Seven Deadly Sins

Jocelyn Eastway - Australian Financial Review

Seven deadly sins
Jocelyn Eastway

AFR


If you think you're such a legend that you don't need professional financial advice, then you're guilty of pride - the first, and arguably the worst, of the seven deadly sins.

Investment was probably the last thing on people's minds when they coined the seven deadly sins - pride, envy, gluttony, lust, anger, greed and sloth - and nicknamed them the seven "capital" sins.

But as it happens, losing capital, or failing to accumulate capital, is precisely what can happen if you allow any one of these transgressions to corrupt your investment thinking.

Apart from giving you a big head, pride can stop you from selling a dud investment because you can't stand to admit you got it wrong. It can also make you buy a lousy investment because it looks like the smart thing to be doing.

Some believe pride is the sin from which all others arise.

Of the other sins, lust and anger are possibly the hardest to control, because they are charged with emotion and encourage us to act impulsively.

If, for example, the managed fund you have invested in performs a lot worse than its peers, anger might prompt you to dump the fund on the spot without knowing a thing about its potential to rebound.

Similarly, lust can lure you into a sexy year-end tax strategy before logic has had a chance to intervene.

Sloth, on the other hand, can lead you to do nothing at all because you think investing demands far too much effort.

Greed and gluttony are partners in crime, making people want too much of a good thing. Invariably, they end up with very little of anything.

Meanwhile, envy fuels a constant desire to keep up with the Joneses - to have a house, car, job and partner that measures up to the next-door neighbour's.

In the following pages, four experts give their views on how the seven deadly sins can get in the way of sensible investment decisions. Some case studies are used to show just how serious the damage can be.

PRIDE
High or inordinate opinion of one's own dignity, importance, merit, or superiority.

There's nothing wrong with being proud of your achievements as an investor - provided those achievements are worthy of praise. Too often, excessive self-esteem makes people think they are doing a lot better than they really are, according to Peter Thornhill, principal of Motivated Money.

"The thing that strikes me is people's ability for self-delusion," Thornhill says. "People do quite poorly, but by self-delusion they can say: 'I have done well."'

"The sin there is that people have no benchmark against which they measure their financial progress. People's perceptions that they have done well are normally based on looking at someone further down the chain. But it's hard to say you have done well if you look up the chain."

Pride often leads to poor investment decisions, according to Arun Abey, executive chairman of ipac. "Pride means not being willing to admit that you have made a mistake. It means holding on to something for the wrong reasons," he says.

The fact that an investment has gone down in value does not make it a bad one, Abey says. But if the evidence suggests it's unlikely to recover, then pride should not stop you from selling. "People are not willing to take a loss and move on to something more sensible," he says.

Finance educator David Hartgill says when you buy an investment, it's a good idea to decide upfront at what point you will sell. "It's best to decide for yourself when would be a good time to sell, what would be the trigger, how much drop in value your portfolio could tolerate," he says. "It's hard to make a decision like that when it's all happening."

Just as pride should not stop you from selling, pride should not be a reason for buying a particular investment, Abey says.

"Something that is very common is buying investments so you have something to talk about on the cocktail party circuit," he says. "It's this perception that I am doing things that these smart people are doing as well."

Pride also makes people think they can do without professional financial advice, Abey says. "It's this notion that because you are an intelligent person and qualified in a particular area, that makes you an expert in all sorts of other areas," he says.

"It's not having the humility to recognise the need for help in other disciplines." Abey says it's all very well to read books about investing. But people should not confuse information with knowledge and wisdom.

Says Hartgill: "It's important to know that no one person understands the whole thing or has the whole thing right. Once you accept that and start looking for quality long-term investments, that's when you start moving towards good investment decisions."

Abey says it's worth remembering the biblical saying: "Pride goeth before destruction, and an haughty spirit before a fall." "So if someone is bragging about high returns, then chances are they are heading for a crash," he says.

ENVY
A feeling of discontent or mortification, usually with ill will, at seeing another's superiority, advantages or success.

