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January 2018

Become a better investor through your holiday reading

Behavioural economist Daniel Kahneman – who teaches us to control our damaging behavioural traits to become better, more-disciplined investors – continues as a powerful force on the best-seller lists as 2017 draws to a close.



Kahneman's Thinking, fast and slow has been on The New York Times bestselling non-fiction paperback list for 147 successive weeks or almost three years. It is currently ranked seventh on the weekly list ending November 18 – even outselling the acclaimed American biography Alexander Hamilton by Ron Chernow, the subject of a hit Broadway show.

Meanwhile, The undoing project by Michael Lewis – number two on this best-selling list – tells the intriguing story behind the pioneering studies of Kahneman and fellow psychologist Amos Tversky into the psychology of economic or financial decision-making.

If you are going to spend time over any summer break reading about how to improve your chances of investment success, your reading list is likely to include books on how to keep wealth-destroying behavioural biases under control.

Some titles appear on Smart Investing's holiday reading list year after year. Some of the best investment books seem to improve with age – just like a good red. And as we develop as investors, the points made in these books tend to make more sense.

If you read a few of the suggested books last year, think about rereading them.

The best investment/personal finance titles tend to give pointers about how to accumulate wealth slowly and progressively through an understanding of the fundamental principles of sound saving and investment practices. Avoid sensational books that claim to offer ways to get-rich-quick; these can act as guides to quickly losing money.

Here are a few titles to consider adding to your reading list for summer 2017:

  • Thinking, fast and slow by Daniel Kahneman: A winner of the Nobel Prize for economics, Kahneman points to the many flaws in financial decision-making – including overconfidence and excessive loss aversion (inhibiting appropriate risk-taking and encouraging a short-term focus) – that can have costly consequences for an investor. His views underline the benefits of having an appropriately-diversified portfolio while avoiding the traps of market-timing, stock-picking and making emotionally-charged investment decisions. “Much of the discussion in this book is about the biases of intuition,” he writes.
  • The only investment guide you'll ever need by Andrew Tobias: His overall message is to take a common-sense approach to looking after your investments and other personal finances. For example, only buy investments you can understand, avoid investments that seem too good to be true, and don't have credit card debt. This book was first published 39 years ago.
  • The behaviour gap – Simple ways to stop doing dumb things with money by Carl Richards: This is an entertaining, easy-to-read guide by a financial planner turned personal finance columnist to keeping our negative behavioural traits under control when saving, investing and spending. His tips include: adopt strategies to avoid buying shares at high prices and selling low, don't spend money on things that don't really matter, identify your real financial goals and simplify your financial life.
  • The millionaire next door by Thomas Stanley and William Danko: Long-term research by late academics Stanley and Danko suggests that “prodigious accumulators of wealth” are typically content to progressively build their wealth while being inconspicuous in their spending. In other words, these wealth accumulators are not in a hurry to make their money by taking excessive risks or in a hurry to spend their money. Conspicuous consumption should not be taken as a sign of wealth – it often means the opposite.
  • A random walk down Wall Street: The time-tested strategy for successful investing by Burton Malkiel: The basic theme behind this classic is Malkiel's argument that investors – individuals and professionals – cannot not expect to consistently outperform the market. Given that belief, Malkiel, a Princeton University economics professor, is a firm believer in investing in market-tracking index funds (including ETFs), dollar-cost averaging (regularly investing set amounts), appropriate portfolio diversification, periodic portfolio rebalancing and low-cost investing. And he emphasises the need for investors to understand the risks of irrational behaviour.
  • The little book of common sense investing by Jack Bogle: As Bogle writes, “successful investing is all about common-sense”. Don't try to pick the best time to buy and sell stocks – consistent success with market-timing is rarely achieved; diversify to minimise risks (and spread opportunities); recognise the rewards of compounding, long-term returns; and keep investment costs low. “The more the managers and brokers take, the less investors make,” Vanguard's founder writes.
  • If you have trouble putting down such fictional thrillers as The Midnight Line by Lee Child, the latest adventure of retired colonel Jack Reacher, perhaps try something different – a novel with a personal finance theme.
  • As personal finance author Paul Brown comments in The New York Times: “If we're lucky enough to get away for a few days, do we actually want to take a book about investing to the beach?”
  • Brown's favourite new novel with a personal finance twist is The Windfall by Diksha Basu. This is the story of a middle-aged Indian business owner who suddenly becomes rich after selling his website for many millions.

