The Elephant in the Room Property Podcast | Australian real estate
The Elephant In The Room Property Podcast with Veronica Morgan & Chris Bates


Episode 83 | Alternatives to direct residential property investment via ETFs | Balaji Gopal, Head of Product Strategy, Vanguard

IMG_1437 (1).JPG

The importance of staying on point when investing

Balaji Gopal, Vanguard’s Head of Product Strategy explains alternatives to direct residential property investment by way of index funds and exchange traded funds (or ETFs). We also discuss the many similarities of property investing & share investing & the associated behavioural biases.

Balaji shares his knowledge & demystifies:

  • What are index funds and how they work?

  • How fees can be kept low without creating a substandard product?

  • Can you access commercial real estate via ETFs?

  • Why having a goal, doing research & staying on point long term is vital

  • Understanding long term financial goals & why you are investing.

It’s a great episode, we hope you learn as much as we did.

Ep 1: Simon Russell
Ep 45: Noel Whittaker
Ep 39: Stuart Wemyss
Ep 73: Roger Montgomery

Guest Website:
Balaji Gopal : Vanguard Investments

Work with Veronica?
Work with Chris?


Please note that this has been transcribed by half-human-half-robot, so brace yourself for typos and the odd bit of weirdness…

This episode was recorded on 1/8/19.

Veronica: You're listening to The Elephant in the Room Property Podcast where the big things that never get talked about actually get talked about. I'm Veronica Morgan, real estate agent buyer's agent, cohost of Foxtel's Location, Location, Location Australia and author of a new book "Auction Ready How to buy Property Even Though You're Scared Shitless".

Chris: And I'm Chris Bates, financial planner, mortgage broker, and together we're going to uncover who's really making the decisions when you buy a property.

Veronica: Don't forget that you can access the transcript for this episode on the website as well as download our free Fool or Forecaster Report, which experts can you trust to get it right?

Chris: Please stick around for this week's elephant rider bootcamp and we have a cracking dumbo the week coming up.

Chris: before we get started. Everything we talk about on this podcast is generally nature and should never be considered to be personal financial advice. If you're looking to get advice, please seek the help of a licensed financial advisor or buyer's agent. They will tailor and document their advice to your personal circumstances. Now let's get cracking.

Veronica: We've had numerous conversations in recent months about alternatives to direct residential property investment and in a number of past episodes you have heard us mentioned index funds and exchange traded funds or ETFs. So we thought today that we should delve deeper into this world to find out exactly what these funds are, how they came into being, whether the increase in popularity is purely due to them being low cost. And there are any that offer exposure to other sectors of the property market. Where better to direct these questions then to a representative of the very organization that invented index funds in the first place, Vanguard pioneered the concept of indexing, introducing the first retail index fund in the u s in 1976 and since then, the Vanguard Group has grown into one of the world's largest and most respected investment management companies and Vanguard now has a global presence with offices in the US and here in Australia, as well as Asia and Europe.

Veronica: In this episode, we pick the brains of Balaji Gopal, Vanguard's, Head of Product Strategy in Australia. Balaji has experience working across government, financial services, investment and management consulting sectors. And at Vanguard, he works closely with global teams in the design and launch of new products as well as implementing changes across Vanguard suite of investment products. And we're looking forward to learning more from this chat. Thank you so much for joining us.

Balaji: No, thank you for having me.

Chris: Thank you. Balaji. I love index funds. I'm not ashamed to say it. Um, you know, I use them for lots of clients and you know, they've kind of come all the rage a little bit, but can you please explain just really what is it and how does it work? You know, because a lot of people would kind of have a misunderstanding that it's just, you know, you can buy it and you just, you know, just money just kind of goes up and you, there's no risk involved with it. But can you tell exactly what is an index fund?

Balaji: Chris thank you. Um, unsurprisingly, we also like index funds and um, we, um, we globally we manage, close to seven and a half trillion, which is through a combination of index funds as well as active strategies. And we'll talk about what that means in a second.

Veronica: So hang on a minute globally, you manage seven and a half trillion dollars worth of index funds, which is basically the value coincidentally of the Australian property market.

Balaji: Yup. It's seven and a half trillion in assets across active funds, index funds and, and a number of things. So.

Veronica: Thanks for clarifying.

Balaji: But I mean, just give you an idea. I think the Australian stock market is, what two to 3 trillion?

Balaji: Two and a half years.

Chris: Yeah, two and a half, three times Australia. Um, you know, bigger than a lot of countries in the world. Um, we're honored to have you here. Um, seven half trillion a lot of money to the question. You're going to tell us what an index fund is.

Balaji: Absolutely. The first trillion is usually the hardest, the best. Um, the best way to understand an index fund is to talk about, um, what is not an index fund. And then draw it back to what an index fund is. Typically you have, um, when people want their money managed professionally, they would engage the services of a professional fund manager, investment manager or an asset manager. They all mean the same thing. What they do is people and entrust their monies to a manager who might invest that sum of money in a certain way. That is agreed between um, in a for legal reasons as well as with the client. Basically the notion there is you want to know how this money is going to be invested, what it's going to do, but more importantly what it's not going to do. And some of these managers then, um, pick stocks or bonds as the case may be for whatever strategy that they're running.

Balaji: And the notion is that they will try and generate a positive return over time that you as a client will benefit from. And for the purposes of this, they charge a fee which, um, which comes off some of the return. And the notion is that over time the returns will be, um, in a positive, sustainable way that will well and truly offset the fees. And you as an investor, uh, benefit from the results. Typically these active managers and we call them active because there is a notion of they are making an active choice to invest in certain stocks. They get measured against what is known as a standard index. And the notion there is, if this manager was compared to just a standard index fund and an index is essentially just a collection of stocks that might represent either a certain country or a certain sector or something like that, say from an Australian standpoint, you look at um, the ASX all ords, which is the All Ordinaries Index or the S&P ASX 300 or the 200, which is essentially the top 200 or 300.

Balaji: So if, the notion there is if a manager and manager is looking to run a strategy that is similar to that index type of exposure. Yep. Um, or broadly around Australian equities, then how has this manager performed relative to just a standard index where nobody's speaking stocks there? It's just a collection of stocks that had been put together based on very rule space set criteria. Yup. So from, um, so this was a, a very longstanding practice from an investment management perspective globally. This is how money was run as a active managers, pick stocks or pick securities and that's how many was run, um, in about, um, and the early 1970's. Um, and this is, this is when the whole concept of indexing started to take shape. Um, it was, um, it was a professor by the name of Paul Samuelson who wrote a, uh, a theory saying, hey, most of these active fund managers can never beat a standard index.

Chris: Yeah.

Balaji: Most, there are people who perform, and this is not a blight on people who pick stocks, but the notion is that when you strip back the returns. Many of these investors can't beat the index. So, oh, this person wrote an article and said, somebody in this world should look at creating an index fund. Right. This was, this was obviously a very foreign concept. And Jack Bogle at the time, who was the founder of Vanguard a, um, he took on that challenge and he believed in that concept and he was also off that view. And um, so long story short, Lo and behold, Jack Bogle created the first index fund in the world.

Chris: Wow.

Balaji: Um, which was, um, which was a u s total market exposure and it took a very, very, very long time or that index fund to take traction because it was a very much a disruptive force in the industry. It was, I think he was accused of I'm being un-American and it is, um, because it went, it went against the whole notion of, you know, you're going after the winner and facing performance. So that's essentially, that's a, I'm sorry it's a long answer, but that I thought the history was important to talk about what the index fund is and how it came up to be.