In financial terms, envy is all about trying to keep up with the Joneses, Thornhill says. "It's about the big house, the big car, the big job. In all respects, many people move beyond their capabilities," he says.

"Doctors, dentists and lawyers are some of the worst investors in the world because they lead a lifestyle that they believe is appropriate to their status in life. A lot of these people end up with no money in retirement. They have lots of toys, but nothing else."

Abey says envy is an extension of the cocktail party story used to illustrate pride (above). "Where envy goes further than pride is that envy can cause people to go against otherwise rational impulses; to go against what they probably think is wrong," he says.

"It's buying something at extraordinarily high prices when they know better, or it's buying something which they believe is junk, but nevertheless, everyone is getting in there, so they can't resist it. With pride, on the other hand, they don't always know it's wrong."

Abey says the dot com boom of 1998-99 was a good example of envy controlling people's investment decisions. "When someone says, 'I have put in $2,000 and made it $100,000', that really distorts someone's value set," he says.

"Your next-door-neighbour goes from being in your camp to having a better car and moving suburbs. There's no easy way you can catch that up."

Hartgill says trying to emulate others' success can lead to all sorts of problems. "Everyone has their own level of risk tolerance," he says.

"What is the thing that one person might be happy with, may not suit you at all. It may also not be an appropriate long-term strategy when it's looked at in the context of your present circumstances and obligations.

"One man's meat can be another man's poison, so don't focus on others. Firstly, work out what's good for you, seek it out, and put your money there. Trying to copy other people's situations may be entirely wrong for you."

GLUTTONY
Excess in eating.

Consuming too much of a particular asset class is no different from eating too much of a particular food group, according to Alyson Clarke, head of technical services at BT Funds Management. "By eating too much of one, you can make your investments unhealthy, just like you can make yourself unhealthy," she says.

There is a tendency for people to invest their money in the asset class - or managed fund - that did best last year. "But if you track the asset class that has had the highest return over a 12-month period, it's very unlikely you will get the same asset class coming out on top two years running," she says.

(International shares were a rare exception, coming out on top three years in a row: 1997, 1998 and 1999.)

"Being overweight in one particular asset class could end up being quite detrimental. It's the diversification story there that's really important," she says.

The obsession that many Australians have with residential property is a classic example of gluttony, Abey says.

"[For these people], diversification often involves buying another unit, often in the same complex," he says.

"Without financial advice, many investors find their portfolios are not effectively diversified, leaving them vulnerable to a market downturn at an inopportune time like retirement."

Gluttony of debt is often related to the obsession with residential property, Thornhill says.

"The fact that people can buy an apartment off the plan and gear 110 per cent is not clever," he says.

"Excessive debt will kill anything."

It's not just property investment where excessive debt can be a problem, Hartgill says.

People who borrow to finance impulse purchases and expensive holidays can have a lot of trouble financing the interest bill, let alone paying back the debt.

"The solution is, when you think you need something, think a couple of times about it," he says.

"Do a bit of an exercise in working out what its real cost is, including interest. And look at the cost of not investing that money elsewhere."

Abey says gluttony can also mean investing too much in things you call "assets", but which are not assets at all.

"It's confusing lifestyle assets, which typically don't have much appreciation, with genuine investment assets," he says.

LUST
Passionate or overmastering desire.

It's easy to be seduced by the offer of a generous upfront tax deduction, or the chance to make money out of exotic flora and fauna.

But lusting after these "sexy" investments, without understanding all the underlying risks, can be fraught with danger, Abey says.

"The advice is similar to the advice for anger," he says.

"Where anger and lust are very similar is that they are initial impulses. The antidote is not to do anything in response to the first impulse.

"Have a lie down and take a Bex. Have a space of time to analyse the situation in a more considered way, and keep the emotion under control. Hopefully the analysis will stop you doing the wrong thing."

Abey says people's attraction to sexy sectors of the sharemarket - such as technology, when it was at its peak - is a good example of lust.

"But lust is generally short-lived," he says.

"So trying to pick the market by falling too much in love with a particular stock or sector at a particular time can see your personal wealth used and abused."

BT's Clarke says people should also be wary of lusting after sexy year-end tax strategies.

