Here’s Why You Should Beware the Financial Planning Mantra

Fiscal cliffs, austerity measures, debt ceilings, sovereign default and quantitative easing were not part of our vocabulary five years ago.

In fact prior to the economic conditions we currently find ourselves in, these terms have rarely been used in mainstream economic commentary over the past 60 years. The world today is vastly different to anything experienced since The Great Depression.

The governments of the western world (including Japan) are largely bankrupt. The greatest credit binge in history has left consumers with a massive debt hangover and reluctance to spend.

Governments are funding an expanding list of entitlements with money they do not have and their balance sheets are drowning in a sea of red ink. ‘Hocus pocus’ stimulus strategies, designed to create the illusion of growth, are only worsening the situation.

This economic disaster has been over 60-years in the making.

The developed world created the biggest credit bubble in history. We are in the midst of a major de-leveraging which does not appear to be ending anytime soon. Amidst this uncertainty, how do you create a plan to protect and grow your capital?
Confucius wisely said, ‘Study the past if you would divine the future.

If we will look at the influences behind the developed world’s economic growth since WWII, it could help us divine how these evolving dynamics might shape our future.

After WWII the economies of the developed world were the beneficiaries of five major drivers:

  1. Households were largely debt free. The Great Depression ushered in an era of frugality.
  2. Cheap and abundant sources of energy
  3. Manufacturing of motor vehicles, televisions and household appliances created consumer demand and generated employment in the manufacturing sector.
  4. Households were re-populating. The ‘baby-boomers’ generation was born.
  5. Minimal government interference.

These major trends were the drivers behind the sustained economic growth capitalist economies experienced in the decades immediately after WWII.

Households had the income and borrowing capacity to gradually acquire the new household ‘gadgets’ – washing machines, vacuum cleaners, motor vehicles etc.

Demand for these labour saving devices was driven by households with more children to look after.

The cost of petrol and electricity were not a huge impost on the family budget.

This self-propelling cycle of productivity was reflected in the share market. The Australian share market rose from 76 points in January 1946 to 420 points in January 1969.  Investors averaged a growth rate of 7.75% per annum over this 23-year period. Life was good.

After a quarter century of rising markets, investors were about to be handed a lesson in market dynamics. The drivers behind the remarkable post war economic performance were changing and share markets would feel the brunt of this change.

The financial cost of funding the Vietnam War (capitalism v communism) began to take its toll in the late 1960’s and two decades of industrialisation meant the western world economies had become heavily dependent on access to cheap oil.

To finance the cost of Vietnam, President Richard Nixon abolished the Gold Standard (a mechanism that imposed a form of accountability on government spending) in August 1971. Free from the constraints of the Gold Standard, the US Government printed money to pay for Vietnam and domestic expenditure.

The other economic game-changer in the 1970’s was the western world’s dependency on oil. The combination of an expanding population and more labour saving ‘gadgets’ meant higher energy usage. To meet the increasing demand for oil, supplies were imported from the Middle East to supplement domestic oil production.

In 1973 the Middle Eastern oil producing nations flexed their muscles. They objected to the US providing military assistance to Israel, so they announced an oil embargo. OPEC was holding western households, with their gas guzzling cars and electricity dependent labour saving devices, hostage. The Middle East had an abundant supply and the western world had escalating demand.

The oil price quadrupled in the space of 12 months. The abolition of the Gold Standard and the oil shocks of the 1970’s unleashed powerful inflationary forces.

Household budgets struggled to cope with this rapid increase in energy costs.

Unions demanded workers be given higher wages to cope with the rising cost of living. Rising wage costs were passed on with higher product or service costs. Which in turn increased the cost of living, sparking further union demands for increased wages. A vicious inflationary spiral had been created.

The investment dynamics of the 1970’s were completely different to those that prevailed from 1946–1969. The share market recorded no meaningful gains. From 1969 (420 points) to 1982 (460 points) the Australian share market managed to rise a mere 40 points (a paltry 10% in 13 years). The 1970’s were a dismal decade for share investors.

While Nixon may have abandoned the gold standard, savvy investors didn’t. Gold rose from US$35 per/oz to over US$800 per/oz. In times of uncertainty, investors discovered the real store of value was in hard commodities not paper money.

Interest rates also broke free from the stability of the 50’s and 60’s. The cash rate rose from around 5% in 1970 to a record high of 21% in 1982.

The 1970’s proved that past performance is the most unreliable indicator of future returns and why using past returns is also a false indicator.

The 1950’s and 60’s gave us Rock n Roll. During this period the share market also danced to the upbeat tempo and rewarded investors with an above-average return of 11.75% per annum.
The heavy rock of the 1970’s was reflected in the share market performance of this decade. The music industry had Black Sabbath but the financial industry had black Monday to Friday.