His once satisfying lifestyle is lost as he turns into a conspicuous consumer, moving to an upmarket suburb and imitating his new big-spending neighbours. As Brown writes, this book may prompt you to think about why you are trying to accumulate wealth in the first place.


Written by Robin Bowerman
Head of Market Strategy and Communications at Vanguard.
01 December 2017

Technical expert flags top 3 traps with CGT relief

While SMSF practitioners may be familiar with the rules for CGT relief, there are some key areas where professionals are hitting snags with the practical aspects of applying the relief, says a technical expert.



SMSF specialist and former Perpetual Private head of strategic advice Colin Lewis said there is still a distinct lack of understanding of the CGT relief that will need to be addressed early in 2018.

“The irrevocable election needs to be made by the time the fund’s return is due in, which is either the end of February or in May,” said Mr Lewis.

What method should trustees claim the relief under?

One of the areas causing confusion is determining which method the fund will claim CGT relief under. Mr Lewis explained that this comes down to the way in which the fund was claiming exempt current pension income at 9 November 2016.

“That dictates going forward what method you use. So right at the outset at a very elementary level, were you a segregated fund or were you an unsegregated fund at 9 November 2016?” explained Mr Lewis.

If the fund was segregated then there will be two options available, he said.

“Now in all likelihood, the most attractive one is where the fund became a proportionate fund because it means they can then apply the CGT relief to any or all the fund assets, rather than to just to a specific asset that they’ve commuted back,” Mr Lewis said.

What date should be used?

The date that should be used is also confusing practitioners, as they may have made a contribution before 30 June, he said.

“If you were segregated at 9 November and you become unsegregated on 30 June, then all well and good, but where you put a contribution into the fund during that period, and you didn’t specifically segregate that contribution, then it becomes unsegregated as of the date of the contribution,” Mr Lewis explained.

This may have happened in circumstances where the members wanted to utilise their last opportunity to contribute the $540,000 worth of non-concessional contributions into superannuation, he said.

“So [in those cases], that’s the date that you’re actually using for the cost base reset, not the 30th of June,” Mr Lewis said.

Is the fund eligible?

One of the biggest areas of misunderstanding is around eligibility for the relief, where a proportionate fund became fully segregated, he said.

If there is a member in pension and a member in accumulation within a fund and the member in accumulation went fully into pension phase during the year, the fund may not be eligible for the relief, Mr Lewis warned.

“One of the criteria of the CGT relief for a proportionate fund is that you don’t become segregated at any time. So if the fund does become fully segregated by moving fully into pension phase during the year, then you are ineligible for CGT relief,” he said.

“[Also] if you had a segregated fund, on the other hand, and you didn’t commute the excess amount during the [2016-17 financial] year, then you haven’t become unsegregated and you won’t be able to apply the relief.”


By: Miranda Brownlee
21 December 2017

As share prices rise, the risk-return trade-off gets tricky

Part of Vanguard's Global Macro Matters research series.



In the eight and a half years since the lows of the global financial crisis, the Standard & Poor's 500 Index has climbed more than 250%, making the current bull market the second strongest – and the second longest – since 1926 (see Figure 1).

The dot-com boom of the 1990s, when the index climbed more than 400% over nine and a half years, holds the record in both categories. This comparison raises inevitable and uncomfortable questions. Can the bull market continue to charge much higher? And, more important, are we in a late-1990s-style bubble, when valuations reached record highs and share prices subsequently plunged by 50%?1

Figure 1. The S&P 500 is in its second-strongest bull market

Notes: Data shown are for the S&P 500 Index from 1 January 1950 through 23 October 2017. “Bear market” is defined as a period with a decline of 20% or more from the previous high. Sources: Vanguard calculations, using data from FactSet and Bloomberg.

