“A case for common sense that is not common sense” Stu Varidel – Principal Financial Adviser at Heart Financial Advisers
Social gatherings for me are a nightmare. Sometimes I wish I was plumber or butcher. It is inevitable that a conversation starter is "What do you do Stu?" What comes next is cringeworthy for me of monstrous proportions. Once I disclose what I do, invariably, the initiator is looking for my endorsement of whatever financial action or decision they have already taken or are committed to taking. They really aren’t particularly interested in hearing the almost inevitable reservations I may have. Sheltering behind my ongoing obligation to “know the client”, I avoid getting involved in what experience has told me is likely to be a frustrating and fruitless conversation by simply saying I don’t have enough information to provide a worthwhile opinion.
But such situations leave me feeling a little hollow. It’s hard to standby while people you know do what I think are often “really dumb” things with their money. I console myself with the knowledge that even “really dumb” decisions can have good outcomes, sometimes! Unfortunately, such positive results often achieved by luck alone often encourage further “really dumb” decisions which are financially fatal.
Poor risk assessment and overconfidence are a very dangerous combination. The examples below provide a flavour for the types of conversations that I have come across over the years:
A friend explains how he had helped his son and girlfriend of 3 months with the deposit on an apartment and went guarantor for his loan, so they could “get into the property market”. While appreciating his generosity, the phrase “rope to hang” goes through my head. I also wonder what financial and life lessons are taken from this behaviour.
A couple in their fifties, with no personal financial knowledge, say they are starting to save money now the kids have left home and the mortgage is paid. They are beginning to “dabble” in options in the foreign exchange markets to learn about investing. I only offer the suggestion that such speculation can be a very expensive teacher.
A retiree explains that he has borrowed heavily to purchase only positively geared investment properties in a remote mining town of 50 houses and was planning to live off the income. He argued that he had little risk, as the positive gearing will provide protection against any potential interest rate rises. How did his strategy fare? Well, some years later the mine strikes difficulties and lays off all its workers and closes due to falling commodity prices and the properties were repossessed by the bank and sold for a fraction of the debt on them. Low risk? Sadly the reverse was the reality.
I commend the benefits of reducing investment risk through diversification by spreading your investment as broadly as you can do in a cost effective manner as you can. To a young adult who contacted me a year ago he enthusiastically agrees. In the next breath, he says he would like to buy an investment property. I really wanted at that moment to hit myself with a heavy and blunt object!
A friend of a client suggests that he is looking for more “low risk, high returning” investments like a debt financed housing development 50 km outside a struggling regional city and has just committed over 50% of his potentially already inadequate retirement wealth to. What could go wrong, I think to myself. I have heard nothing more on this and hope he didn’t proceed with this.
The common theme that runs through all the above conversations is an absence of the appreciation of investment risk. Clearly, a dose of good common sense might be useful as well. While optimism is a very desirable human trait and one I cleave to myself, a failure to ask “what can go wrong?” will lead to poor decisions and disastrous outcomes.
There is also a tendency to consider each decision in isolation, with the expectation that every decision will be “a winner”. The notion that “risk and reward are related” is either ignored or not accepted or understood. Investing and making money are seen as ends in themselves. This contrasts with our view that investment is always only a means to the end, with that end being to secure your desired future lifestyle with minimum required risk. None of the actual or intended financial decisions discussed above would be contemplated with our advice approach. Although I am not privy to the desired future goals for each person discussed above if the sizeable downside risk inherent in all of the actual/intended financial decisions did crystallise it would force significant negative adjustments in lifestyle expectations.
It would give me no pleasure to see anyone punished for making a bad decision. But it is frustrating that most people are not open to the rigorous research that suggests there is a better way to take investment risk and maximise the chances they will be able to meet their financial goals.
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