Veronica: That's an interesting point because weed stocks, you can pick little bits and you know, a few shares in that company. If you choose that company in that sector and that industry in that country, you know, you can actually truly have a diversified portfolio as distinct from property. People talk about diversified property portfolios. But really and truly it's such a lumpy asset. So, therefore it's really difficult. You have to be, you have to be a billionaire to be able to have a diversify property portfolio. So, so therefore with property, when you've got one asset or only handful of assets, then it's important to outperform. Um, and also cause you got big costs of getting in and getting out and all that sort of stuff. It's important to try to outperform the rest of the market, you know, and that's, that's really how you're gonna make it work. But with stocks cause there's additional costs involved in managing those funds and managing those, those assets, all those portfolios over time. Then it's a, you know, like the whole concept of not trying to outperform is an interesting one. Cause I mean, as you say, it's like John Bogle was accused of being an American cause it's like that's not the entrepreneurial way. Right, right. Yeah. So it's fascinating though because the cost aspect of it, part of it isn't it?

New Speaker: That the cost aspect is, is fundamental to it. And, um, and I'm, Jack Bogle also pioneered the whole concept of, um, this stop investing doesn't need to come at a huge cost because nobody in the world can control, um, how markets behave in certain conditions. People might have a view, economists might have a view, stock pickers might have a view, but nobody generally in aggregate knows how things are going to play out. It's the degree of certainty people might have different degrees of certainty, but, um, to the extent that you're investing in an index fund or an index strategy, then you're getting access to the broad cohort of that exposure. Now, if I talk about in Australian exposure, it's, if you're talking about at the top 300, you know what you're getting. It's the top 300 and how that performs and the one thing you can control is cost.

Balaji: You can't control the markets, but you can control what you pay. And from an investor perspective, the guiding principle is if you pay, lower costs, you keep a lot more for yourself and um, and that's helping you from your, towards your goals. So cost is one thing that can be attributable to an investor in terms of, um, you know, everybody should have to pay the lowest cost possible, particularly in investing.

Veronica: And that keeps more funds invested,

New Speaker: That keeps more funds invested in and more, more of your funds are working for you to make your goals and your objectives rather than paying. Um, and then an external investment manager who may or may not be, um, outperforming the benchmark. So yeah, cost is a very, very critical component and absolutely risk as well.

Chris: Yeah, you might, I mean, unAmerican, you know, it's usually people might, these kind of real big personal of challenges, you know, when they feel threatened because so all the other fund managers back in the 70's would have been really threatened by this because I, it's someone doing something that makes them accountable because if they can, if that strategy index could beat them, then that means that they haven't really got a job that's actually, you know, really a job. Because if they can't outbet the index, then they know they shouldn't really be working.

Veronica: Warren Buffett's famous bet on that. Right?

Chris: Yes. Well that's right. And he did make that and he won that bet, you know, handsomely against hedge funds. But it's also the same problem that financial advisors face because in the past a lot of financial advisors were seen as their job was to outperform investment markets and that's why you would go to a financial advisor to teach you how to invest money or actually to manage the money and actually to invest it.

Chris: But for a financial advisor to decide, look, I don't do that. I don't know where the world's going. I'm not. I can't outperform investment markets. A lot of financial advisors were kind of put to the side and said, well what's your job? You haven't really got a value proposition. So financial advisors have had to kind of grow as kind of as a profession and to realize that, you know, recommending index funds is actually in the client's best interests and it's actually, you know, doing their job. Right. You know, because all the stats are there to of prove that since the 70s but you know, 80% roughly fund managers don't outperform the index. Is that kind of roughly the numbers?

Balaji: That's right. It's closer to 90 yes. Yes.

Balaji: And so 90% of.

Veronica: So you got, you know, you managed to get one of those 10% of active investors or fund managers or stock brokers or whatever you want to call them, that can actually consistently out perform. Because of course the data does say that, you know, most of them, if they out perform, might do it for a year or two or maybe three years and then they'll have a bad year. And so when you aggregate it over a period of time at that, that's when the, you've got to measure it. So you've got that those people will cost a hell of a lot of money to get to manage your money.

Balaji: Absolutely. It's very high and Oh, few points. This whole notion of um, um, active managers criticizing indexing hasn't stopped and that still continues and that will continue. And like you said, because it's disrupting their business model. To be very clear, we are not saying that active investing is bad. Um, especially in the last 10 years, a lot of money has come to indexing strategies, whether they're managed by Vanguard or anyone else from active managers. But the most important point there is it has come that money, that shift from an active to a passive strategy has come from poorly performing active managers. There are managers who consistently yes, um, you know, from a, from a long standing track record perspective outperform. And so we believe in that. I think the challenge there is it's finding these managers. Now Vanguard has about a trillion and a half dollars of active strategies as well.

Balaji: Um, uh, in, in the u s and um, and we'd be talking about what on what shape that would take in Australia. But the one thing, whether it's active or passive, is to just consider the lowest cost that you could possibly pay to get access to that strategy. If you can do that and you can find some fantastic managers who can outperform that is good, but the, whether it's outperforming or what level of exposure you might have to a certain sector or stock, it's always got to come back to your goal because what difference does it make if somebody outperforms a portfolio, which is negative 10% and an out and a fund managers outperform by negative 8%. The reality is you've just lost negative 8%. So what does that do to your goals? So these are some fundamental things that investors need to think about. What am I in, what am I goals? And as a consequence of which, what is the mix of assets, how do I get access to and what is the lowest cost and paying. And, and Jack Bogle always said, you know, he, he had the saying stay the course. And that is fundamentally important because

Veronica: yes, yeah,

Balaji: it is. It is so fundamental that, you know, investors will always behave irrationally. And I'm not talking just average, um, retail investors or advisors, I'm talking large institutional investors. We're just humans so we behave irrationally. So I think from, from that perspective, you just need to make sure that you understand what your goals are. You stay the, course and when markets go down, it's not a, it's not the case of, you know, selling down assets or when markets go up, you know, you, you're having the fomo effect and wanting to buy more assets. So, I mean, you would have seen this in, I'm playing out in property.

Veronica: We do. We, it's all the same stuff and it's behavior. I mean, our very first episode for anyone who hasn't gone back and listened to it, with, Simon Russell, who's a behavioral finance specialist, behavioral scientists, and you know, he reflected on, I'm going to an auction and talked about all those behavioral biases that he could see played out. And of course he's, he's built a whole career and written a couple of books on behavioral finance. Yeah. Um, and so yes, you can be. And now I see that in my business and we in turn my team, you know, we buy property for a living when we're buying it for ourselves. Um, we can be so impacted by our elephant. They're, you know, our, our subconscious mind, even though we know we know better, we know different, we know better. So we use each other as, as sort of an honesty box, if you like, you know, because exactly experts can still be swayed. Experts can be swayed because they feel that they've got to justify their previous claims or you know, if they've made a call on something and they don't wanna look like they don't want to look foolish. Like, there's so many things that can result in that. So I guess that's all taken out of an index, isn't it? But what goes into an index, what does it, cause there is lots and lots of different funds aren't there? And so there's obviously gotta be different measures or different guidelines or criteria as to what companies or, what shares go into individual funds and are all index funds sort of equal?

Balaji: No, that's a great question. So the way it works in the industry is you have companies like Standard and Poor's, the S&P or MSCI or FTSE people have heard of the FTSE 100 Index, the MSCI world ex Australia or S&P ASX 200. These are companies who provide index related information sed on certain methodologies. So definitely to answer your question, not all the index or indexes or indices are the same. Um, but, um, it, it comes back to what is the methodology that is gone into building that index. So an Australian 300 stock index is going to be very different to an MSCI World Index, which will have, um, you know, a few thousand stocks. So again, it goes into the exposure you're trying to get and what is the best possible way to get that exposure. That's important. And consequently, I spoke about two broadly diversified exposures.

