I remember a while ago when an acquaintance of mine in Dili confidently announced that it was “good to see the back of the wet season” and she was very much looking forward to the forthcoming dry.
Sure enough, I went for lunch at 12.30 the next day, by 12.45 the heavens had opened to reveal a momentous tropical storm.
By 1.00pm the local kids were gleefully playing on the steps outside (which had turned into some kind of waterfall) and by 3pm Dili looked like this:
Some would say that that my acquaintance jinxed the weather with her comment, or if we were being colloquial we might say that this is “Sod’s Law”: that being the “humorous or facetious precept stating that if something can go wrong or turn out inconveniently it will”.
Slightly more scientifically, but in a similar vein, this concept is also known as…
The exact source of the term is a little disputed, but the idea of Murphy’s Law has some merit. In a report by Alfred Holt at an 1877 meeting of an engineering society, it was found that:
“Anything that can go wrong at sea generally does go wrong sooner or later, so it is not to be wondered that owners prefer the safe to the scientific. Sufficient stress can hardly be laid on the advantages of simplicity.
The human factor cannot be safely neglected in planning machinery.”
If something can go wrong, it eventually will, so simple is better than complicated. And for this reason, in personal finance it makes sense therefore to have a…
Rainy day fund
Well, given the tropical rain I saw yesterday, it was an obvious analogy wasn’t it? It’s often said in personal finance that you should have a “rainy day fund” of savings to cover unforeseen events on un-budgeted costs, and two months of salary is a commonly quoted figure.
While I wouldn’t recommend it, what many people elect to do these days is retain a spare credit card which acts as their rainy day fund.
How does that work?
Because when an individual or for a company is bankrupted it is not usually the diminished value of their net assets which sends them broke, it is illiquidity: the inability of the person or company to pay for a debt or obligation as it falls due.
We saw this plenty during the financial crisis where certain banks and financial institutions had balance sheets which stated that technically they were not insolvent, yet they ran out of readily available cash and required a bailout (or in some cases were allowed to go under).
Defence from Murphy’s Law
It’s an interesting fact that under International Financial Reporting Standards (IFRS) it is possible for auditors to sign a clean opinion of a set of accounts which shows a balance sheet valuing a company at double (or more than double) what the market believes a company to be worth.
Remember Murphy’s Law when it comes to investing: if something can go wrong, eventually it will, and particularly if it is complex (think Enron).
It might seem unthinkable that by picking out the shares of a very large, a firmly-established or a highly profitable company to invest in that it could never go bust, but what truly amazes is when you look back at the top companies from 40, 30, or even 20 years ago, and see how many of them no longer exist.
This is one of the great benefits of buying an instantly diversified product such as an index fund.
Short of a global catastrophe on an almost unimaginable scale every company on the index will not be worth zero. And if one does go under then it won’t hurt too much because you hold a widely diversified good spread of companies.
You will also own every stock worth owning in the index, for even the next Microsoft will enter the index as it is rebalanced each quarter, so you don’t even have to worry about missing out on “the next big thing” or the next “10,000% return stock”.
Murphy’s Law in property
I apply similar but slightly different principles in investment property.
Now, I don’t have a problem with the idea that individually property hotspots can outperform over certain periods of time.
However, after a decade-and-a-half in the world of finance one of the observations which strikes me most often is how I have a few examples of people and companies timing decisions very well and thousands upon thousands of examples of terrible timing.
The benefit of hindsight makes decision-making and timing markets appear very easy, but in reality it is very difficult to time investments extremely well.
One company I worked for took out a hefty convertible bond debt denominated in US dollars at a rate of 65 cents in 2008 (largely forced upon the company by its own illiquidity at that time) – it may seem incredibly dumb now, but at the time I don’t recall many forecasters tipping the dollar booming to 110 cents!
Murphy’s Law applies to the world of property too: although property investment books will still promote the idea of prices always going up ahead of inflation, at some point there will be a correction, and at that time you only want to be holding quality property in a high-demand location.
That’s why in property investment I only want to own properties (and some of them debt-free) located on land within a reasonably close distance of the centre of cities like Sydney where the population increased from 3.6 million in 1991, to 4.1 million in 2001, to 4.6 million in 2011.
The population is forecast to boom to a scarcely believable 7 million in the coming decades.
A good time horizon for holding investment property is two to three decades, or preferably longer.
There will be ups and downs over that kind of timescale but with a monetary policy which aims to devalue our currency every year, only a limited supply of land available and 7 million people competing for it, one thing you can be sure of is that prices won’t ever be cheap.
As we saw recently in parts of the US that is by no means always the case in remote locations.