Weighed down by high inflation, rising oil prices and the abandonment of the gold standard, the 1970’s were an abysmal period for share investors. The share market struggled to average less than 1% per annum growth from 1969–1982.

The secular bear market sharpened its claws and for the thirteen years it tore portfolios to shreds.

A 65-year-old retiree in 1969, who believed ‘share markets always go up’, had to wait until the ripe ‘young’ age of 80 before any meaningful market gains were achieved. The best years of their retirement would have been spent in a continual state of financial uncertainty.

As the eighties rolled around, the share market was given its burial rites by Business Week magazine when its August 1979 cover pronounced ‘The Death of Equities’. Even the most strident believers in the share market’s power for out-performance were prepared to raise the white flag and surrender to the powerful forces of inflation.

But once again the world proved it is dynamic and not static. Along came US Federal Reserve Chairman Paul Volcker and his mission was to break the vice like grip inflation had on developed economies.

The baby-boomers were now aged between late teens and early thirties. This generation was full of optimism; energy and a desire to live not just exist. Millions of baby boomers worldwide combined to re-energise the consumer market.

Unlike the oil embargo of the 1970’s, Saudi Arabia decided to capture a greater share of the world oil demand and started to over-supply the market. The oil price fell accordingly.

A new breed of businessperson, the ‘entrepreneur’, was set to dazzle the market with their business acumen and penchant for making deals. These brash, aggressive and unstoppable titans of the business world captured our imagination.

This was reflected in Michael Douglas’s character in Wall Street — Gordon Gecko — when he said ‘greed is good’. This was the baby-boomers first exposure to real wealth creation and they wanted a slice of the action (greed).

With inflation being tamed and energy supply stabilised, the new game in town in the mid-1980’s was backing the entrepreneurial winner — Alan Bond, Christopher Skase et al.

Around the same time the fledgling investment (financial planning) industry was finding its feet. Savvy investment professionals tapped into the public’s desire for a slice of the big returns on offer from the entrepreneurial boom.

Investment advisers (complete with their newly acquired credentials to provide advice) happily clipped the ticket for the eager investor. This game of greed, being played by all parties, came to an abrupt halt in October 1987. Share markets plunged overnight and greed turned to fear.

The once worshipped entrepreneurs were now vilified for being greedy, selfish and corrupt. Investors felt betrayed by the share market and turned to good old bricks and mortar. At least they could see and touch their investment. This need for the tangible asset led to property prices doubling in a few short years.

After 1987 the investment advisory business was a shadow of its former self. Without past performance to act as a greed motivator, the new breed of advisers could no longer persuade investors to part with their hard-earned dollars.

No investing means no commissions and no commissions meant starvation. The brief and exhilarating dalliance in the world of investing was over for a large number of advisers and they exited the industry to resume their previous careers.

The financial devastation caused by this period led to governments imposing tighter regulations on the investment industry. This was the first of many steps towards better protection for consumers.

The advisers who remained in the industry needed to earn a dollar. With property the flavour of the month, the merits of unlisted property trusts were being promoted to an unsuspecting public. All was good until the commercial property market tanked in 1990 and investors lost their shirts.

While investors had shunned the share market for property, underneath all this the economy was undergoing profound changes.

The geeks of the world began introducing us to the transformational power of technology. Labour intensive businesses were about to receive a huge productivity increase from the introduction of technology. Typing pools and telephonists were rendered obsolete by technology.  Businesses were being revolutionised and the bottom line reflected this.

Banks had become far more creative in issuing consumer credit. The finance company became a dinosaur as credit cards replaced the unsecured personal loan. Even the retail store lay-by system died a graceful death. Who wanted to actually pay something off with real cash before you owned it?

Baby boomers were now aged from thirty to mid-forties, right in the prime of their consumption years. Unlike their frugal depression- raised parents, baby-boomers found they could convert tomorrow’s income for a loan today and have it all now. They didn’t possess the patience of their parents.

The costs for this newly acquired lifestyle of McMansions, two cars, annual holidays and children in childcare or private schooling were the need for both parents to work. Retirement was a distant issue and probably in the deep recesses of the baby-boomer mind they thought rising markets and an inheritance from their frugal parents would cover this.

The tech-boom was the new money making game in town and baby-boomer investors wanted a slice of the mania. Memories of the entrepreneurial boom and bust had long been erased and replaced by ‘greed myopia’. How many lessons does an investor need before the message sinks in? With hindsight we know we needed one final one in 2008.

In the mid-1990’s the sitcom ‘Friends’ introduced baby-boomers to the lifestyle of Gen Xers. The young single days were a distant memory to the boomers and they were focussed on the responsibilities that come from approaching middle age. Money to be made, bills to be paid. The technology revolution was an opportunity to fast track the wealth creation process.
The ‘tech boom’ created another asset bubble and generated a lot of barbeque talk about the next hot stock. Any Initial Public Offering (IPO) with a dotcom behind its name was nearly assured of instant success.

