Kuta Beach

Kuta Beach

Saturday, 31 October 2009

Risky Business (Catalyst)

Link: Risky Business (Catalyst)

Risky Business, from the ABC science show Catalyst, shows how poor payment systems for fund managers may have incentivized managers to take high risk.

The show also explains that human behavior (and the behavior of many other animals) is influenced by biochemistry. When a man fails, cortisol is produced in his body, which causes him to become risk averse. Conversely, if a man wins, testosterone is produced in his body, which causes him to become risk loving. This may explain why stock prices moving in one direction (up or down) can be exaggerated. In a bull market, traders win money, which increases their appetite for risk, which increases stock prices even further. Conversely, in bear markets, traders lose money, which increases risk aversion, which decreases stock prices even further.

Saturday, 24 October 2009

Old Car or New Car?

In the United States there exist so-called lemon laws that state that if a new car you buy stuffs up a certain number of times you are legally entitled to a replacement car.

To understand why there are calls for lemon laws in Australia, read Helen Moss's submission to Consumer Affairs Victoria regarding lemon laws.

Such lemon laws were proposed for Australia in 2007 by state governments here. But today, all of a sudden, the Commonwealth government has stepped in and claimed that lemon laws are not necessary because new legislation -- the Australian Consumer Law -- will cover consumers if their cars are dodgy.

It is possible that this new national legislation will work, but there is also the possibility that going to court to fight car manufacturers won't be practical for the average person because of high costs.

That some new cars may be lemons I believe is a good reason never to buy a new car.

If you buy an old car, even if the car turns out to be a lemon, you lose less money because the car you buy is not worth as much.

Furthermore, do not think that warranties will protect you. If you buy a car and there is a fault and you bring it to the dealer for repair, the dealer has no incentive to fix the problem for you for free. They waste time and money, so they have an incentive to lie and say that there is nothing wrong with the car. However, if you have no warranty and you simply bring your car to the mechanic if there is a fault, you pay for the service and the mechanic has an incentive to fix the problem because he gets paid for the service. He will therefore likely do it and also be polite to you because he has an incentive to do so.

Before you buy a second-hand car, make sure you get it RACV tested.

Why Invest in Australian Companies?

The views expressed here are for education purposes only.

About 55% of my net worth is in Australian shares, 30% in non-Australian shares, 10% in bonds, and 5% in other assets like cash and one car.

I have heavily weighted my portfolio to Australian shares because I have a lot of faith in the future of the Australian economy. I will list below the arguments for investing in corporate Australia.

High exposure to resource companies
Concerns about government debt and money-printing in developed economies have stoked inflation fears. When people are worried about inflation, they seek refuge in assets like gold, silver, oil, copper, etc. One-third of the companies in the ASX200 index is made up of resource companies. If inflation does explode, rsource companies are able to sell their products for more, increase revenue, and hence increase dividends and stock prices.

Australian companies pay higher dividends
For the price of their stock, Australian companies tend to pay higher dividends than non-Australian companies. Thanks to the imputation credit system introduced by Paul Keating in the '90s, Australian investors are also advantaged because company profits are no longer double-taxed.

Eventually the stock market will rise
Many fund manager talk on and on about how if you hold stocks for the long run you are guaranteed to make a killing. This view has been challenged by Professor Zvi Bodie who claims that holding stocks for the long run is actually more risky than holding stocks for the short term. Professor Bodie's assertions should be taken very seriously. They suggest that most of those who rely on their superannuation (or 401(k) in America) are playing roulette with their retirement money. Let us assume that Professor Bodie is right. Let us also assume the worst-case scenario, which is that the ASX200 follows a random walk. This is in line with the idea that the stock market is a casino (as Keynes said it was) and that holding stocks for the long-term does not reduce risk. Let us also assume that the ASX200 cannot reach zero. I make this assumption because it implies that the entire Australian economy is destroyed and that civilization is no more in this country. While apocalypse in Australia is certain possible, let us assume it cannot happen. Even if we simulate the ASX200 index following a random walk and never reaching zero, eventually there must be a rally, and when this rally happens, it is a good time to sell. In reality, when humans see stock going up, they buy more stock, which pushes stocks up even further, creating an even bigger bubble. This herd mentality should ensure that if a rally does occur, it will be amplified. The difficult part is knowing when to sell, which is similar to the decision of when to walk away from the casino once you have made enough money.