How the Investment Industry’s Financial Planning Models Are Broken

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In today’s Money Morning…the theatre of the Presidency…broken polling models, and broken economic models…the great failure of the investments industry…your wealth at risk…and more…

Editor’s note: How broken is the Australian financial services industry? You’ll be shocked by the answer, which you’ll find in Vern Gowdie’s new book How Much Bull Can Investors Bear? Find out how to download it here. Below Vern shares an extract of Chapter 2 of this book is an essay originally published on November 16.


‘Dow rips to all time high as investors embrace Trump presidency’

— CNBC 11 November 2016

Did anyone predict that headline a few weeks — even days — ago?

No way. It seems the impossible has been made possible.

The day the election result was known, the S&P futures plummeted.

Here we are a few days later, TRUMPeting a Donald-inspired surge in market optimism.

Love it.

What I’m waiting for is Yellen’s resignation. Unfortunately, I think I’ll be waiting a while.

Janet was appointed Fed Chair until January 2018.

Personally, I think Donald will want to keep her in the chair.

Should predictions of a US recession in 2017 come true, Yellen will be the perfect scapegoat. She did it…which, in part, is true.

If the economy doesn’t tank, then Donald takes credit for a strong economy.

Either way he spins it, he wins.

The theatre of his unpredictable presidency has me eager with anticipation.

Speaking of unpredictability, how broken are the polling models? The pollsters spend tens of millions of dollars tapping into voter psyche…and on the two biggest decisions in recent history — Brexit and the US election — they’ve been completely blindsided.

The pollsters’ model isn’t the only one that’s in need of recalibration. The central bankers, with a veritable army of PhD-credentialed staffers, have built economic models based on past consumer behaviour patterns…keep lowering interest rates to encourage the masses to borrow more in order to buy stuff they don’t need.

They keep pounding the ‘arrow down interest rate key’ and the modelling tells them that ‘in theory, you have economic lift off’.

In central banker world, the model is right, and the consumer is wrong/too stupid/uncooperative…take your pick.

A bit like the Trump voters…these uneducated, white, middle-aged men don’t know anything.

Broken models lead to surprises. Nasty ones that leave the so-called ‘educated progressives’ shaking their heads in utter disbelief.

The models make one fundamental — and pretty darned important — error. They extrapolate the past into the future. They do not expect a change in trend.

And this leads me to the broken model that’s going to affect you more than any other…the investment industry’s financial planning software.

The planning models have zero predictive capacity for a sustained market downturn. Imagine sitting with a financial planner in Tokyo in 1989 and they say to you: ‘The market has quadrupled in value during the past decade, however, we’ll be a little more conservative and only project growth at 7% per annum.’ Wrong. Over the next 20 years, the Japanese share market lost nearly 80% of its value.

The fact that growth is an assumed given is an error that’s as glaring as the Democrats assuming Trump is unelectable.

Other than taxes, the sun rising in the east, and the Clintons’ lust for money, you should never assume anything.

What has been does not necessarily mean that it will be.

The questioning of extrapolating past trends into the future is what my soon-to-be released book, How Much Bull Can Investors Bear, is based on. [EDITOR’S NOTE: This book has now just been released. You can find out how to download it here.]

In the scheme of things, the pollsters’ misreading of the voting trend wrong is immaterial in your life.

What isn’t immaterial is your investment capital and retirement dreams.

Believing the financial planning ‘pollsters’, without questioning their assumptions, could be the costliest decision of your life.

Today I’d like to share with you an extract from Chapter Two of my upcoming book. The chapter is titled, ‘Truth or Dare — a Challenge to the Investment Industry.

Let’s rewind for a moment and look at the period leading up to the market top in 2007. It really was an easy sell for the investment industry. Share markets had returned, on average, 15% per annum (growth plus dividends) for nearly 25 years. Interest rates had fallen from over 16% to around 4%. Little persuasion was needed to encourage investors to swap their cash for shares.

There were the occasional hiccups in the growth story — the 1987 crash and 2000“tech wreck” — but bad news was marketed as good news. These periods (and subsequent recoveries to newer highs) were later used as evidence to convince doubters of the market’s resilience. The mantra of “the market always recovers” was born, and the uptick in the charts was all the proof needed to confirm this assertion.

