By David Hargreaves
During and after the finance company sector meltdown between 2006 and 2010 the term 'financial literacy' (or more to the point, a lack of it in New Zealand) was bandied around quite a bit.
I think the problem we had, however, was slightly more specific than that. I think the majority of people understand money and how to use it fine. And indeed how to save it.
Again and again what came through to me as I was reporting on the carnage - and it's worth refreshing memories on this with interest.co.nz's excellent deep freeze list - was that there was a basic lack of understanding, not of money or saving per se, but firstly of risk and reward, and secondly of diversification.
There were two constant themes coming from those who had lost money: First, they were chasing a yield offering them maybe half a percent more on a finance company investment than they could get in a bank. Second, they thought they were 'diversified' because they had their nest egg spread across five finance companies.
What's wrong with those pictures?
To tackle the first one - there seemed little or no understanding of the difference between a bank and a finance company and what happened to your money (IE where it went) after you dropped it on the counter. There's a world of things a bank might do with your money, whether it be lending it to someone as part of a mortgage, or investing it offshore. Most of the finance companies on the other hand were lending it straight to property developers. All of it. Ask yourself, which sounds more risky? The reality is the 'risk' of finance company investment was nowhere near adequately priced in the New Zealand market.
The finance companies SHOULD have been offering anything like say five full percentage points more to investors given the much higher risk they were taking with their money. But no. Because the public really didn't understand the risk they were taking with finance companies then so those companies were able to entice investors with interest rates only a little better than the banks but with massively more risk. The finance companies got away with murder because we let them because we didn't really understand them and what they did with our money.
So, and on to the second point - spreading money across different finance companies was not any sort of diversification, because it was all going into the same asset class - property. So, never mind that you've got deposits with five finance companies, if the property sector hits the skids all five of those finance companies will get into trouble. Which is exactly what happened.
Okay, so, there's the history lesson - and apologies to the many of you who are well versed in it. But it is worth reiterating this because these problems, these huge gaps in our knowledge and understanding of how investment works, still seem to be there. Very much so. I refer to the Financial Markets Authority's latest annual survey into the public's attitude to financial markets.
Surveys, as I've said before, are worth treating with a pinch of salt. However, to the extent that you can get people to actually demonstrate choices or test their knowledge or lack of it on issues then obviously they can be very useful. And the bit that got me in this survey was, yes, about diversification and risk/reward. I include text taken directly from the survey here because I think it's worth highlighting:
Diversification and the risk/return trade off:
Diversification:
Half of New Zealanders aged 18 years and over said they have heard of and understand ‘diversification’ and virtually all of these people correctly identified ‘Investing all your money across different investment choices such as shares, property and cash’ as diversification. However only 17% also identified all other options as ‘not diversification’ indicating that perhaps people are not as knowledgeable as they think on this topic.
Not surprisingly, investors, and those aware of FMA, are more likely to say they understand diversification.
Risk/return trade off:
A lower proportion of New Zealanders understand risk/return trade off than understand diversification (42%). Again it’s the investors, and those aware of FMA, who are more likely to say they understand risk/return trade off.
When it comes to investment types, New Zealanders overall are more knowledgeable and able to give an opinion about risk level associated with the following: Term deposits, Residential property, KiwiSaver funds.
On the other hand, New Zealanders are less knowledgeable overall about the higher risk investments: Hybrid bonds, Derivatives, Property syndicates, Private equity funds, Shares in a company through equity crowdfunding.
It’s concerning that women feel significantly less knowledgeable than men about all investment types and the risk associated with them, except for: Term deposits, Residential property, KiwiSaver conservative and balanced funds.
To explain: In the bit about diversification, the survey participants were invited to identify what a diversified investment approach was - which they could do. But then, given a series of examples, not unlike my five finance company example further up, they were largely unable to correctly identify that as NOT diversified. So, the concept is still not clearly understood.
Likewise, risk and reward - such a key component of the finance company investment catastrophe - is still not well understood.
Now, I know great efforts are being made on the subject of financial literacy, with this now being offered in schools etc. That's great and maybe the rewards of that will be seen in future years. Maybe it is still too soon to be seeing the benefits of these efforts.
However, I do have another thought. Maybe the focus is wrong. It's one thing to understand money and the concept of 'saving' - but how well understood is the idea of 'investment'. And is that the real problem?
People are encouraged to 'save' for their retirements. To 'save' for their futures. But that to me implies a passive thing. You save by dropping money in a bucket and watching it slowly pile up.