Irrespective of whether there was a sound business plan or not, greed was the force behind the rising tech share prices. This game of ‘finding a bigger fool’ crashed spectacularly in early 2000 with the ‘tech wreck’.

The USA was the epicentre of the ‘tech boom’ and when the tech wreck hit over there, it was carnage. The loss of wealth effect caused the economy to grind to a standstill.

Every post-World War Two recession had responded to low interest rates and loose monetary policy so Alan Greenspan (Chairman of the US Federal Reserve) followed the tried and proven formula.

Greenspan moved quickly to reduce interest rates to encourage people to borrow and spend. Right on cue the people responded and borrowed like never before. Shares, property and consumerism powered ahead. The seeds of the Global Financial Crisis were being sown.

The 2003–2007 share market performance was extraordinary. The global lending binge enabled western consumers to buy all sorts of goodies. Demand for Chinese manufactured goods soared. The Australian resource sector was a major beneficiary of this debt driven consumer spending spree.

Loaded up with home equity loans and margin loans, investors piled into the market. The upward trend continued with little disruption for more than four years. Unfortunately the longer the trend goes for, the more people believe it is different this time and they rush in for their share of the easy riches.

The defaults in the sub-prime lending market put a match to the whole debt woodpile. It burned slowly at first and the authorities reassured us they had the sub-prime fire under control. But this fire raged with such intensity it burnt down the houses of two major investment institutions (Lehmann Brothers and Bear Stearns) and caused third-degree burns to many other major corporations that were deemed ‘too big to fail’.

It has taken 60 years for the western world economies to be transformed from young, trim and energetic to old, fat and lazy. Look how the five major drivers that existed after World War Two are today:

  1. Households are (on average) heavily indebted. ‘Buy now pay later’ is the consumer creed.
  2. Energy is expensive due to rising global demand and higher costs of extraction.
  3. The manufacturing sector has largely relocated to Asia
  4. Households are not re-populating to the same extent as the baby-boom era. Population growth is now a combination of births and immigration. It is widely recognised that a broader population base is required to support the aging baby-boomers.
  5. The higher living standard genie is out of the bottle in the developing world. There are billions more people pursuing dreams of affluence. The western world will face stiff competition for the resources it once took for granted.

The Global Financial Crisis rang the bell on the delusion we could have-it-all.  Statistics show the global debt binge began in earnest in the early 1980’s. This coincides with baby-boomers reaching an age where their views of what the world owed them and how they could have it, influenced the lending criteria of financial institutions.

A baby-boomer bank manager could relate to the aspirations of their baby-boomer customer. This three decade long experiment with ‘living beyond your means’ has reached its predictable and painful conclusion.

For baby-boomers, on the cusp of retirement, this reality check could not have come at a worst time. Volatile share markets have impacted negatively on superannuation balances, but at the same time the cost of living is increasing and we are living longer. This is not the ideal equation for a trouble-free retirement.

Share and property markets have both delivered capital growth during the 60-year post World War Two period, but will they do so in the era we are now entering?

Possibly, but the rate of return may be a lot lower than we have experienced in recent decades. There is a high probability we are in for a period where markets unwind the excesses of recent times and you may have to wait several years before any genuine resumption in capital appreciation is achieved.

So retirees should adopt a mindset of ‘prepare for the worst and hope for the best’. When calculating your retirement conservative numbers should be applied to your capital. Applying the rates of return from the boom years is a recipe for disappointment and possible disaster.

This goes to the heart of my issue with the financial planning mantra of ‘in the long term the share market always goes up’. This will be of cold comfort to a 65 year old who has to wait 10 or more years before the market delivers on this promise. The best years of their retirement will be a distant memory.

The average balanced superannuation fund has 50% or more of its portfolio in shares, in my opinion this is a huge risk to take with your average retiree’s financial wellbeing.

If these assumptions prove correct, the hollow excuses from fund managers and financial planners will be cold comfort for those thousands of retirees who, by not questioning the veracity of this mantra, watch their money disappear over the cliff.

The challenge for investors is to navigate their way through the volatility that will accompany a world that is divided in two – western economies suffering from private debt contraction and public debt expansion and emerging markets moving slowly but surely towards a higher standard of living.

Investors who are not prepared for this investment roller-coaster ride are likely to make panicked decisions and their capital will suffer accordingly.

Hopefully this look back through history provides some perspective on the evolution of the modern economy and the challenges confronting us.

Eleanor Roosevelt said, ‘Learn from the mistakes of others. You can’t live long enough to make them all yourself.

Learning from the mistakes of the past, is far less painful and costly then making them yourself. The past 30 years was an economic aberration — created by demographics and prosperity that was taken for granted. Now it is time to pay the piper.


Vern Gowdie
for The Daily Reckoning Australia

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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