Our analysis finds that:

  • Traditional valuation metrics, such as CAPE (cyclically adjusted price/earnings ratio), paint an alarming – but incomplete – picture when compared with long-term averages. Vanguard's “fair value” CAPE, a more useful measure for assessing over- or undervaluation than traditional metrics, suggests that while shares are trading above fair value, they aren't yet near the extremes reached in the dot-com high.
  • Even so, our five-year outlook for US equities is subdued at best, and the benefits of global diversification are particularly compelling because of better prospects for non-US equity markets. Our simulations show that, under current market conditions, a globally diversified 60% stock/40% bond portfolio may offer return prospects that are on par with an all-US equity portfolio, while having significantly less tail risk.2

Conventional valuations are unusually high
Price/earnings (P/E) ratios are an important signal to identify periods of equity market overvaluation and even bubbles, when market prices become completely detached from corporate fundamentals such as dividends, book value and earnings. While valuations are not a good market-timing tool, elevated valuations are typically followed by depressed returns over the following decade. After reaching a CAPE multiple of 44x in 2000, the S&P 500 Index returned a cumulative -8% over the subsequent “lost decade.”

Whether we use one-, three-, five-, or ten-year average earnings in the denominator, P/E ratios are quite high. The four valuation ratios in Figure 2a are between the 89th and 95th percentiles relative to their historical levels. The CAPE is at the 95th percentile of its historical levels. As Figure 2b shows, it stands at 31x, just below two standard deviations from its long-term average of 18x since 1926. By just about any conventional measure, equities are overvalued.

Figure 2. The S&P 500 Index is unusually high relative to history

Note: Analysis above is for the S&P 500 Index since 1926. Sources: Vanguard calculations, based on Robert Shiller's website, at

The fair-value CAPE tells a less alarming tale
While the levels in Figures 2a and 2b seem alarming, a straight comparison of CAPE (and other valuation multiples) with their historical averages can be misleading. Such comparisons fail to account for changes in the economy and markets, including inflation levels and interest rates that can influence the fair values for these multiples. For example, a secular decline in interest rates and inflation pushes down the discount rates used in asset-pricing models, thus inflating P/E ratios. In this case, a high CAPE may indicate not overvalued stock prices, but low bond yields. At the 2017 CFA Institute Annual
Conference, professors Robert Shiller, creator of the CAPE, and Jeremy Siegel cited low interest rates as a possible partial explanation for elevated CAPE ratios.

In Vanguard's Economic and Investment Outlook for 2015, we introduced a fair-value CAPE that accounts for current interest rates and inflation levels.3 This fair-value concept provides a more useful time-varying benchmark against which the traditional CAPE ratios can be compared.

Figure 3 plots the Shiller CAPE versus our fair-value model since the 1950s. In the late 1990s, the difference between these two would have suggested a bubble. Today, the CAPE is approaching historical highs, it's only marginally higher than our estimate of its fair value. In other words, the
market, going by the fair-value CAPE, is approaching overvalued territory – but it is not grossly overvalued, as it would be in a bubble.4

Figure 3. The Shiller CAPE is approaching overvalued territory

Notes: Fair-value CAPE is based on a statistical model that corrects CAPE measures for the level of inflation expectations and for lower interest rates. The statistical model specification is a three-variable vector error correction (VEC), including equity-earnings yields (S&P 500 Index), ten-year trailing inflation, and ten-year US Treasury yields estimated over the period from January 1940 to September 2017. For details, see Vanguard's Economic and Investment Outlook. Sources: Vanguard calculations, based on Robert Shiller's website, at; the US Bureau of Labour Statistics; and the Federal Reserve Board.

Implications of high US equity prices, low yields
Even if comparisons with the late-1990s share market bubble are too extreme, our analysis suggests that US equity returns during the next five to ten years will be subdued at best. Today, the always-compelling case for global diversification is particularly strong. Consider the results from our Vanguard Capital Markets Model (VCMM) simulations:

  • US equity seems set for lower returns and a higher risk of loss. As illustrated in Figure 4, our five-year US equity return simulations show roughly a one-in-three chance of surpassing a 5% annualised return. The probability of a 10% or worse decline in any given year is 69%, which is high relative to the historical probability (42%).
  • Global diversification improves outlook. Relative to US equity, global equity (60% US equity/40% global ex-US equity) offers better potential for return with slightly lower odds of a 10% or worse decline in any given year. Investors with no allocation to global equity can benefit by diversifying globally.
  • Global bonds enhance diversification, limit tail risk. A global balanced 60% stock/40% bond portfolio has similar potential for return as US equities, with much lower downside risk. Although global bonds are likely to have muted returns themselves, low correlation with equities provides a ballast during times of equity market turmoil, making diversification the only free lunch.