Shouldn't we be talking in more forceful terms about how our people 'invest' for their futures. It might sound like semantics, but to use the term 'invest' involves the thought of active participation.
I don't think we are taught in this country to be 'investors' - not like people are in parts of Asia say, where from my experience the first-hand knowledge of 'investment' and really managing your own money is so much more advanced.
Okay, we might like to think of ourselves as property 'investors' - and that's still the main course of action for most New Zealanders when it comes to generating a nest egg. But that's still fairly passive as well. You put an offer on a house, you buy it and you either live in it and watch it grow in value or you rent it out and watch it grow in value. Passive.
Until people have a better handle on how to actively manage their money - and let's not call it 'financial literacy' anymore, because I think that's a misnomer - then we run the risk of a finance sector disaster part II. And no it might not be finance companies or anything like that next time. It might be something else entirely.
The point is, until we predominantly understand things as basic as risk and reward and being diversified in where we put our money then we are running the boom and bust risk. We are running the risk of repeating the same mistakes that were made with the finance companies.
We don't need to be a 'saving' nation. We need to be an 'investing' nation. Engaged. Switched on. Understanding how to actively manage our own money.
Big problems ahead if we can't do that.
42 Comments
Nice article, fully agree. Even on this website which must have a much higher than average financial literacy, you see frequent comments suggesting diversification is not valued or understood. I've had several conversations discussing friends or their families having money to invest and the only decision was where to buy their rental property. When I ask them how about shares I get blank looks.
Sadly the '87 crash had an impact on many people who had herded into stocks too late in the cycle. I have several family members who have passed their fear directly onto the next generation. So rather than get into stocks this time its been property.. And this time it's been heavily leveraged investment as well. In most places the numbers as a yield investment haven't stacked up for many years (but the tax benefits have encouraged the speculation) and the lack of fundamental understanding of maths perpetuated a myth. Its been easy for the banks to sell the debt and for the speculators to perpetuate the myth.
Now we stand at that critical juncture where the cost and availability of credit is changing and could well spark a crash.. In the years to come will the specu-debtors be warning their children off property?
'In the 2018 - 2025 correction I had to work four jobs to cover the mortgages on the investment property, couldn't sell it because the values were less than the debt and didn't want to lose the family home as well. It was a tough time lad..my advice to you would be to rent and let someone else deal with the hassle of owning a house.. Never again I tell you, you're better off getting into shares and don't go borrowing too much money to do it!!'
The highly leveraged property investors may not be able to work 4 jobs - there may not be work available.
The economy will likely go into a recession and many will become unemployed - the unemployment rate will increase. Formerly double income households might become single income households. Waged workers might find that their hours are reduced as there is less work available for them.
For owner occupiers, debt servicing ability will be significantly reduced - the original mortgage debt servicing calculation was based on two incomes in the household, now that there is only one income, the high debt level cannot be serviced, so the owner- occupiers sell to downsize - the problem is that there are many other owner-occupier households in the same situation.
The key is what the banks will do - will they play hardball when the debt servicing cannot be met by owner occupiers and seize collateral to sell? or will they work with the owner occupier borrower and allow P&I borrowers to go on interest only terms until the borrower's financial situation improves? I heard that in 2008, the banks did work with some highly leveraged owner-occupiers.
As for highly leveraged property investors - the banks could play hardball. The issue is that they are a large proportion of property owners perhaps even larger than in 2007 levels (i.e pre GFC) - however I can't recall statistics to verify this.
Purchasing a house and renting it out to meth heads is NOT an investment. It's a pain in the rear, loaded with expenses like maintenance, insurance, rates, upkeep, and my favorite: "property managers". This on an item that increases only in line with inflation. Not to mention terrible from a diversification standpoint.
Far better to buy low cost, widely diversified index funds form Vanguard for 0.04% expenses.
mfd. I experience the same. I was astonished to recently discover a couple of people I'm associated with, and who asked me about investing, had all their cash on FD. Both owned the obligatory (in NZ) couple of rental properties but are terrified of the sharemarket. These are serious professional people yet they have seven figure sums rotting in the bank.
https://rbnz.govt.nz/statistics/c50-money-and-credit-aggregates
B2. Term deposits = 151,439
B1. Savings deposits = 78,159
only $229,598,000,000 "rotting in the bank"
It is interesting.
Many of my generation of retired baby boomers seemed to have learnt about financial literacy only through bad experiences; most notably the 1987 share market crash and the 2010 crash of finance companies.