"It's really being careful with those strategies and not just going into them because you are lusting after the tax deduction and getting out of tax," she says.

ANGER
A strongly felt displeasure aroused by real or supposed wrongs, often accompanied by an impulse to retaliate; wrath; ire.

A fall in the sharemarket can be a source of great anger for many investors, according to Thornhill. "It's people's anger at the apparent lack of success with the stockmarket. It's a perceived grievance that the stockmarket has lost my money," he says.

"People are irrationally fearful or annoyed with the market." In many cases, that fear is based on ignorance, Thornhill says.

Despite having read vast amounts of information, people don't always understand how the sharemarket works, or what they are investing in. "There's a belief that information is a substitute for knowledge," he says.

"There was anger when the dot com bubble burst and all these ignorant people started to lose their shirts. They got angry. These computer trading programs they bought provided vast amounts of information, but no knowledge."

Abey says it's natural to feel angry if the stock or fund you have invested in performs a lot worse than its peers in a given year.

"The initial reaction when you are at the wrong end of a big disparity [in performance figures] is a desire to punish, which is an emotional thing," he says.

"What you have to do is replace that with a desire to analyse and think it through. Sometimes the right thing is to punish, but it should not be the result of your first impulse."

If a fund manager shows strong rebound potential, you might decide to grit your teeth and stick with the investment, he says. In the long run, this will usually produce a better result than bailing out at the low point.

Hartgill says divorce is another event that can stir up huge amounts of anger, and lead people to make the wrong financial decisions. "There's often a significant amount of anger in the thing," he says.

"It's important to know that once the financial arrangements have been completed, the situation you find yourself in is the situation you find yourself in. Whether you are angry or not is not going to help the matter.

"It's important to accept it and move on. In any sort of anger situation, where you feel your emotions are getting in the way, good dispassionate advice is worth heaps."

GREED
Inordinate or rapacious desire, especially for food or wealth.

In a financial context, greed is about lacking the emotional intelligence to know how much is enough, Thornhill says. "Greedy people are those who believe that their aim in life is to spend their last dollar on the day they die," he says.

"They don't consider the person who comes behind." As a result of this attitude, many Australians don't understand the concept of philanthropy, he says.

Hartgill says greed is one of the two main psychological drivers in our investment decision-making, the other one being fear. "We would all very much like to wake up in the morning a little bit richer than the night before," he says.

"It's not unhealthy, because it's good to have ambition. But if you allow your greed to get the upper hand, the extra risk you take on may not be something that you can cope with." This in turn can trigger fear, which leads people to sell out of investments at the worst possible time.

"The greed motivator really comes out at times when the sharemarket has had a good run, and it often leads to an expectation that the market will always go up," Hartgill says. "Greedy people get in and try to keep it going. Then it turns into fear as soon as there's a correction."

Hartgill says the Estate Mortgage debacle of the 1980s was a classic example of greed.

"They were paying about 2per cent more than their competitors, and people went in in droves," he says. "For a couple of extra per cent interest, which is not much after tax, people were risking large amounts of their capital."

Abey says the same thing is happening all over again, with promoters of mortgage schemes sometimes offering 10per cent interest, when a cash account is paying 4per cent. A combination of greed and sloth - in failing to do the research - sucks a lot of people in, he says.

Instead, people should be asking: "If someone can borrow money for 6.25per cent or 7per cent, how come someone is actually paying me 10per cent? Each 1 per cent difference in interest rates represents a very substantial increase in risk."

Similarly, greed motivates people to respond to "get rich quick schemes", without thinking through the potential risks.

In 1999, for example, the Australian Securities and Investments Commission managed to raise $4.2million from investors who fell for its April Fool's Day test, Millennium Bug Insurance.

ASIC had created a fake internet investment site telling people they were certain to triple their money in 15months if they invested in a company called Millennium Bug Insurance.

The year before, ASIC tested people's gullibility with prospectuses for investments in blue-bottle farms, geeps (a cross between goats and sheep) and land-and-air space packages, which allowed you to charge rent from the air traffic flying over your house during the Sydney Olympic Games.

