So your investment adviser persuaded you to put your money into a growth fund that shrank as share prices plunged.
Who should you blame? Your adviser or the system?
Why didn’t the expert see that coming? That is, after all, what we expect our investment advisers to do. That’s why we pay them. Thousands of Australians have been caught out in this way, over the past year or so. And they are not the only ones worried about it. The Reserve Bank is too. Its deeply secret fear is that in difficult times like these people will lose faith in the financial system.
And these are tricky times. It is not every day, after all, that a major bank, like the National Australia Bank, warns that Australia could be in for a "very hard" landing, as it did this week.
That is unless the Reserve Bank realises its mistake, and cuts interest rates quickly. An assistant governor of the Reserve Bank, Philip Lowe, revealed some of the bank’s fears when he addressed the backroom boys and girls who arrange retail finance in Sydney today.
He said the seeds of "financial disturbances", like those that are currently engulfing us, are mostly sown in the booms that precede them. "In the boom, when economic conditions are benign and asset prices are rising, many investors perceive that risks are low," Lowe said.
So they are prepared to borrow large amounts of money to buy assets. Naturally, the banks are only too willing to help at such times. So are financial advisers. The banks look forward to getting the interest they expect you to pay on that loan. And the advisers get their commission. It’s plain sailing until "something happens to put the whole process into reverse," Lowe said.
In the present case, that something is the so-called credit crunch, which originated in the United States, as reckless loans went bad. As Lowe noted, "The difficult policy question is what, if anything, should be done about this."
"While there is no shortage of ideas of what could be done, there are no easy answers," he said. There was not a lot of cheering at this point in the assistant governor’s speech. Nevertheless, his analysis of the problem was spot on. "The concern here is that current arrangements encourage short termism," he said. In other words, why should your adviser care, so long as the commission gets paid?
So should the system be changed? Lowe was blunt about that. He said too little attention is paid, at present, to mid-term risks — like share market crashes. Lowe didn’t have to specify that particular risk to an audience of financiers. He also argued that monetary policy should "lean against a financial boom". But, hey — hasn’t the Reserve Bank tested that strategy? Twelve successive rate rises would seem, to many, to be quite a heavy "lean". Alternatively, he suggested, banks could be required to build up their "their capital buffers" in good times.
Bank shareholders, however, probably think they have already suffered enough over recent months. Consumers stand to suffer too: higher capital requirements can be reflected in higher bank costs and charges.
Greater official surveillance becomes attractive in tough times but by then it is usually too late. Fortunately, the Australian authorities did keep a close eye on the nation’s home lending practices during the boom which came to an end last August. "APRA (the Australian Prudential Regulatory Authority) has pursued a relatively activist approach, tightening up prudential requirements on housing loans over recent years and increasing the attention it has paid to banks’ mortgage exposures," Lowe said.
This was not the case in the US and the consequences have been spectacular. If you think Lowe’s analysis of the present troubles is better than his recommendations for fixing them, you are right. That’s because, as Lowe himself noted, there are costs, as well as benefits, to each of the great ideas that he canvassed.
But there is one great idea that he forgto to mention.
That is, of course, to grill your investment adviser before you commit a single cent to a proposed investment. It is always very important, however, not only to listen to their answers, but to weigh their replies carefully.
Finally remember too what you can — and cannot — legitimately expect from your adviser. Expecting good analysis and advice is reasonable. Accurate prediction is more difficult. Those who do know what will happen don’t work as financial advisers. They sit around on beaches in the South of France, with their feet in buckets of champagne.
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