Hence their love of property.
It is common to hear among my contemporaries; "With a rental; if there is a problem it is of my making and I will wear it. I'm not prepared to trust anybody else; they are mainly thieving, money-sucking corrupt b'stds." Current problems in the Australian banking and insurance sectors is just further proof of this.
So, this is all the financial literacy they need and want.
I'm guessing you're referring to these problems
https://www.youtube.com/watch?v=SO5MnQDZrNc
https://www.youtube.com/watch?v=T3KdR9gzr3Y
printer8,
I retired here from Scotland in 2003,having spent over 30 years in the investment business. At the first dinner party we went to,I was astonished to hear a reference to the '87 Crash and have it discussed in some detail. The people round the table were all well off,but none had money in the stockmarket-their money was in commercial/residential property.
In the UK,'87 had been forgotten within months and most people I knew,had no property investments. Having said that,most had excellent final salary pension schemes and were able to retire early on comfortable incomes.
Too true yet is comes down to trust, flexibility and myth. If they were looking down the barrel of expensive cancer care or buying a house then having the money easily able to switch to cash in a short time would be more useful. If however they were looking long term people tend to set and forget with what they know and very rarely take the time to research & explore all the options.
With a high incidence of property investment promotional ads & property marketers it is understandable that property investment has settled more widely to become familiar to most people. There are far, far fewer general public media ads, educational media, dramatised, heck even reality type shows that portray other investment options outside of a bank account and property. Thank god the wolf of wall street & the big short came out, but for the general public there needs to be a lot before it is a meme that easily disperses around. E.g. there are practically no ads about pension schemes & very rare mention in NZ because most people do not have the opportunity to access them any more and elsewhere they are practically ignored in media due to being exactly a long term unadventurous scheme. Even mention of kiwisaver in general media, while slightly more prevalent than pensions, very rarely drills down to the details or strays outside the major managers, and any mention in advertising is to focus on the use of KS for, you could probably guess, first home purchases. We are in a country which had several crippling financial company collapses, (and many fraudulent ones), that were substantial in proportion to the country size yet very little media exists for the general public to see a digestible story.
Give it time though, the property investment "gurus" may switch to other methods to fleece people for paid investment training and the banks might step up with the tech in their investment platforms. But it is less likely they will go very far outside of what can be easily described & understood without more education. Ideally they want people to believe the advertising without question or comparative research. Make them believe there are few options outside of the local banks, property & KS. Even major investment managers in NZ are not very common, & that in it's own might mean it is easier to trick people to only stay with what is familiar or more worryingly into high risk alternatives & fraudulent ones.
With The Block running another season with nothing much else outside the same one note it seems we will be stuck in this property market hell & less diverse investing public for a while yet.
David, you are bang on.
Most people learn to save, some don't. They didn't previously teach any financial literacy to students at school when I was younger - that was at a public school in Auckland. The schooling system back then then leaves financial literacy up to the individual to learn for themselves (some individuals may be ignorant about even learning about how to save) - most children learn from their families, through a child's observation of their parent's financial habits. For many in lower socio-economic families, the parents didn't know about basic financial literacy so its a case of the blind leading the blind and hence the circle is very susceptible to repeating itself, in the next generation.
As to investing that is next level financial literacy. This is how I would categorise the two levels.
Financial literacy 101 - budgeting & saving
Financial literacy 201 - basic concepts of investing, risk vs return, asset allocation and diversification
Financial literacy 301 - credit risk assessment
Financial literacy 401 - stock market investment and security selection
Financial literacy 501 - derivatives, structured financial products.
Most people learn the first level. Fewer people learn the second level.
So in that context, how can savers be expected to know how to assess the credit risk of a bank - especially when NZ has the open bank resolution where depositors could find themselves taking haircuts on their years of hard earned savings? This is why the stability and safety of the financial system is so fundamentally important. The credit risk of the banks may not have been an issue in the past, but with household debt at record levels relative to GDP, near record high house prices in Auckland and that banks have a significant portion of their loan assets in mortgages (especially relative to their loss absorbing capital), credit risk of the banks at this point is much much higher.
Your point about diversifying amongst the finance companies in 2008 reminds me of a story of an individual who got caught out doing exactly that.
