investment. However, during this period, you would have lost over 50% of your money on seven occasions. And guess what? Few investors have held the shares since the IPO for that reason and enjoyed the long-term benefit.
Whilst we continually challenge our investment philosophy, it will always remain a systematic approach that avoids random decisions or reactions to short-term events. That is not what you or any of our clients want us to do for them – you want us to achieve long-term outcomes for your family.
Whilst we all yearn for the promise of certainty, it is our role to remind you there is no certainty in financial markets. Uncertainty is the friend of the buyer of long-term value. If there was no uncertainty, expected returns would be much lower.
We help people deal with risk and uncertainty in the real world. Risk is what you don’t see. None of us knew a pandemic would arrive in 2020, but our client’s investment strategies were ready and prepared for it. You need to save like a pessimist – have a buffer and control your cashflow – and invest like an optimist, because as we saw in 2020 and every scary event before, markets always bounce back.
The value of advice is both tangible and intangible. Every person quantifies the value in their own way. Our role is to help foster good behaviours, as good investing outcomes are achieved by consistently not making mistakes rather than making a big play or consistently good decisions.
Achieving the goals and lifestyle you aspire to for your family is a tough job to do on your own. The evidence from thousands of people, who have been properly advised, is that the real value of having a financial adviser is the peace of mind it gives you, the sense of security and confidence about your future.
[i] Source: Investsmart as of July 2020