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Spicing up two main investment principles

Advice often given to younger or less-experienced investors includes:

  • Define investment objectives
  • Benefit from the magic of compounding
  • Look out for assets that are underpriced
  • Maintain a sensible diversification
  • Allow for the cycle in investment returns.

Each of those five points is an important principle of investing. Together they provide just about everything an investor needs for success, other than money and experience.

Unfortunately, many introductory lectures on investing are dreadfully boring. (Trust me to know about boring presentations on investments. Over the years, I have delivered about 10,000 offerings in person or in writing. Or was it one presentation given 10,000 times?). They are not tailored to hold the attention of either young investors or of older-but-inexperienced ones.

Make investing more engaging

The solution is to re-express the key principles of investing as parables or fables. To begin this revolution in the teaching of the basics of investing, I offer an investment parable to help the next generation of investors understand the cyclical nature of investment returns (and the case to be counter-cyclical) and an investment fable to exalt the wonder of compounding.

A parable is a short allegorical story designed to illustrate or teach some truth, religious principle or moral lesson and which conveys its meaning indirectly by the use of comparison, analogy, or the like. A fable is a succinct fictional story or verse, often presented at a level that children can understand and illustrates a particular moral lesson.

Parable 1: The cycle in investment returns

The Australian bush ballad, 'Said Hanrahan', is more than a great tale. It should be upgraded to a new status as investment parable.

Written by John O’Brien, who in real life was a Catholic priest named Patrick Joseph Hartigan, and published in 1921, its recurring theme is “we’ll all be rooned”. (‘Rooned’ is, of course, Irish-Australian for ‘ruined’). The poem is only a page and half long, and was once taught to Australians in primary school (thank you to my teacher, Mr Ashley O’Toole, at Vacy Public School in 1949).

The poem (or should I say ‘pome’?) hints at these features of the investment cycle:

  • The cycle, which is always with us, is caused or aggravated by swings in public sentiment.
  • Cyclical swings often develop a momentum that runs too far. When people sit (or squat) around endlessly predicting gloom or boom, the investment cycle will overshoot both down and up.
  • Anyone who can identify turning points in the cycle before others is on the primrose path to riches.

The poem begins with people chatting outside a country church, on a winter’s morning, during the worst drought “since the banks went bad” (in the 1890s). In talking together, the parishioners keep raising their assessments of the harm the drought will bring to the once-prosperous farming community. Hanrahan concludes “we’ll all be rooned … before the year is out”.

Of course, “In God’s good time, down came the rain”. For a time, the rain was welcomed, as it “drummed a homely tune on iron roof and window pane”. But then it “pelted, pelted all day long”, and creeks and dams overflowed. Hanrahan opined: “we’d all be rooned if this rain doesn’t stop”.

And stop it did, “in God’s good time”. Optimism briefly reigned as “spring came in to fold/A mantle o’er the hill sublime/Of green and pink and gold”. However, a new concern soon worried the “men of mark/As each man squatted on his heel/And chewed his piece of bark/There’ll be bush-fires for sure, me man/There will without a doubt/We’ll all be rooned, said Hanrahan/Before the year is out”.

John O’Brien left us an apt reminder of the mistake most investors repeatedly make of extrapolating ahead the current phase of the investment cycle, and to suggest it’s the beginning of a long-term trend, though it is just one phase in the investment cycle.

Parable 2: The magic of compounding

A common problem in trying to enthuse young investors about the magic of compounding is their attention can fall away when you introduce them to the daunting formula:

An alternative approach is to share a viewing of the Mary Poppins movie and to focus on the scene where the directors of the Fidelity Fiduciary Bank entice Michael, with sister Jane watching closely, to invest his tuppence in one of the bank’s financial products (Did banks really offer managed products in 1910?).

Their advice, which in my view merits elevation to the status of a fable, is delivered as a verse. Part of it runs like this:

“If you invest your tuppence in the bank, safe and sound

Soon that tuppence, safely invested in the bank, will compound

And you’ll achieve that sense of conquest as your affluence expands

In the hands of the directors as propriety demands

You see Michael, you’ll be part of:

Railways through Africa! Dams cross the Nile! Fleets of ocean greyhounds! Majestic, self-amortising canals! Plantations of ripening tea!

All from tuppence, prudently, fruitfully, frugally, invested.”

Sure beats a dull formula, and gives you opportunity to explain 'self-amortising'.

As things turn out, Michael pulls out of the deal. He inadvertently starts a run on the bank by demanding his money back and spends the tuppence on buying seed to feed the birds. (Is there the opportunity here for some advice on work-life balance?)

Wrap up the session by pointing out that, had Michael’s tuppence been invested in Australian shares in 1910, and allowed to compound, Michael’s descendants would today hold an asset worth about $1,200 – and think how much bird seed they could buy.

 

Don Stammer has been involved with investments since the early 1960s including senior executive positions in Deutsche Bank and ING. These days, in his semi-retirement, he’s an adviser to Altius Asset Management and Stanford Brown Financial Advisers. The views expressed in this article are his own.

4 Comments
Brian
September 12, 2017

Very well done!. Thanks Don.

Kevin
September 09, 2017

The formula is petty daunting,parables and fables are the ideal way. I think the problem is people are told they must save up.

When I started to explain compounding I used rule of 72,even that baffles people.

Tried a different way,buy 1000 shares in a company,use NAB, the worst example.Give it 25 yrs to compound,use the DRP.So when super started NAB were less than $10 a share but call it $10 a share.

25 yrs later 4,000 shares approx. at $30 a share $120 K and 25 yrs to pay back a 10K loan,no problem.More blank looks of how can that be possible if everybody says you must save up or put as much as you can into super.Everybody repeats it is too risky.

Was it Aristotle 2400 years ago that said " If the facts don't fit in with what they want to see,then the facts are wrong.The history of the human race in one sentence.

Westpac is 200 yrs old this year.I think it was 200 shares @100 pounds each to get it off the ground.So 1 share is 0.5% of the company,today 0.5 % of the company is around $500 million ,just by leaving it alone.Collecting all those dividends.That is compounding

The historical info is supplied by the wonderful Trevor Sykes (long ago Chanticleer) from his long out of print book Two centuries of panic.The equally educational and entertaining follow up Bold riders is also an excellent book.

People see what they want to see.Perhaps the emperors new clothes is the best story/fable/parable.

Derek
September 08, 2017

I think the allegory concept is why the little book "The Richest Man in Babylon" is so timeless. Financial lessons packed into well told stories. It is hard to go past this classic!

Kym
September 07, 2017

I don't think I'll use this as a conversation starter for my young adult children.
I kind of followed the flow but I am closer to the Authors gen so am used to the style.
Modern communication needs to be more punchy and analogies drawn from popular culture which is, at all times, only a momentary interest.

 

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