The 101 is a good point, it doesn't matter what you know about investing if you spend every penny you earn. The first and most critical thing to do is make sure your spending is well below your income so that you can build up an excess, finding the right home for it is secondary. While most people will manage to balance their budget, I'm not sure if most people manage to skew it so they build up long term savings unless they are forced to by mortgage principal repayments
After following the essential step of spending less than they earn, the best practical saving hacks for those with tight finances that I know is
1) "to pay yourself first" - i.e. have an automatic payment deduct from each paycheck a fixed sum each paycheck cycle into a separate bank account and not touch it for living costs - the amount can then be invested in some way - its builds up pretty quickly. Then live off the remainder. People can adapt - due to a change in career and taking a 60% pay cut, finances got very tight, I recall making my own lunch and taking it to work, going out less, eating out less, deferring clothes buying, etc.
Most people pay themselves last and try to save after paying their expenses and living costs. Quite often if they see cash in their bank account, they might splurge on the movies or a coffee, etc, rather than put that money in savings.
2) when getting pay rises defer lifestyle creep as long as possible (and save the pay increase)
Both are good tips. The first one, I have separate accounts with Westpac and ASB, one is my day-to-day account another my savings/investment account. Every pay day a chunk of my income goes automatically from one to the other ready to be shuffled away somewhere useful. Every so often I increase the size of the chunk.
The second is probably the most common trap, "ooh a pay rise now I can buy a bigger house, or get that gym membership". It takes a little self control to think about your spending in terms of what adds value rather than just what you can afford.
I was surprised when discussing strike action a while ago some of my colleagues on good 6 figure incomes genuinely having to consider whether they could afford to lose a day or a week's pay. Not having that buffer really limits your life options.
Right on. I first heard this in 1975 when I started working and as a result saved 10% of every paycheck for best part of 40 years. I have never regretted this discipline, and can now live as comfortably as ever in retirement. Great advice for anyone at any stage of life. Pay yourself first.
Not quite true that there wasn't financial literacy taught in schools in the past.
As a primary school kid in the late 1950's we were taught a very simple financial literacy.
There was the Post Office Savings Bank and every Wednesday we would bring our passbook and 6d (or a shilling if you had wealthy parents) and student monitors were delegated to complete the banking process.
The message was simple; continue to make a regular deposits and watch your savings grow, and you would end up comfortable in later life.
P.S.Sadly, most of us learnt later that girls, booze, drugs, and having a good time were all far more exciting.
Linklater01,
Agree with you entirely. However non-professional investors do get involved in them. Some financial products that many non-professional investors get into are:
1) futures
2) options
3) contracts for differences
The reason they get involved is the attraction of returns with the leverage embedded in the product.
There are also structured products that are sold to non professional investors - primarily to high net worth individuals. Within these structured products are embedded options. One such product sold was called an accumulator - salesman were marketing these products to financially unsophisticated high net worth individuals as a product to buy enable them to buy shares of a company at a 3-5% discount. In reality, that discount was due to a short put option position embedded in the structured product (i.e option premium paid to the buyer of the structured product). Many of these high net worth individuals had to sell their homes to have the cash to buy the shares put to them when the market price fell in 2008 / 2009. The running joke afterwards was that they were called not accumulators but "I kill you laters" ...
There was a massive FX accumulator sold to a company called Citic Pacific on the Australian Dollar - during 2008/2009 they lost a lot of money on this product as the AUD FX rate plummeted and the CEO (and company founder) and CFO lost their jobs.
Also I recall Warren Buffett's sister Doris got caught out in the 1987 stock market crash. She was selling put options as an income strategy.
Interestingly, Warren Buffet is a huge options writer. His 2008 letter to investors in Berkshire Hathaway
Berkshire Hathaway's Option Investments
Buffett says in his letter, "Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indexes: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on Sept. 9, 2019, and our last on Jan., 24, 2028. We have received premiums of $4.9 billion, money we have invested."
Pragmatist,
These securities are OTC contracts and unlisted. They also have different terms to those listed on exchanges - these different terms can make the options that Berkshire Hathaway has written much more financially attractive than the listed option contracts. Also Berkshire Hathaway sets the price of the options at which it is willing to sell at and the buyer can choose whether or not to accept those terms.
Yes, i realise these were privately arranged options, given there was only iirc 27 contracts covering 4.9 billion dollars of premiums. And yes, there is plenty of danger in writing options, where losses are unlimited in some cases. I wonder if he still has any of these option positions open, or has he purchased them all back now?
Pragmatist,
Berkshire Hathaway has removed a key source of risk with their short option positions on equity indicies with the key terms of the OTC - I'll leave you with the joy of discovering what these are, so won't spoil it for you.