Revenue streams were based on a percentage of funds invested. All industry participants clipped the ticket and enjoyed rising levels of income and profitability.

It’s now nine years since the Australian market topped out in late 2007.

In spite of the massive amounts of central bank intervention, there remains an uneasy calm with markets.

Each week there appears to be a mix of good and bad news — markets up, then down. The bouts of volatility earlier this year unsettled investors. The central bankers calmed investor nerves with the promise of more stimulus…markets rallied strongly.

The mere hint of a 0.25% interest rate rise in the US sends markets into a lather. Taking the prospect of a rate rise off the table is cause for jubilation on Wall Street.

People (especially those close to, or in, retirement) are of two minds as to whether they sell now, realise their gains and/or losses and go to the safety of cash, orwhether to maintain their allocation to shares (and possibly buy more) to participate in the central banker engineered market recovery.

The conditioning from 25 years of rising markets, in addition to a widespread belief in the omnipotence of central bankers, holds enough sway to make the latter seem a viable proposition.

In this period of perceived “stability”, the investment industry’s marketing efforts have moved into overdrive.

There have been countless articles headlined with common themes like: “Sharesoffering fair value”; “high dividend yield stocks to buy”; “maintain a long term share market view”; “invest in value stocks”; “protect your portfolio with defensive stocks”; “is there a better time to invest in the market?”; “money in the bank is wasted”…and they go on and on ad nauseum.

Financial planners are using high profile economists and industry commentators as guest speakers at client seminars to reassure investors that all is OK.

The main thrust of the industry’s marketing message is best summarised as:Shares are good value, cash is trash, and when it comes to shares, it is either a bad time to sell or a good time to buy.

No stone is left unturned in the efforts to convince investors to stay the investment course.

Industry super funds buy airtime to promote, in bold print, their superior past performance (with the small print caveat of “past performance is not a reliable guide of future performance”) as a means to attract more dollars to manage.

We are constantly told “it’s time in the market, not timing the market” that delivers the best long-term results. At best this is a half-truth…one we will explore later in the book.

As stated earlier, the industry players, whether they realise it or not, are fighting for their survival. A loss of investor faith in the market’s ability to deliver superior performance will see their industry suffer the same fate as the Thanksgiving turkey.

There are two points worth considering with the current situation the industry finds itself in:

  1. It’s obvious the fortune of the share market plays an integral role in the investment industry’s prospects. A prolonged downturn in the Australian share market would expose the industry as an expensive one-trick pony. If the share market goes lame, then the easy-fee circus is largely over. Without the performance of the share market to sell, the industry will find it difficult to maintain its relevance.
  1. Can you ever recall hearing the analysts, industry commentators and economists, who are now telling us the market is ‘good buying at these levels’, making any pronouncements in 2007 about the market being overvalued and telling investors they should sell? No. The hypocrisy is galling.

The next serious — and I suspect more severe — market downturn is certain to testinvestors’ belief in the market’s resilience and powers of recovery. Unfortunately, when this happens, it’ll be another case of being wise after the event. Repenting in leisure is no way to spend your retirement.

To enable investors to make informed choices, does the industry dare tell the truth about the share market’s long–term (secular) cycles before the next downturn occurs, or will it continue to use selective data to support its own interests ahead of yours?

The answer to that question lies in the old saying, “In the horse race of life, the horse named ‘self-interest’ always wins by a nose.”

You must question the investment industry’s status quo. Otherwise you risk making a mess of your financial situation…a mess that could take years, or decades, to resolve.

Broken models — be they political, economic or financial — lead to poor outcomes and unpleasant surprises.

Finding out after the event that the model is broken is about as useful as a ‘Vote for Hillary’ t-shirt.


Vern Gowdie,
Editor, The Gowdie Letter

Editor’s Note: Australia’s economy is shrinking. Third quarter figures show the biggest GDP fall in eight years. The 0.5% fall in economic output was five times higher than analysts had predicted. Those same analysts are now predicting a rebound next quarter. But what if they’re wrong…again? What if this is only the beginning of a long and painful decline. Vern Gowdie has been preparing his readers for precisely this possibility. You can find out more here. Don’t put this off. The survival of your wealth may depend on it. Go here now.

About Vern Gowdie

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of…

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