Balaji: You have some very narrow exposures. You could construct an index out of anything based on certain rules. You could construct an Australian financials, um, index, which is, which will be investing in the four banks plus maybe Macquarie from a Vanguard standpoint, the way we look at, um, when we look at whether we launch a product and what sort of product should we launch, what is the index it should seek to track if it is an index strategy? Is, is it broadly diversified? Um, and, and also one of the questions we want to ask ourselves is, will this strategy have a long standing investment merit? Now can the strategy be available, you know, 10, 20 years from now or 30 years from now and still generate an investment outcome for investors who want to invest in it. So what that does is it takes us away from going down.

Chris: the latest trends, the latest trend. And this is what's happening in index investing because, you know, it's got a bit of a name to it now, there's an enough confidence to what we are starting to see indexes, numbers in an investment options kind of proliferate. Um, I wanna, you know, you buy an index in, you know, a health or automation or AI indexes or you know, gold or, you know, and it just keeps on going and or aging population or,

Veronica: so there's sort of like a punt on an industry or, or a demographic or isn't it so.

Chris: Dramatic ideas that, where things may go in the future. And is that really fundamentally great investing or is it speculation.

Veronica: Because it comes away from those principles, doesn't it?

Balaji: Absolutely. Okay. And you know, I think to add to what Chris said, you know, recently there was also a marijuana ETF or a bitcoin ETF.

Veronica: And, and, um, say that thing about risk we're talking about.

New Speaker: and in the US there was a triple leveraged bear ETF , which means you're essentially taking a punt on market's going down, but you've leveraged three times.

Speaker 2: Oh my God.

Chris: Yeah. I mean, well, you know, like,

Balaji: isn't it like the whole selling short don't go crazy.

Chris: Yeah. And like, you know, and technically there's, you know, there's companies here like Vanguard's got, there's a number of different, you know, you know ETF providers in Australia and one of those offers, one of those type of ETFs in Australia. And there's times in the cycle where, you know, like people may want to use these ETF but they're not, you know, buy and hold, you know, options that you hold for a long period of time because they are extremely expensive. And you know, if you do hold them and you buy them at the wrong time, things go bad pretty fast. And so you've got to be really careful. A lot of people think with index investing is you can't go wrong and you can just hold it, et Cetera, that you've, you've got a really kind of opened the tin a lot because they're not all equal in the, you know, they're not all risk free. In terms of indexes though, um, in terms of like where, you know, people can get in access to property in particular, um, what are some of the ETFs that you offer because you know, it's pretty easy to get access to commercial property on a global scale, isn't it, via some of your products?

Balaji: Absolutely. So we, we offer non-trade non-direct property, exposure through ETFs and funds. So Vanguard we offer for funds and ETFs away, almost agnostic to the strategy. So we offer, um, um, an Australian RIT index, which is essentially a RIT a real estate investment trust. What it is that it's just a, a collection of companies that invest in properties and the types of property we are talking about typically not residential, but unless you're talking about the Mirvac's of the world who are building big residential developments, there's still reputable body. So these are companies that are listed on the stock exchange. They invest in um, um, commercial buildings. They invest in shopping centers, they invest in, you know, big industrial or Stocklands of the world.

Balaji: Dexus and Westfield and the Westfields of the world from our stand point. Again, S&P constructs an index, which is an ASX 300 RIT index. We invest into that. Now, whilst it gives you a diversification away from just residential property, you also need to understand with an index like this, there's roughly about 29 stocks in the index. No, there's not a lot, especially because the segment is narrow and this is probably the point where we would, we're okay, but you know, it's still only 29 we would, we would be quite happy with 290 but 29 is small. But that's not to say that it's a, it's a bad outcome. It's, it's still relatively concentrated. These companies invest in a number of, um, um, buildings in, um, in Australia. And because it's an Australian based structures, you have the benefits of um, some that and I'm franking credits some flow through as well,

Chris: thanks to labor. Excellent.

Veronica: And the John Howard.

Balaji: And the flip side to that is, um, if you want to truly diversify, um, then you look at a global, um, RIT world where you have, um, a lot more stocks, um, you know, about 600 or more, but that's investing in different markets. And again, trying to get the same outcome. You don't have the massive benefits of franking there. Um, but it's, these are very different types of exposures and if you really want property exposure, this is a way to do it. But at Vanguard, we, um, we caution people to say, we think, and you know, both of you would know better than anyone else that, um, you know, Australians have an overexposure to property, but there's, there's other factors that are influencing that decision. So if you're trying to diversify away from that, then whilst property is a way there's, you might want to think about diversification more holistically because, um, there's such a strong exposure, like even our Standard Australian 300 stock exposure has about an 8% allocation to property, but it's not just the direct property allocation that you might be making. It's also you could be getting more exposed to property through other may other means. Yeah.

Chris: So, you know, not really getting, saying much more diversified property on property or property.

Balaji: Yeah, that's right.

Chris: Yeah. I mean there's um, one of your products that you've released, um, last year I think it was, I think it was in, um, it's something called like your diversified ETFs. Yep. Um, and I guess what these are, is that you, instead of buying, you know, lots of different indexes, um, and having that, you know, the challenges of managing different that are all performing differently. Some are doing well, some aren't doing well. Um, and then potentially having to rebalance and sell some and buy something, you can actually buy something called a Diversified ETF. Can you doa bit more explaining how that actually works, um, for consumers and, and why they potentially might be a good option for some people.

Balaji: Absolutely. Well, all right, talk about the product. I'll talk about the rationale behind how we think and how that's translated into this product. At Vanguard, our core principles are we need, we think people, investors should start with their goals and then they should start with a balanced view of, you know, what is the mix of asset allocation that will get me there, whether it's stocks or bonds or it could even be, you know, what if people are holding property then you know, am I diversifying enough and you know, what is the right risk and return that I'm comfortable with. And I think risk also needs to be something personal. It's not a mathematical measure in terms of, you know, how comfortable am I to lose money and what are the behaviors that I might exhibit when I start losing this money? Again, we're getting into the behavioral aspects, which I'm no doubt you're seeing in property. We also think cost is a big aspect of it. And then the final one is, um, the discipline. It's about staying the course. So once you decided on this stay the course, no matter what.

Veronica: which he's always going to be easier if you've actually taken the time to work through your goals and plan it, isn't it? Because then you think, well, I've made these decisions for good reasons and so therefore I'm confident enough to just let it go.

Balaji: Yeah, absolutely.

Chris: Yeah. And it's a good point actually, because if you haven't taken the time to stop before you invest and you, you know, and I'll have this very, very common, almost daily, I'll speak to you know, clients and whether they're investing in property or thinking or they're thinking about, I can't, I'm not going to invest in property for a few years, so maybe I should go invest in, buy some shares or whatever. Um, not many people think more than two or three years down the line. Um, and you know, generally speaking, you know, there's things that happen, right? I want to do, start a business, you know, start a family, um, or I wanna buy a house.

Chris: Um, and you know, and it's all going to buy an apartment and I'm just not ever going to be big enough because we're going to have a second child. Um, and you know, that's our plan and we're going to outgrow it. And so, you know, just taking that time to really think how your life's going to change and what your requirements are and if you're going to need this money because if you are going to need that money, you know, two, three years is just not enough time or runway to invest and if you are in, so it's easy for people to say, Oh, you know, keep it there and keep it there forever. But if you haven't actually realized and actually done the numbers, you can't actually keep it there forever because you need it in two years. So you know, if you are putting investing money, you really do want to know that you're not going to need that money. And ideally not for a long, long time.