From memory, they did restructure some of the contracts, and some are still open.
Having been a keen reader of Buffett for over 20 years, there is so much financial sense in what he has to say. Buffett readers should note that newbies who are not financially savvy should not do as he does with Berkshire Hathaway with respect to derivatives.
There are many followers of Buffett in the investment management business who get themselves into trouble as they fail to remember this essential rule
1) Never lose money
2) Don't forget rule number 1
I recall Bill Ackman failing to follow this rule. Whitney Tilson also closed his business as a result of forgetting this rule.
Buffett and Munger say that in investing they aren't trying to do brilliant things, they just try to avoid doing stupid things. Look at LTCM and how brilliant the individuals were, they looked brilliant with some really eye-popping returns, yet look what ultimately transpired - any number multiplied by zero equals zero.
There is one other quote that is I find very useful in investing from Charlie Munger - "All I want to know is where I'm going to die so I don't go there". This is useful when looking at investments in stock markets.
The stats are clear, country wide most do not save a core amount that is remotely enough to build upon... be it lack of capacity or discipline/psychology. Diversifying can be useful however you do not have a portfolio large enough to truly get the benefits of financial instruments.
Sure the media is full of Aucklanders that have had a lucky break with capital gains although the numbers as a whole for the country are not that large...
Financial literacy education should span all the asset classes. Including holding foreign cash.
It should also provide information on what the risks are for each of them. This is key. Absolutely every investment may tank. And may not recover for a long time or even, ever recover.
Take power company shares, if there was a large widespread earthquake they would be low for ten or more years especially if NZ doesn't have sufficiently diversified gas supplies.
Go into an bookstore in Asia and view the magazines. Hundred to choose from about business, tech, finance and investment. Go into a New Zealand bookshop. If there are a couple of hundred titles there will be only few on those topics. Store owners know their audience. If we were interested the mags would be there.
Rich Dad, Poor Dad is pretty much where the education stops. And of course the occasional property seminar where someone like Tony Alexander might show up, Can you believe that he was saying this in April this year?
Normalisation of property investment. Not just ownership, multiple property investment for everyone... you could not have everyone do this though. The music has definitely stopped and much of the population are now without chairs. Sort of a self fulfilling prophecy, pulling in more punters to drive the growth, therefore the price & availability moves away from what a large proportion can now access. Wow that video is very depressing, (for the key points chosen, including the assumption the young generation is just going to cafes and bars and that is what is preventing them from home ownership). Someone should call the word equivalent of social services because I call BS on his use of the term neural network.
So many fifty shades of grey and twilight clones prevalent. One friend managing a secondhand book store (a bit of a bernard black character), was asked if they had any in stock. He replied 'No, we only sell books, not trash'. Mind you though they do burn well. Perhaps that is their true purpose. Even doctors offices have very little interesting in them. I did luck out once and one doctor's office had the technical medical literature for immunology & a small aircraft magazine, (which for me is the equivalent to finding magazine type mental porn)... As the big short demonstrated for some people they need a naked woman or other devices to feed them information... https://www.youtube.com/watch?v=anSPG0TPf84 Perhaps there is some opportunity to increase the video and visual media pool for the general public... but then looking at what poured out of the more tech fashionable cryptocurrencies was a lot of trash video promoters, some even for literal ponzi schemes (linked to cryptocurrencies but fraudulent). Even the trading bot videos were pretty low tech and funny. But as Sturgeon's law states, 90% of everything is crap, not just one sector of media.
I notice none of the comments mention the game coming to an end.
Yet all investment and all saving is a bet that the future will be even bigger than the present. Products and consumption (read: processed parts of a finite planet and filling of finite planetary sinks) need to keep on in the future for investments and savings to have something to be spent on - and therefore to exist.
No amount of financial literacy will help people ascertain whether the future can indeed support the production/consumption continuance, either in bigger form or as-is form. Let alone what happens in the inevitable depleting phase. Economics, as taught, is no better than medieval religion - and I challenge any teacher of it to a debate on that. There have never been any takers....... funny that.....
Almost everyone with skin in the game - bankers, economists, landlords, every wide-eyed investor/saver - doesn't want to know their efforts are to be wasted, but avoidance of discussion doesn't make the problem go away.
Objectively you are correct, but how does that translate into real world actions for a population that wants to consume? Taxinda made her captains call on munting the potential for future finds of oil and gas but I don’t see the Lefties that support her stopping driving or cutting off gas supplies. Absolute hypocrisy.
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