Figure 4. The benefits of global diversification are more compelling than usual

Notes: Summary statistics of 10,000 VCMM simulations for projected five-year annualised nominal returns as of September 2017 in US dollars before costs. Historical probabilities are probabilities of a 10% or worse decline in any given year for rolling five-year periods and are calculated from 1960 onward based on calendar-year returns. The global equity portfolio is 60% US equity and 40% global ex-US equity. The global bond portfolio is 70% US bonds and 30% global ex-US bonds. Balanced portfolios include global equity and global bonds. For VCMM details, see Vanguard Global Capital Markets Model.2

Investing is always a balancing act between return objectives and risk preferences. Given current valuations, risky portfolios appear to offer low return with even-higher-than-usual odds of loss, while a global balanced 60% stock/40% bond portfolio offers an unusually compelling trade-off. The next few years could be challenging for investors, who may have to navigate an environment with low returns and a compressed equity risk premium.

Decisions around saving more or spending less will be as important as staying diversified and controlling costs. Adhering to investment principles such as long-term focus, disciplined asset allocation, and periodic portfolio rebalancing will be more crucial than ever before.


Research & Commentary


1 The CAPE ratio rose more than three standard deviations above its long-term average in the late 1990s and early 2000s, and thus the period can be considered extremely overvalued or a bubble.
2 Joseph Davis, Roger Aliaga-Díaz, Harshdeep Ahluwalia, Frank Polanco, and Christos Tasopoulos, 2014. Vanguard Global Capital Markets Model. Valley Forge, Pa.: The Vanguard Group.
3 Joseph Davis, Roger Aliaga-Díaz, Andrew Patterson, and Harshdeep Ahluwalia, December 2014. Vanguard's Economic and Investment Outlook. Valley Forge, Pennsylvania: The Vanguard Group.
4 One important point to keep in mind is that as the depressed company earnings of the 2008-2009 global financial crisis begin to roll out of the ten-year moving average calculation next year, the Shiller CAPE could fall slightly (to around 28x, assuming current prices and earnings don't change much).

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Rising risks to the status quo

The financial markets' low volatility underscores investors' conviction that the long-term global economic trends of modest growth and tepid inflation will also define shorter-term cycles. But risks lie in mistaking the trend for the cycle.



The most pronounced risk in our 2018 outlook is that already tight global labor markets will grow tighter, finally leading to a cyclical uptick in inflation. A wage or inflation spike in 2018 could lead markets to anticipate a more aggressive normalization from historically low interest rates just as central banks are either normalizing monetary policy or contemplating doing so, thereby producing a market-rattling shock.

Global investment outlook: Higher risks, lower returns
For 2018 and beyond, our investment outlook is modest, at best. Elevated valuations, low volatility, and secularly low interest rates are unlikely to be allies for robust financial market returns over the next five years. Downside risks are more elevated in the equity market than in the bond market.

In our view, the solution to this challenge is not shiny new objects or aggressive tactical shifts. Rather, our market outlook underscores the need for investors to remain disciplined and globally diversified, armed with reasonable return expectations and low-cost strategies.

What follows is a brief overview of our economic and investment outlook for 2018.

Economic growth: Unemployment, not growth, is the key
We expect economic growth in developed markets to remain moderate in 2018, while strong emerging-market growth should soften a bit. Yet investors should pay more attention to low unemployment rates than GDP growth at this stage of the cycle for prospects of either higher spending for capital expenditures or wage pressures. We see low unemployment rates across many economies declining further. Improving fundamentals in the United States and Europe should help offset weakness in the United Kingdom and Japan. China's ongoing efforts to rebalance from a capital-intensive exporter to a more consumer-based economy remains a risk, as does the need for structural business-model adjustments across emerging-market economies. We do not anticipate a Chinese “hard landing” in 2018, but the Chinese economy should decelerate.