Balaji: Yeah. And we think all investing should be for the long term because it, if nothing, at least it gets rid of any short term behavioral biases that you might come into. And coming back to the diversified story. So based on these principles, Vanguard's always launched, a multi asset class diversified strategies, which is not just, um, diversifying across asset classes, but also sub asset classes. We're going gonna talk about equities, it's all stocks. We're looking at, um, should it, what proportion should be in Australian stocks versus global stocks, bonds and, and, and, and other categories. So we, we've had these diversified strategies, which had been a plain vanilla approach. And um, you know, they've been very successful with a lot of, um, investors in Australia and globally just investing in strategies like this. Around about last year we looked at how do we improve the access to this for the number of people?

Balaji: And we just created an ETF version of the strategies, right? So essentially what you are getting is you can buy a diversified portfolio as, as if you were buying a stock on the Australian Exchange. And we'll talk about what ETFs mean and what are the differences in the second. But it was, um, it just made things very easy. And for people who want to, um, have access to a diversified portfolio, you don't want to think too much about wanting to manage, um, and monitor market movements and, you know, the rebalancing and thing. Yep. All of that is incorporated into this product. It's, um, it, it incorporates some of our best thinking by our investment strategy group. Um, and um, and ironically, it's, um, when you keep something so simple and so low cost, not just about performance but it's, it's outperformed and it's been in the top quartile across one, three, five, seven and 10 years. So, uh.

Chris: and to give you an idea, I mean, um, so in the past, prior to this new product with is these diversified ETF's, which, you know, investors can go onto the stock exchange and buy any, in. The way I kind of think about it is depending on the strategy, you know, low risk, medium risk to high risk, cause there's a number of different funds, you can pretty much buy every single company in the world. Really. That's right through just going on and buying one share on the stock market, which you can do via a broker, which is can be done within minutes by setting up an account with Comsec or CBC or you know, a stock broker could actually buy one share in every single company in the world and then have almost half ownership in every single company and then also have a strategy that technically over time wouldn't it?

Chris: Yeah. Everything from US to Europe, Japan to Asia to, you know, all over the world and just through one trade. But before you did have these strategies, but you'd have to have a minimum, you know, amount to go into them. You'd have to fill in a, uh, application form. You'd have to send it off, send a check, etc. If you ever wanted to sell it, that whole same process would have to happen. So it was very difficult to kind of get in and out. Now, one out of the ..

Veronica: You can do it online. I mean, I mean I've got to, you know, I might through my bank, you know, I've got my access to my share account, my little list of ETFs that you know, that I've got. Most of them are Vanguard, not all but. Um, and I did all that research as to which ones I was going to choose. And then afterwards I think it was like, oh, it could have just bought one diversified. Yeah, I'm not going to touch them anymore. I'll just add to them.

Chris: So the elephant in the room is 100% for you.

Veronica: The reason that Chris and I do this podcast is because we passionately believe that property buyers can do it better. We really want to help all of you understand all the risks, but also the ways in which you can avoid your elephant making a decisions.

Chris: But what we would love for you to do is just to share this episode and share other episodes with people around you that are going through the property process. Just by you sharing our episodes, you're really helping us.

Veronica: Give us a review on iTunes. Five-Star please will be very appreciated because this is about making sure that we all benefit from the wonderful information that our guests have been sharing with us.

Chris: I think the Vanguard fee model is something that people don't really understand. Um, and it's quite a lot the ultimate fee model for people because, um, you know, you basically, as soon as Vanguard stakes starts making more money set up, postie it onto investors, they pass it onto their you know, people who are investing in their funds by reducing fees. Can you explain how that actually works and why you do that?

Balaji: Absolutely. I'm sorry, I should have explained that at the outset when was talking about Vanguard, but Vanguard has this, some uniquie structure, which is called a mutual structure and like indexing to explain the mutual structure. I'll explain what a, what is not a mutual select and we can come back to it. But typically, uh, organizations that set up, and especially if you're talking about financial services companies, people might have a few funds. They might run certain strategies, they charge a fee, a portion of that goes into their profits. And, um, and that's the more of the capitalist model, which is it's on to make more money for the capitalist. Um, what a mutual structure is in from a Vanguard standpoint. And it's pretty astounding because Jack Bogle, when he was a late teenager, he wrote a thesis on the fact about how do you manage the conflict between managing money and an investor's needs, um, which is pretty astounding. And the, one of the reasons why he wanted to set up Vanguard was not to start off the indexing fund, but to try and address this conflict. And, um, and if you look at all of the things that have panned out from the Royal Commission, fundamentally it goes down to that, you know, how do people manage the conflict between the shareholder and an investor, a shareholder, and, and, and an, an a customer who might be investing in a client.

Chris: So versus, yeah, they advisors greed. That's right. Technically, versus the customers. Great. Yep. And who's about really, who's, where's, where's the line here?

Balaji: That's right. So Vanguard was set up as a mutual structure, which structurally that means all of the Vanguard funds own Vanguard and by extension all of the investors in Vanguards funds, own the Vanguard. And what that means is we don't have an external public, we are not publicly listed. So we don't have, um, an external investor group coming in and expecting returns from us. We don't have a private owner who, who puts all this pressure on us. Even Jack Bogle started the firm, he grew up become a billionaire starting this firm, but he chose to do it this way. And this was one of the primary forces for setting up Vanguard. So I think it's, um, it's, it's resulted in, in us looking at, um, being extremely client focused. And the way we do it is our model is we build, um, the best performing funds or ETFs.

Balaji: We, um, we built scale on them and once we reach a certain scale, we then pass back those returns through fee cuts back to our investors. And this is vicious circle where we, we raise assets, we um, and then we lower the fees, which then which sees more assets coming in, which we cut down the fee. So we've been able to bring down the cost of investing globally by consistently across our entire product suite in all of the markets that Vanguard operates. And so it's gotten to the point where when Vanguard tries to go in and set up operations in certain new countries, and this happened in, in Canada recently, how about the other incumbents there? Their stock price went down. Now that's almost, we call it internally as, and the media calls it the Vanguard effect. But again, we're not, we're not about trying to market or do something giving this is, this is all about looking after the client's need and keeping your costs low and just that message has been able to, um, and especially if you're a trusted band one that investors trust, I think we've been able to build scale because of that rather than deliberately trying to chase growth for growth's sake.

Veronica: It's really interesting isn't it? Because, you know, like you said, under management, you've got seven point 5 trillion in the world, right. In Australian dollars, yes. In Australian dollars. So it certainly hasn't impeded your growth having, having that much more, altruistic vision, and values at the outset. It's actually, you know, there's gotta be heartening really I guess. And I didn't know that to be honest, so I didn't know it came from that I'd had no idea. I just invested because originally I came across the concept through an article that Noel Whittaker wrote and we interviewed Noel Whittaker a while back Yeah, great interview with Noel. And I read in an article that he wrote in the Herald, this is some time back and I went, oh, this sounds interesting. And I started researching it myself and sort of then came up with all these, um, ETFs that I decided that I would invest in.

Veronica: But then, then Stuart Weymss and we've, we've interviewed Stuart Weymss who is a financial planner and he's very much, you know, along the lines of evidence based investing and, um, and in his book Investopoly. So, um, I read his book and that has a really good explanation of it as well. It's interesting though, because sometimes when I'm talking to people about ETFs, I say the problem is that the, um, yeah, no, I'm going to try and work out how I can explain this, that, that like for instance, if you've got the low performing stockbrokers in equities, you know, fund managers and all the rest of it, they start then funneling all their clients into ETF. So then they're buying a piece of the S&P 500 or you know, whatever. Does that then perpetuate share prices that, that I would not, they're not really free trading then because they're actually trading as an index rather than individually on the, on the stock exchange. Does that make sense? Is that an issue?

