Index Investing: Naïve or Smart?

Index Investing: Naïve or Smart?

What is index investing?

Many investors shy away from index investing because they deem it to be too naïve for their investment purposes. There’s definitely a higher seduction factor associated with a bottom up, active investment approach. Yet the recent trend has clearly been towards index style investing (due largely to the dissatisfaction with actively managed investment alternatives).

An index is a statistical measure for determining the performance of a portfolio of constituent investments. Charles Dow created the first (“Dow Jones”) index back in 1896 to act as a proxy for the performance of the US stock market as a whole.

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DIY Financial Planning – The real costs may not be evident

DIY Financial Planning – The real costs may not be evidentDIY Financial Planning appears to be a low cost alternative

There are a lot of smart people who make some rather dumb choices with respect to their finances. More often than not this is driven by short term thinking and the desire to save an immediate out of pocket expense. There is often a failure to lift the eyes and see the bigger picture.

An example that highlights this is the use of superannuation. We’ve talked previously about the significant benefits of making pre-tax contributions to super. However, in this article we look at the benefits of making post-tax contributions to super.
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Investment Gobbledegook …

There are no orphan shares …
Investment Gobbledegook
A lot of what passes as serious investment commentary is simply “gobbledegook” i.e. nonsense or drivel. It defies share market realities and is at odds with the philosophy that markets work.

Yet, unfortunately, some of the people and organisations generally regarded as finance experts are the main proponents of this gobbledegook. Let’s consider a couple of examples.

In a recent article in the “Sydney Morning Herald”, a private client adviser of a major stock broker explained why the share market had fallen for the past three days, after a period of strong gains, as follows:

“I think it comes down to a bit of profit-taking. I guess the market is acknowledging we’ve had it pretty good for the last couple of months and it’s time to take a breather.”
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Protected Equity Products: Can you have your cake and eat it?

Protected Equity Products: Can you have your cake and eat it?Loss protection and tax advantages …

Protected Equity Products (PEPs) are heavily marketed at this time of year.

They are promoted as an opportunity to benefit from share market growth, without the risk of losing capital. They involve borrowing up to 100% of the purchase price of a basket of shares for a minimum period (generally 3 – 5 years). You keep the dividends and any gains and are protected against investment loss.

The loan interest is also usually prepaid to bring forward a tax deduction and reduce a current year “tax problem”. What a deal – no downside and tax benefits!

However, even with this basic explanation, the alarm bells should ring for smart investors. PEPs play to at least one psychological bias (i.e. “loss aversion”) that investors should be wary of and contradict at least one of our wealth management decision making principles (i.e. “It’s about ends, not means”).
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“Timber”: Agribusiness Managers Felled

Diseased from the beginning …

“Timber”: Agribusiness Managers FelledWithin a couple of weeks of each other in April and May, the two largest stock exchange listed managers of managed investment schemes (“MIS”), Timbercorp and Great Southern, went under. Most likely, shareholders will end up with nothing while creditors are almost certain to take a substantial haircut.

Timbercorp and Great Southern sold interests in agriculture based (or “agribusiness”) investment projects, particularly forestry plantations, to investors or “growers”.

While the “green” credentials of the projects were highlighted, the primary purchase motivation for investors was the large up-front tax benefits offered. The long term economic viability of the projects was always suspect, even more so now that their ongoing management is under a cloud.

Based on our wealth management principles, we think these projects and the decisions to invest in them were flawed from the start. It is a tragedy that there is now an estimated $6 billion of funds and 61,000 investors (see Footnote) caught up in a disaster that could have been avoided by applying a few tried and tested decision making fundamentals.
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