Putting your money in last year's best-performing asset class, or managed fund, is another example of greed, Abey says. "If one thing has done better than others, gravity forces people to go to the best-performing one and fail the rule of diversification," he says.

"People forget that diversification means holding things that are going up in value as well as good quality, but currently unfashionable, things that are going down in value." By abandoning the discipline of diversification, and failing to rebalance your portfolio each year, you run the risk of having all your money in this year's worst-performing asset class or fund.

Greed also motivates people to try and pick the best times to enter and leave the sharemarket, Clarke says. "It's going in and out, and thinking that by timing the market you are going to end up better off in the long run. But this may not necessarily be the case," she says. "It's time in the market that's more important than market timing." (see case study).

SLOTH
Habitual disinclination to exertion; indolence; laziness.

Being in a hurry to get rich quickly can make people very lazy about researching their investments first. "It's really to do with not being prepared to do the hard work before going into an investment," Hartgill says.

"You need to get a good understanding of investment markets and how they operate; next, the type of sector you are going into; and next, the individual investments - how they have performed in the past, how they might perform in the future.

"Then you need to consider things about yourself, and what your needs are. It's a long and logical process and you have got to be prepared to go through all that before any individual product or investment is chosen."

Sloth can also mean failing to do some research before you get out of an investment, Abey says. "If a thing has gone down in value, if you don't actually do the work and find out why it has gone down, that can be sloth," he says.

"Sloth is not doing the work to see why something has gone up or why something has gone down. It causes you to either pay far too much for things, or to get out of things that are good-quality things. It causes you to be a victim of fashion.

"You end up buying bad-quality stuff that's going up and getting out of good-quality stuff that's going down."

Leaving all your cash in a low-interest, or no-interest, cheque account is also very slothful, Abey says. "It's not about going from there to the sharemarket. It's about going from there to a cash management trust, where you can get an extra 3per cent [and a cheque facility] without changing your risk profile at all."

Figures supplied to ipac by the Australian Prudential Regulation Authority show about $119billion sitting in interest-bearing cheque accounts, and about $25billion in no-interest cheque accounts.

When it comes to building wealth, Thornhill believes sloth is the greatest sin of all. As the saying goes: "Today's pleasures beckon more strongly than tomorrow's pain."

He says government policies have gradually removed the need for anyone to do anything for themselves. So many choose do to nothing at all. "They know that if there's a rainy day, something will come along," he says.

Thornhill says there is also a belief that a little amount of money will solve everything, and that no effort is required. "People pay to go to the gym so that they can get fit, or they pay for a diet so that they can lose weight," he says. "But in many cases, people are paying in a vain attempt to make sure they don't have to do anything themselves. And that's sloth.

"You could diet and not pay for all the paraphernalia, and you could exercise without going to the gym; but people are not prepared to be disciplined and take matters into their own hands."

Thornhill says if someone were prepared to put away $50 a week, and managed to earn 12per cent a year, then they would have $1.4million at the end of 35years. "The reason most people don't have $1.4million throughout their entire lives is because they could not save $50 a week if their lives depended on it," he says.

Another reason people fail to build much wealth is that they don't take an active interest in their superannuation savings, Clarke says.

"The sin is thinking that superannuation is not your own investment and leaving it there to do what it will," she says.

If, for example, you have money in several super funds, you should look at consolidating those funds, to save on fees, she says. People should also be looking at which asset classes their super is invested in. "Take charge of that by investing towards growth assets. You will end up with much larger retirement savings," she says.

Sloth also means thinking that your employer's compulsory super contributions - rising to 9per cent of salary from July1 this year - will be enough, and failing to contribute anything yourself, Clarke says. "In reality, you need at least 15per cent of your salary going into super each and every year if you want to achieve a retirement income of around 75per cent of your pre-retirement salary," she says.

"Don't be a sloth with your super. Retirement is a huge part of your life and it's not an area you want to be complacent about."

Says Hartgill: "The important thing to remember is that it's the serious acquisition of long-term quality assets that's going to power your lifestyle after the pay cheques stop."


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