Balaji: It perfectly makes sense. Um, and it goes back to the question that I'm, well, the point that Chris raised at the outset about, you know, on managers coming in and, you know, criticizing indexing. Yeah. We've, unsurprisingly we've done our own research from bottom up perspective in terms of what does this mean and not just because we're in, we're a predominant indexing business, but also because we very concerned about if, if it's not the right thing for clients, then that is of a concern to us. So we think that indexing still forms a very small component of the overall investible universe. Yeah, it's rough. You know, 10 to 15, 10%. Yes. It has grown quite phenomenally, but it's still a small chunk. Um, active managers. So people who are picking stocks and securities still constitute the vast majority of the, of the,

New Speaker: they're not a dying breed.

Speaker 4: They're not, they're not a dying breed and we, we don't want to come in and just I suppose and say indexing is only the way. We just think that in 90% of the cases it does its job. And there are some good active managers who will also tend to outperform. So also if, if, theoretically, if, if this trend keeps continuing, it'll just generate more opportunities for active managers to come in, look at these distortions and then buy certain stocks or sell certain stock just to try and do what they do best. And we just haven't seen that player. But again, it comes back to indexing is still a small part. We don't think it's anywhere near the point where of this starting

Chris: really. I mean, I, I, my, I kind of, you're on it. You're right. If, if indexing was, say 70 or 80% of the market and you know, that would potentially start to create some issues, but it's not, and really the way that Vanguard I think are growing, you know, and other index funds are growing so much, is there taking money away from what I would consider lazy investment managers? And you can very easily what those investment managers are because, um, you know, the correlation of their funds, um, and you know, how they perform, he is extremely similar to how the index is. Um, and you know, so Australian share manager, um, you know, would invest in a broad range of stocks and their correlation to the Australian index is not 0.9%. So whatever the Australian market does, they do. And so those fund managers who have these very high correlations and they charge a high fee to do so,

Veronica: and that's usually your percentage as a under management. Yep, Yep. Yeah. And therefore they're doing effectively the same thing or maybe even cheating and using index funds and then charging more money for that for the privilege.

Balaji: Another way to describe what you said, it's a, it's a great articulation is we call it in the industry benchmark hugging. So some of these, um, yes, managers need to manage these strategies, but what they do is because of the fear of reprisal of underperforming index, they run their strategy very, very close to the index. So again, and when you overlay that with the cost, they are almost guaranteed to underperformance. So

Chris: it's a really good point actually. So it's called, um, you know, if you, uh, even if you got like for example 10 fund managers in a room, um, and you, the name of the game we funds management is to build up a fund because your model is based a percentage of that. So you don't really care so much how it's performing as long as the fund is growing because your revenue is based on how much money you're managing. And Fund managers get to a point where they're making good money and they've got a fund. And the last thing they can do now is to underperform. Because if soon as you start getting onto performance, it starts, the investors start saying, well, why have I got my money here? I'm under performing the index. And so, um, what they all basically do is they start to hug the index because they want, they want to do is to, so no under performance is that why upset the investors, but they don't really need outperformance.

Veronica: It's stressful, stressful. I just exhausted just even trying to think of working like that.

Chris: Yes. But I mean, he can't knock them because as a business now they've got staff, of course, they've got offices, they've got marketing, they've got branding.

Veronica: some sort of value value proposition to get people in the first place and you know, and then you've got to keep earning. You got to keep proving your worth and saying, you know, I, you know, we're on the right thing. He, you know, you'd be doing worse off if you did it by yourself.

Chris: Yeah. And so basically we have these funds basically end up hugging the index and charge, you know, 1% for it. Um, and, and where these kinds and over time though, they slightly underperformed because of their fees. It's hard. The returns are underperforming just to keep ahead of the index. And they basically, at some point the investors switch on and then they start going into someone like a Vanguard. And, um, that's kind of what happens if I management world. The last thing funds who are doing well want to do is take any risk. And so that's the wall of what you're paying them for.

Balaji: absolutely. And that's why it's so important when you have, um, you know, active managers managing strategies to sometimes, you know, still apply the same principles of, you know, staying longterm because people, if they're doing the right thing, um, sometimes the market, um, is slower to respond. But it's about measuring performance over the long term. You don't want to measure someone who's lost something in a, in a month or six months. You want to look at, you know, over what does the trend look like for one year, three years and five years. And so long as they're, they have this trend towards positive of outperformance, that's what you want. Yeah. But it's not about making any hasty decision just because someone's had a short amount of performance and, and the really good active managers and there are, um, just because there's an exodus of money going into passive, that doesn't mean these people are not doing well, know what the countries that the good ones continue to get good.

Balaji: So it's about being able to find them, staying with them, being patient, and being disciplined.

Chris: It's a really good point. So the active managers that probably had some of the best ones to choose, do go through periods of under performance because January, the way that they outperform is to take risk. And sometimes they under perform because there's risks aren't paying off yet. Yep. Because they're betting on things that uh, haven't happened or may happen. And so the market sometimes goes in irrational ways and these funds, so you'll look at them and you'll go, well that funds not a very good fun because it's underperformed the index by 5% in the last year. But then you look at their three in their five and their seven year performance. And because over that period though there has shown they've actually outperformed. And so,

Veronica: But it comes back to that, you know, what you said originally is having a goal, you know, doing the research, actually deciding what vehicles are going to get you to your goal. And you know, in, in if an active manager has made various calls on certain sectors or companies or whatever based on lots of research and, and an educated opinion, then you know, you've got to stick with that rather than knee jerking and, and, and doing well in the equivalent in the property world is hotspotting you know, trying to, to pick Hobart and apparently Hobart's on the nose. I just saw that apparently there was on the front page of whatever the main paper down there is. I should know it. I've been in it, but um, saying that investors flocked to the mainland, it's all over for Hobart. Dear oh, sorry. I shouldn't, I do

Balaji: and gets interest. That's an interesting point because one thing we've also noticed is investors continuing along the um, irrational behavior hypothisis. They will always, people will always look at wanting to invest in the best performing managers and especially an active manager. We did some work in timely at Vanguard and this was, um, some, some, the results were staggering. We looked at the year 2000, uh, we looked a top performing fund manager first and the second we looked at how they performed in other years. So in the year 2000, these guys were number one and number two in the year, 2005 out of 366 managers that were compared, these guys were 363 and 364, um, pretty close to bottom. It's a wild bottom. And it's, um, which was, which was, um, an interesting analysis because that's why it's so important to not chase performance and bring it back to your goals like you said.

Chris: Yeah. I mean that's, um, and that wouldn't just be that year. That would be very common with that, you know, that are the top performing funds the next year they are what you call dog funds that, you know, at the bottom of the, you know, the pile. Um, I mean, I guess, uh, can you explain how like these type of funds also deal with fun flow issues and um, how you've got to be a little bit careful with some funds that can become in vogue and out of vogue very quickly. And you know, how index investing kind of protects you from that a little bit.

Balaji: Yeah. From an index perspective, we can always, um, one back to, you know, you are not betting, um, on where the other, you are just getting exposure to the market, whether it's a, a global equity strategy or a bond strategy. But what you're doing is you're bringing it back to you in a diversified portfolio context. Say for example, if you've got, um, a stock portfolio combined with a bond portfolio, the bond portfolios seeks to serve as some level of insurance. So say if you have a GFC type event, you know, you'll have the bond portfolio giving you a little bit of a handbrake to your portfolio so you're not losing too much money. When it comes back to some of these, um, some of these strategies who, especially those who are underperforming flow is an important, um, aspect of the business model and the need to continue to raise flows and they need to continue to be able to articulate why the why there's been an outperformance around performance.

