Some 10 years after the finance company sector meltdown New Zealanders are still displaying an alarming naivety in the world of investment, David Hargreaves says

Ayrex
binary options
Tweet

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.

best investing platform

Profitable Copy Trading

social trading binary options

Profitable binary options trading

trading binary options

Binary options bonus no deposit

binary options bonus no deposit

CFD Trading Tips

CFD Trading Tips