Inflation: Secularly low, but cyclically rising
Previous Vanguard outlooks have rightly anticipated that the secular forces of globalization and technological disruption would make achieving 2% inflation in the United States, Europe, Japan, and elsewhere more difficult. Our trend view holds, but the cycle may differ.

In 2018, the growing impact of cyclical factors such as tightening labor markets, stable and broader global growth, and a potential nadir in commodity prices is likely to push global inflation higher from cyclical lows. The relationship between lower unemployment rates and higher wages, pronounced dead by some, should begin to re-emerge in 2018, beginning in the United States.

Monetary policy: The end of an era
The risk in 2018 is that a higher-than-expected bounce in wages—at a point when 80% of major economies (weighted by output) are at full employment—may lead markets to price in a more aggressive path or pace of global monetary policy normalization. The most likely candidate is in the United States, where the Federal Reserve is expecting to raise rates to 2% by the end of 2018, a more rapid pace than anticipated by the bond market. The European Central Bank is probably two years away from raising rates or tapering bond purchases, although a cyclical bounce may lead to a market surprise. Overall, the chance of unexpected shocks to the economy during this tightening phase is high, as is the chance that balance-sheet shrinkage will have an unpredictable impact on asset prices.

Investment outlook: A lower orbit
The sky is not falling, but our market outlook has dimmed. Since the depths of the 2008–2009 global financial crisis, Vanguard's long-term outlook for the global stock and bond markets has gradually become more cautious—evolving from bullish in 2010 to formative in 2012 to guarded in 2017—as market returns have risen with (and even exceeded) improving fundamentals. Although we are hard-pressed to find compelling evidence of financial bubbles, risk premiums for many asset classes appear slim. The market's efficient frontier of expected returns for a unit of portfolio risk now hovers in a lower orbit.

Based on our “fair-value” stock valuation metrics, the medium-run outlook for global equities has deteriorated a bit and is now centered in the 4 %–6% range. Expected returns for the U.S. stock market are lower than those for international markets, underscoring the benefits of global equity strategies in the face of lower expected returns.

And despite the risk for a short-term acceleration in the pace of monetary policy normalization, the risk of a material rise in long-term interest rates remains modest. For example, our fair-value estimate for the benchmark 10-year U.S. Treasury yield remains centered near 2.5% in 2018. Overall, the risk of a correction for equities and other high-beta assets is projected to be considerably higher than for high-quality fixed income portfolios; balanced portfolios are expected to stunt a rise in return volatility.


By Robin Bowerman
​29 November 2017

Opinion – 2018 to be the year of the machine

As artificial intelligence (AI) moves from the realms of fantasy to reality, it brings both opportunities and threats for investors in 2018. 



The possibilities of AI were underscored in 2015 when Google’s DeepMind AlphaGo program triumphed over the reigning world champion in Go, a Chinese board game of profound complexity.

This year, DeepMind announced that a new program, AlphaGo Zero, had beaten the original AlphaGo 100 times to nil. Information technology now allows the gathering, storage and analysis of the vast data sets needed to mimic the computational powers of the human brain. 

This not only brings hope, but also fears that manual work will be replaced by robots and decision-making by algorithms.

Apple’s newest iPhone provides a commercial example. In 2012, Google algorithms learned to find videos of cats on YouTube. Google’s researchers created a neural network of 16,000 computer processors with one billion connections that achieved 75 per cent accuracy. The machine was never told what a cat was during the training. 

Jeff Dean, the Google Fellow who led the study, told The New York Times: “It basically invented the concept of a cat.”

Progress since has been spectacular, and now AI-based face recognition acts as the password to unlock the iPhone X.

An understanding of the underlying technology guides us to where next year’s investment opportunities may occur. Many industries offer great data sets, and if AI can help identify patterns and make better faster decisions it will drive higher sales, cut costs and even save lives.