Balaji: What we've found both at, um, my experience at Vanguard and even elsewhere is just like in any, any industry. And even you could transport this to an advisor if you're proactive about it and if something's happening and if you can relate it back to, hey, this is what I've tried to do, which was in sync with my investment process, but here are the things that changed and here ae the lessons I've learned or here are the things that are outside of my control. That's okay. And so long as you're happy with that response, that's okay. But the ones who don't do that um, they consistently lose these flows because people end up voting with their feet. Yes. And again, what that does to an active manager strategies. Suddenly when they are losing all this money from their mandates, they, there's an extra bit of pressure to try and retain that which takes the focus away from doing what they're meant to be doing, whics managing the portfolio that their clients have entrusted them. So it's kind of this vicious circles, um, which, uh, advisors would recognize as well. So,

Chris: yeah. So what happens, you know, a lot of the time is, um, it's, it's most advisors make these mistakes and um, you know, they'll build portfolios cause the clients come to them too, manage money and then they'll build a portfolio of 10 funds and then they'll sit that, that inevitably, because financial advisors aren't the best at picking funds and, um, you know, aren't the best at building portfolios and it's very difficult to manage portfolios of funds. The year the client will come in and there'll be problems with the fund, the portfolio, because some funds will be under performing, some will be over performing. Um, they'll have to do a rebalance. The client will come in and expect changes. That's what they're paying for. Um, and it's very easy. The fee, the advisor will start selling the funds that are underperforming, the funds that are out performing because it's an easy discussion. Right? And so what happens is the fund then starts to see fun flows that are leaving and customers are leaving the fund. And then the mindset of the fund shifts. Um, and this, the fund managers are basically now having to sell shares instead of buy shares and not look for opportunities, try not to sell their best companies in their best opportunities. And you know, what happens is that just makes the performance even worse because they're selling shares at the wrong time.

Veronica: The question has to be, how do you find, if you want an active fund manager and probably you're not, probably the great person for us is of, um, how the hell do you find one?

Chris: So you personally, you need someone who's, you know, um, lots and lots of experience and has actually a philosophy that they stick to. Um, and it's usually a philosophy that's contrary in or at least different to what the index is. Um, and they, they, they ride that strategy. So I believe that the best strategies.

Chris: They don't deviate that that is their strategy.

Veronica: That is their strategies. It gets, um, what, uh, it gets, what's the word I'm looking for? It gets improved as they learn more and all that sort of stuff. But it doesn't, the fundamentals don't change. Is that what you're saying?

Balaji: Absolutely. When it comes down to, uh, the quality of the people running it, what's driving, what is the process? What is the philosophy and also the track record. Now we, we have indexing but we also have, um, Vanguard ironically started doing this for the Wellington asset management business. So we've got a trillion and a half dollars of active assets and we have a, a team that looks at finding the best managers, some of the strategies and some of these manager relationships that we've had been in place for, you know, 40 plus years. And so we monitor them. Our, senior management monitors them, our board monitors these managers. And what we do is we get some of these managers to try and articulate what's happened in the portfolio. Why, whether it's outperformance or underperformance, because sometimes people get lucky, but it's again, going back to, um, the quality of the people, you know, perform the, the, the process that they have, have they done what they're going to do and the longstanding track record and the, and what they're trying and the way in which they're trying to do. If you like that, then there's, there's some very good fund managers out there, but they're just very, very difficult to find. And finding them comes at a cost, which again, needs to be type factor then takes away from your returns.

New Speaker: And the hardest thing with performance is we, it's very hard to know over short periods and sometimes long periods, whether it's luck, um, or the is it a skill it's just performance. You just don't know. So if there's a group of 10 fund, uh, fund managers and you look at their performance, um, you know, two or three of them are probably gonna outperform the index because they made a cou of bets and they paid off now and they, and seven or eight didn't perform because they made a couple of bets and they didn't pay off. And it's just hard to know whether that was actually skill. And, um, I think for younger people, um, you don't need over long periods of time. You don't need to play in that space because compounding returns over 30 or 40 years will get you the result that you need for your retirement outcomes. So yes, you may want to do it cause you may want to get a better return. You may want to play around, but there's a risk involved, you know,

Veronica: I think, isn't this as best? Isn't there a best practice of, you know, maximum 10% of your total funds invested or something should be speculative. Oh, is there is, I mean, there's gotta be, there's a fear, isn't it? It's meant to be best practice. Is it 10% or was it five? I mean, you can quite low. Is it one?

Chris: Yeah. Tip in a lot of investing comes from, you know, if you, uh, you want to tell people that you're investing, there's a lot of, um, ego-driven investing in conversations and on picking stocks or, you know,

Veronica: Oh, I know, I hear about it. So, you know, it's, you know, hearing about property at the bloody barbecue, hearing about, you know, oh, I just bought these stocks and I made, you know, 400% growth, blah, blah, blah. It's whatever. And it's, yeah.

Chris: A lot of that stuff is not investing right. It's not really, I'm going to, it's really, you're just doing it because you're interested in it or you want to do it if you're really gonna do the best thing for your future. Yeah. Anyway.

Balaji: What we also find is an overwhelming number of people never talk to you about their losses. No. Exactly right. And then never, ever say, ah, lost this money. Um, and it's particularly, males are very reticent as just, um, call that out. And, and this is a big problem because you have in Australia with so many people, um, running their own SMSF. Yes, I know some of them have lost tons of money.

Veronica: They don't even know it.

Balaji: Sometimes they don't even know it or they're in denial or they're just believing it will come back. But again, it misses the whole fundamental point of they're all goal. The primary goal should have been to protect these assets, to help them in their retirement. And they've just gone in and invested in all these different little stocks. They've made money on some. They've lost money on some. But fundamentally it comes back to the notion that, you know, their assets might not be sufficient to, um, to help them in retirement, which is, which is a terrible situation. So again, we, we always bring it back to the, to the goals because it's not about getting overwhelmed by products. And sometimes when, um, we go to certain events or seminars, the number of people come in and say, you know, there's so many products and what did we do? And then some people come in and say, there's not enough product. I don't think not having enough product is the issue. I think. I think I'm whatsoever, um, and I'll say this even as a product pack practitioner, but I think it's, it's people's ability to relate that back into, in then there needs to be a clear linkage between here's my goal and this is why I'm investing in that goal. And if you don't know that reason and, and even whole notion of, um, you know, what percentage of my portfolio should be and speculative stuff, it's whether it's 5% or 10% or whatever that is, what is the risk that you can withstand if you can't withstand it, maybe shouldn't be in it.

Veronica: That's funny. I've, when I, uh, find it, I had a financial plan done some years back and, you know, you fill in the questionnaire, your, your risk assessment because I, I don't, you know, ask you questions such as, you know, how much money would you be prepared to lose on an investment or you know, those, those, would you, would you invest in it in a, in a fund or if would you make an investment if you thought there was a 50% chance you could lose money, for instance, those sort of questions you get asked. Right? And of course, I, no, no, no, no, no, no, no, no, no. And then, but then it says, would you borrow money? Yes. How much money would you borrow to invest I will borrow shit loads, you know, and, um, and it's like, so I came with this bizarre risk risk profile because it's like, I'm prepared to borrow money, but I won't, I won't actually speculate and I'm not prepared to lose money. And, um, and it's because of the way I think about property. It's like I'm very, very careful. I don't think the risk is in how much you borrow. I think the risk is what you assessed, what you asset the asset in which you spend that money. Right? That's right. Wherever you buy is where the risky is, not the actual how much money you borrow it as, shaming, affordability and serviceability, all that sort of stuff. And so it just makes me laugh cause you know, is there a proper risk assessment of all or that, you know, according to that I'm high risk. I've got a high tolerance to risk in one aspect, but absolutely zero tolerance in the rest.

