Behavioural Finance aims to understand how and why people make certain financial decisions.  Much of economic theory assumes people will act “rationally”, yet reality frequently upsets these elegant theories.  By gaining an understanding of how we interpret financial information and react to it, we can perhaps reduce the harmful effects of some of our instinctive “humanness”.

Regret Aversion

One Behavioural Finance concept worth grasping is Regret Aversion.  We instinctively try to avoid a situation of regret or disappointment.  It’s not hard to see how we have become hard wired for this trait.  If we burn our hand on the side of the toaster, we don’t put our hand their again.  However it’s a small step from this useful application of regret aversion to “well once at school when I spoke to the class, someone laughed, so I never talk in front of groups now”.

Often, regret aversion is at the heart of procrastination.  We can see that undertaking a certain action makes sense, but there is a chance this bad thing might happen, so lets just be safe and do nothing.  This thought process is why most people don’t become self employed.

We all know that share markets have had a volatile and difficult time over recent years.  It is tempting to conclude, “investing is for mugs, I’ll just put my money under the bed, it can’t go down that way”.

In 1990 the Australian share market declined 17.52%.  This was only 3 years after the 1987 stock market crash where markets declined over 30% in a matter of days.  Then, like now, there would have been some, applying the regret aversion thought process.  “I can’t stand any more of this volatility, I’ll just put my money in the bank where it is safe”.

Over the next 10 years, the Australian Share market gained an average of 14.8% per year, whilst cash earned between 5% and 6% for most of that period.

There is an interesting experiment reported by the Journal of Economic Psychology looking at peoples preparedness to exchange one lottery ticket with another.  Even though they could could achieve a bonus for exchanging, may none-the-less chose not to exchange, fearful it seems, of the regret they would feel should the ticket they gave away prove to be the winner.

Regret aversion is an understandable, instinctive, human trait.  However if we understand this natural tendency within ourselves, we can perhaps question our decisions.  Is this decision I’m making rationale given the current facts, or am I letting some past event, which has little if any relevance to the current circumstance, lead me in a direction that is not in my bests interests?

Victoria’s Small Business Mentoring Service provides an affordable avenue for small business owners to gain outside expertise.

The non-profit organisation links volunteer mentors to businesses seeking help.  Typically the mentors are retired executives with a wealth of experience to share.

Started in 1986, the service claims to have helped more than 15,000 business owners over its 25 years of existence.

If you are a business owner operating a business with less than 20 staff, you might wish to consider contacting the Small Business Mentoring Service for help and support.

Heard about Self Managed Super and want to find out if it’s right for you?  Why not download our free ebook – SMSF’s – Australia’s most popular way to save for retirement

Guidance Financial Services – specialist financial planning advice for business owners and the self employed

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Standard & Poor’s released their review of the global banking system, ranking Australia third safest, behind  only Switzerland and Canada.  This assessment has provided analysts with confidence that Australian banks will retain their coveted “AA” rating.

The Financial Review today quotes Commonwealth Bank CFO David Craig as saying a downgrade from AA to AA- would have no impact on funding costs, however ”….if it was to (single) A, that would make a difference”.

With the Reserve bank recently lowering interest rates to stimulate the economy, what we don’t want to see is banks needing to raise rates to counter rising cost of funds (due to a reduction in their credit rating).  Small Business, including those hundreds of thousands of self employed contractors, are the well established engine room of our economy.  They require bank financing to grow and create new employment opportunities.  High interest rates choke off this potential for growth.

Guidance Financial Services – specialist financial planning advice for business owners and the self employed.

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It is apparently worth about $5 and that is in novelty value.  Zimbabwe no longer issues its own currency.

The wonders of printing money as an economic strategy.

Click here for an Income Protection Quote:

Income Protection quote

Guidance Financial Services Pty Ltd – specialist financial planning services for business owners and the self employed.

http://melbourne.startupweekend.org/

Looks like an interesting event for those with an IT/entrepreneurial streak.

It’s on 4-6 November.

Guidance Financial Services – Specialist financial planning advice for business owners and the self employed

The Financial Planning Association (of which I’m a member) are currently promoting the difference between Certified Financial Planners and the rest, so that consumers are better informed when seeking out financial planning services.  I fully support this initiative.  If you are interested, the details can be found here.

Download our Free ebook – SMSF – Australia’s most popular way to save for retirement.  Click on the green “Learn more about SMSF” on the right of this page.