These developments have opened the door to new opportunities for innovative companies. One example is NVIDIA, a US semiconductor company. Its original business was graphics processors that accelerated 3D graphics, driving the boom in video games. But the chips that power 3D graphics are also able to perform the tasks that drive machine learning. 

NVIDIA chips have become key components of machine-learning systems. As a result, sales have increased and the company’s share price has risen more than eight-fold in the past three years.

We are still in the early days of AI growth. If AI can allow businesses to identify valuable data patterns and improve decision-making, there is more incentive to capture and store data. 

Tesco, the UK retailer, talks about every part of its retail infrastructure – from carts to tills to shelves – being able to generate and store data. This information can both help control costs and target higher sales through a deeper understanding of individual customers.

The rise of AI is also good news for the semiconductor industry. Demand for memory chips produced by companies such as Samsung Electronics is already robust and growing.

These trends will help sustain this growth.

Companies that own great data sets will benefit from their “asset”, too. Facebook, Amazon and Google have vast amounts of data about their users and are actively investing in AI. 

In 2018, we expect investors’ attention to shift to opportunities in more specialist niches, such as healthcare, which can be just as promising. American health insurer United Health has one of the largest data sets in the industry. It monitors the health data of tens of millions of patients, from drug prescriptions to hospital visits. 

It is working on detecting early changes in its customers’ health using AI. The company’s management team talks excitedly about being able to predict diabetes long before it develops and to intervene early to help its customers prevent or manage the disease.

AI is also a threat to some existing business models. Algorithms are already effective at answering simple IT questions and providing customer helpdesk support. AI can even review basic legal documents. 

Today, these tasks are performed by IT services and business process outsourcing companies. The survivors will be those companies that adapt by automating these activities and shifting their offering towards more value-added services.

The speed of progress in AI has been spectacular. The full impact on industries and societies lies ahead. Already, it has created a lot of value and presents real and material opportunities. 

The investment winners of 2018 will be those companies that not only have the right data but also understand how to use it.


Mikhail Zverev is head of global equities for Aberdeen Standard Investments
22 Dec 2017
By Mikhail Zverev

Financial advice is the leading trigger to review insurance inside Super

Financial advice has been found to be the leading cause of people taking action to review their life insurance inside a superannuation fund.



The life insurer conducted a nation-wide survey of 1554 Australians aged between 18 and 64 in August 2017 examining awareness and engagement around insurance in superannuation.

The survey found that 29 per cent of respondents made changes to their life insurance cover after a financial adviser recommended they did so.

According to MetLife, advice was the largest driver of change, followed by 20 per cent of respondents who said they made changes after receiving some form of communication from their superannuation fund.

The survey also identified other areas which prompted people to take action, but these were based around specific events, including taking out a mortgage (18 per cent of respondents), starting a family (17 per cent) and getting married (16 per cent).

“It is interesting that the two major triggers for engagement are when they get help and support…”
MetLife Australia Chief Executive, Deanne Stewart said, “It is interesting that the two major triggers for engagement are when they get help and support – either from a fund or planner,” Stewart added.

MetLife found that general knowledge about insurance inside superannuation was high with 74 per cent of respondents being aware of it, but knowledge fell away when it came to specifics.

Only 54 per cent believed they had any insurance inside super, and of those who were certain they had cover via their fund 72 per cent stated they had limited knowledge of what their cover provided in terms of accident and illness.

Two-thirds of respondents stated they did not know how to calculate the level of cover they needed while 56 per cent were unaware of the tax benefits of purchasing insurance within a fund and 52 per cent did not know that many super funds offered automatic acceptance for most insurance applications.

“We’ve worked hard as an industry to raise awareness of insurance inside super and it’s rewarding to see that people are taking notice and awareness is on the rise. But at the same time it’s concerning that more people aren’t taking action, despite 55 per cent of those with default cover suspecting they don’t have enough,” Stewart said.

“We need to really focus on engagement, ensuring more working Australians are making the most of their insurance inside super. As industry professionals we have a key role to play in supporting people with simple steps to take control of their cover and ensure adequate protection for them and their loved ones.”


By MetLife Australia Chief Executive, Deanne Stewart
December 12, 2017