Chris: No risk profiles are the biggest waste of time. Um, and you know, there's people that their, um, clients don't understand them

Veronica: well if they don't understand the risks and how can you answer the question as well, right?

Chris: Yeah. And, um, you know, there's many different risk profiles out there. I remember when I first started in advice 12 years ago, it was three questions, you know, and it was in a bank. You know, they're there. They've been there to, to allow the advice to go ahead and to facilitate, um, advice and they're actually really pointless. And, um, you know, and they're very, very, you know, there's many different versions out there and really they just allow people, the fund provider or the advisor to recommend a product, et Cetera, you know, to actually go through the whole process, a really detailed conversation and it's really educating clients. It can take sometimes hours and many sessions to actually, because what a client answering those questions, they go in there and they just tick the boxes that they think they should answer, not what actually they need to achieve their goals, what they understand, et cetera. So really they shouldn't even happen. Um, but unfortunately it's just the kind of the means to the ends that they have to go through. Um, I guess in terms of, um, you know, just ETFs more broadly, um, what do you kind of see, you know, the future of investing, kind of, do you think there's going to be any new products that kind of people are going to look for or do you think it's always going to go back to kind of, you know, the, the foundations?

Balaji: I'm Chris, there will always be new products around the world. I think right now there's, um, there's about 7,000 ETFs around the world. I think that's just way too many. Um, but there will always be different providers launching products because especially if you are not in the business of, you know, gaining a lot of assets, almost forced to try different things and see what sticks. Um, and some investors rationally or irrationally will come in and buy those and if they stick that, that's okay. And that's kind of the business model. There's going to be a lot of test and learn happening. Um, so from a Vanguard perspective, it's always going to come back to the foundation. And as I said at the outset, if we don't believe something can be very diversified, fairly liquid and that we can offer at a low cost and that can make its investment outcomes in the longterm, we won't do it. Yes. Um, and um, and for every product we, we as a team ask ourselves, would we invest in it? And the answer's no, then we should be thinking about it. No. Again, it'll come back to the foundations.

Chris: And the reason I asked that question is because next year there will be, and that will be the next year, there'll be all these new latest products and lots of providers of it, aren't they? I mean, new ideas, et cetera like that. But really the bitcoin ETF, yeah, that's fine. But really what you should be doing is kind of sticking to the foundation of what has worked for the last 40 or 50 years. And so, you know, don't follow the latest kind of investment trends.

Balaji: Absolutely. But we're also not saying don't, um, don't just do this because if you are doing something completely understand why you're doing something and you know, if somebody wants to make an investment in a business, we're not saying that's a wrong thing, but you can't withstand the loss of losing your capital. Um, I think that that's where it comes back to fundamentally. And we think for the most part of every investor, what you need is a relatively simple proposition at a low cost and you'll be much better off. And like you said, Chris, the last 40 to 50 years, this is what's worked. And there's no reason to believe that it won't. That's a good point around losses actually because losses a, um,

Chris: Yeah, we've got an anchoring bias that we, um, if it's on paper, we feel like we've lost money, but technically you haven't really lost money until you've sold. Um, and so, you know, like if, if the market's going up or it's going down, a lot of people think that I've made $20,000 because the market went up yesterday and I've lost $10,000 today.

Veronica: But the problem with that though is if like if you said you bought fund into a fund and it goes up and down on every now and then I jump into a lot prepared. Of course when it's all green, sometimes there's red in there, but it's just a daily thing and it pops up. It pops flops. I look at my total balance and just goes as long as it bigger than what it was when I first invested in the fund that I'm happy. Um, The thing is, um, you can get wiped out. I mean, you can buy shit, you know, you can buy garbage. Was it Roger Montgomery was talking about some, some share in the US where their whole, you know, the IPO basically said they never intend to produce anything that ever intend to produce a profit even. Um, and yet people get buying as so what the hell? Some sort of digital, you know. Anyway, the point being there's a lot of really crap properties or sorry, um, yes, there's a lot of really crap properties, but there's a lot of really crap companies that list on the stock exchange and it really crap stocks that ultimately they've got very poor propositions and they get wiped out when there's a GFC and you actually lose your money. Like it's not about waiting until they sell that that will be out of business. And so there's, there is enormous risk as well ever losing everything.

Balaji: Absolutely. Especially if you put a big chunk of your net worth into that. In some cases it's some, as we know it with some business owners, well might put all their savings into the business and make try and make it work. But in a, in a, in a stock where somebody else is managing that and you have no control over group and you put your net worth in it, a lot of people have lost a lot of money, which is quite unfortunate.

Veronica: Yeah. Because somebody else is in control as you say. It's, you know, it's a bit like when you, I read some stat about, um, businesses that have actually been funded by venture capital have a higher rate of failure than those that sell fund. And, um, and, and main reason is apparently because of venture capitalists get to a point where they say, right, what money back now pull the pin.

Balaji: Absolutely.

Chris: Venture capitalist, I think they make 10 bets knowing that one's only ever gonna survive.

Veronica: Yeah. So they just, they're really, they're really, um, they're brutal. They're brutal in terms of their time. That's it. Bang time's up, moving on.

Speaker 4: But ironically, every investor only latch onto that one winner, that venture capitalist had. They will never talk about the nine failures , human nature.

Chris: Every week. We hear incredible stories of the dumb things, property buyers do, dumb things that end up costing you a whole lot of money and a whole lot of stress mistakes that can be avoided. Please. Balaji, can you give us an example of a property dumbo? We can all learn what not to do from these stories.

Balaji: Well I do. And it's, um, it's a combination of the properties slash shares debate. Um, especially in the jeep, just post the GFC. We, um, we saw a few people who, um, use equity in their property to go in and buy some stock as a diversification play. What they did was got a margin loan on that and a, that's a terrible strategy and specific to the situation that this particular stock was ABC. So we all know what happened there. So, um, that was a terrible childcare. The childcare, um, stock bet.

Balaji: Um, I think this is where people got caught up in the situation. Everything was generally going up and people thought they will always make money. Um, and they, yeah, and because of this and the stock tanked, they lost, you know, quite a bit of money in the stock plus the loan and then the property went down. Plus they had to pay back this amount of the property. So it was a completely terrible situation. So the lesson back there is, you know, be careful of leverage. And again, related back to your goals in terms of what, can you, are you, are you able to withstand these losses?

Chris: Reminds me of an ave a interview. I had, um, I got back from the UK in 2011. Um, and I was looking for a job for a financial advice company and uh, I went to these company in Melbourne and the guy sat me down and he's like look. So what we do here is we refinance that home loan, we release their equity and then we get a margin loan and then we go and buy some shares. And um, yeah, that's what we do here. And I'm like? Is that your strategy? And he's like, yeah, that's what we do for everyone. And unfortunately, you know, a lot of financial advisors do work on these cookie cutter models. Um, where the strategy is when you walk in, you know what you're going to get delivered. And um, obviously I didn't take that job. I told him I didn't agree with the strategy. Um, and what we had a bit of a disagreement. I walked out the door and recruiter wasn't very happy with me, but, um,

Veronica: Wonder what they risk profile questions would have been, yeah.

Chris: Would've been, it would've been the advisor would have basically directed the client into a risk profile that would've matched the advice they wanted to deliver. And you're right, you gotta be extremely careful with, with leverage and margin loans because there is things called margin calls and it's, um, if that margin call happens because there is a change in asset prices, that could be a complete freak out of the markets or it could be company. You've just got to be extremely careful. And, um, you know, using home equity, you don't have those margin calls as much. Um, so that's a little bit less risky and a little bit cheaper. But, um, you know, you just gotta be extremely careful with leverage.