Guidance Financial Services – specialist Financial Planning advice for the self employed and those running a business.

It was announced yesterday that BHP Billiton had secured regulatory approval to expand its Olympic dam site.  The board will now make a final decision on whether to proceed by mid 2012.  The mine would be the worlds largest deposit of uranium, fourth largest copper ore body, and fifth largest reserve of gold.  It will also produce 4mill oz of silver over its life, which is estimated at a very broad 40 to 100 years.

But the stat that really got me was the size of this thing.  The pit will be:

4.1km long

3.5km wide

1km deep

That is one very big crater!

Guidance Financial Services – specialist Financial Planning advice for the self employed and those running a business.

Photo by amandabhslater

The Australian Financial Review reported this morning (26/8/2011) that once again the Self Managed Super fund sector was the fastest growing in the retirement savings space.  There is now $418billion in Australian self managed funds, held by 456,472 funds.  During the June quarter, 7,466 new funds were established whilst only 64 were wound up.

SMSF’s held $139billion in shares and $114billion in defensive assets (primarily cash).  Investment in residential property grew to $14.5 billion, as more and more people realise that self managed super funds can now borrow, making access to this investment far more attainable.

24.2% of funds had balances of less than $200,000.

Download our Free ebook – SMSF – Australia’s most popular way to save for retirement.  Click on the “Learn more about SMSF” button on the right of this page.

Download our Free ebook – SMSF – Australia’s most popular way to save for retirement.  Click on the “Learn more about SMSF” button on the right of this page.

The establishment of Self Managed Super Funds (SMSF’s) to borrow and purchase an investment property continues to grow in popularity.  The government provides a lot of tax concessions to superannuation funds, and as a consequence, places restrictions on what they can and can’t do.  When it comes to superannuation funds and borrowings, the restrictions are particularly prescriptive and onerous and it is important anyone pursuing such a strategy seek out specialist advice (SPAA accreditation should be sought out).

I wrote recently of a potential trap for SMSF trustees around improving property purchased by your fund.  Another area that has the potential to wrong-foot people concerns the outcome where a property is destroyed.  There are very specific rules around “replacement assets” where a Self Managed fund has purchased an asset (we’ll assume a property here) using borrowings.

Were your rental property to suffer a fire which destroyed the kitchen, there is no problem in having your insurance company repair the damage, provided, as per previous comments, the property isn’t improved in the process.  The problem comes where the property is entirely destroyed.  The Tax Office have stated that there expectation is that in the event of complete destruction of the asset, the insurance proceeds will be used to clear the debt, and then a new loan facility will be established to cover the rebuild (if rebuilding is what the trustees decide to do).  To have another home built whilst retaining the same loan would be considered a breach of the replacement asset rules.

Now there are a couple of issues with this.  For one, some insurance companies don’t offer cash payouts.  They insist that the property be rebuilt.  So trustees will need to check that cash payouts are possible for their policy.  The second issue is that the loan is not just for the building, but also for the land.  Imagine this scenario:

$600,000   Purchase price

$200,000   Building value (and insurance amount)

$300,000   Loan amount

The home burns down, $200,000 is paid by the insurance company.  This is paid off the loan as per the ATO’s expectation.  However a $100,000 debt remains.  And there is now no rental income coming in to service the loan.  In this case, unless the SMSF has other funds available to clear the debt, then the land will need to be sold.

As an interesting aside, after the Queensland floods the ATO was asked how they will go about applying the above interpretation of the laws given many homes have been completely destroyed.  They indicated they would not look to pursue people who went ahead and rebuilt.  A sensible and pragmatic approach.  Too bad it’s not provided to all Australians.

Superannuation contribution caps have long been a frustration for those endeavouring to save for their retirement.  Of particular concern has been the treatment of contributions which exceed the cap (known as excess contributions).

In last nights Federal budget, the Gillard government made some very modest concessions in this regard.

The Government will provide eligible individuals with the option to have excess concessional contributions taken out of their superannuation fund and assessed as income at their marginal rate of tax, rather than incurring excess contributions tax.

This measure will apply where an individual has made excess concessional contributions of up to $10,000 (not indexed) in a particular year and will only be for breaches in respect of 2011-12 or later years, and only for the first year in which the breach occurs.

So there is no relief for excess non-concessional contributions (ie. contributions made with after tax money), no relief for problems already in the system, and if the excess is over $10,000, you are out of luck also.