Veronica: Yeah. Which is, cause of course you don't as often obviously get margin calls on your home loan or

Chris: potentially it can happen if you, uh, you know, have to sell one property in a portfolio and they're all cross secured and you all of a sudden have to, put money, you know, if your own pocket to make things balance. So you've gotta be careful.

Veronica: Look, years ago when I was selling property, I once sold a property for a guy that couldn't settle because he owed more than he had failed businesses and a whole bunch of stuff. So he couldn't settle because he owed more than the property had sold for. And in reality, I knew what he paid for it. He should have had loads of equity in that, but he'd obviously been pulling it out and using it for whole bunch of other things. That's a good point. Yeah. Yeah.

Balaji: Also, just because someone's willing to lend you money or there's money to be borrowed doesn't mean you should. Yeah. Yeah.

Veronica: So that's less of a less of an issue these days.

Chris: Now, I mean, I love about listeners that we thinking, you know, they love index funds and they've only talked about the positive. Um, it's an us. Yep. Yeah. And um, you know, but there are certain risks that index funds have and you know, that there's some weaknesses potentially with the why they work. Can you kind of explain some of the things that, you know, consumers need to be aware of with index funds?

Balaji: It's a perception thing with an index fund. It's part, at least the ones from Vanguard stand point out, very diversified, which, um, which what that means is, you know, it, it takes you away from some of the poor performers, but it also may be, there's was the argument that you could be missing out on some returns if you were, if you had more concentrated exposures to certain stocks, that's one thing. But, um, you know, that's, and you could go with some, um, active managers who might in the short term outperform seven strategies and get you a much better return and outperform the, the, um, the index for argument's sake. Um, so there is this whole notion of feeling like you've even up that return. Again, it comes back to an investor you want, but we, we still think fundamentally the index is very diversified and um, and especially if it can be linked back to an investor's goals.

Balaji: And I think there is nothing wrong with that. Um, I can't think of too many risks of, um, from an indexing perspective where it could go wrong is, and one of the big risks is you have a number because of this whole, um, a bunch of money that's gone into ETFs and indexing in total. A lot of people who've never done it now feel like they can come in and launch ETFs and try and do these things. There's a big risk in that. Some of these people are going to blow up a) because they can't manage the complexity of um, these of these assets. Now, just because indexing is a simple proposition doesn't mean it is simple because you still need that very strong investment team, a very strong, um, technology infrastructure and operational infrastructure. Some of the, some of the smaller players can never be able to get to. So I think the bigger risk is one of the smaller players will blow up and then people start questioning the whole industry. And that's something regulators are concerned about. And you know, and we certainly feel, we need to play a role in helping educate the market as well as the regulator. But that, whilst, it's not directly related to the next thing, but I think that's, um, that's the notion of what could potentially go wrong.

Chris: Yeah. I mean it's a really good point because, you know, yeah, not all indexes are equal and some companies, you know, to actually managing it, you don't actually just by you actually go on, there actually is a lot of trading and managing fund flows and redemptions and you know, the technology and reporting and making sure that you are tracking that index because otherwise you're not doing your job. So there's a lot that goes into it.

Balaji: It is, isn't this, to bring this home a little bit, um, from our perspective and when we make investments in indices, it's, um, it's okay to allocate $5 million to the market, but when you have $50 billion to invest, I'm just making that number up. But you have to be a bit more methodical in terms of how you start allocating that because the impact it can have because of the impact you can go and you don't want to create dislocations in the market. So that's why the quality of the investment team, is paramount and you want people who've done this, um, who know how to do this and allocate that money in a manner that's um, reasonable. We don't want to create adverse impacts at the time. Also, we want to make sure that you are exposed to the market, which is kind of the fundamental reason why you invest in an index anyway. So it's, um, yeah, the concept of indexing is simple, but the execution is difficult and, and it, um, it needs a very strong infrastructure and teams and people to run it.

Chris: Yeah. And I guess probably as a final point, there's lots of way called fintechs coming out in the world that, um, you know, that I've got a great marketing and great, um, positioning and ease of access to investing via apps on phones and things like that. And, um, a lot of those use index funds, um, and a lot of them are using things that we've very short term mindsets of. Um, you know, round up just, you know, plug it into your bank account every time you spend money you can. Yeah. You know, these are great and I've had lots of clients, um, use them and I do think they're good, but a lot of people are using them for very short term purposes. You know, I'm going to build up some money in my roundup and then I'm going to, you know, take that money and buy a TV or whatever. Um, it's not really a like.

Veronica: 5 cents in the jar, isn't it? Really?

Chris: That's, you know, um, and unfortunately what it's doing is creating bad investment behavior because what it's actually doing is people are looking at these apps and they're saying that, you know, I've invested in this kind of startup and over the last year I've made 8% or I've made 2% this month and it's going really good and it's a really good thing. And then they start throwing more money in it. Oh. And they start telling their friends as well, they turn 10. So, um, you've really got to be careful all these types of things with index funds because the reality is you can not measure performance over short periods of time. If you looked at the Australian stock market over the last six months, it's gone up 20% we looked at over nine months, it's probably broken even, or a little bit up, you know. And so you've just got to be extremely careful with these, with index funds over short periods because the performance is just pointless. It's what happens over five, 10, 15 years.

Balaji: Absolutely. And especially these situation's more pronounced if someone's looking to save a deposit and they put all their money into it, to the market, whilst the index is low cost. I mean, if the market goes down in its entirety, you might in the short term not be able to get that money back and then you will, make it up over time anyway. But I think that that is an important consideration. But I think, again, like any industry, there are good robo-advisors. You know, you've got the stock spots and, and um, you know, to use that as an example, they very much focused on, you know, taking note of investor goals and what they're doing is just providing a really good mechanism to offer a portfolio. So it's taking them away, taking people away from investing in stocks or things like that and more focused on thinking about a portfolio that invest in low cost investment funds. So I think to the extent that, um, some of your investors and listeners want to consider these, and I think that's, there's nothing wrong with that. But what you don't want to do is suddenly start going in and build all these concentrated portfolio exposures and um, and, and if you can't link it back to your goal and why you're doing it, and if you're especially going after chasing the winners, um, it might feel like you're doing the right thing, but in the long term you might not.

Chris: And I agree 100% with stock spot. Um, Chris is a legend and knows exactly what he's doing. And if you look at he's process when you go through his application online, um, there's warnings all over everything and what everything is encouraging people to invest long term. No, they are like, there is, you cannot go ahead until you do this and do that and it's, yeah. And you know, and whereas a lot of other things aren't providing those warnings. Right. And, um, I do agree with its' the educational approach and you know, and it's smart business, you know, as a business, he wants money to stay there on the platform and to stay in his business. Um, whereas a lot of these kind of in and out, in and out, in and out, it's not really great for anyone. And, but if you've got people who have got the right mindset, they invest and then they leave their money, there longterm, they win. You know, the business wins. Everyone wins. Yeah. Thank you.

Veronica: Well on that, thank you so much for coming in and speaking to me this, it's been I think great to sort of get a greater understanding of, of index funds. Um, you know, both Chris and I, obviously Chris is a financial planner, but, I'm a property person, but I am, you know, and some people accuse me of being bullish about property, which is really funny. They clearly haven't actually listened to any of the episodes of this podcast because I do not believe everybody should invest in property. And I do not believe every property is worth investing in. And I actually do believe that there are, that people need to diversify outside of property and, and look elsewhere. And so that's one of the reasons we like to enter this, these sort of conversations into the general property conversation because it's a bigger thing than just buying property.

Balaji: Well, thank you for having me. This was a great conversation.

Chris: Thank you very much. Cheers.

Chris: We want to make you a better elephant Radha. And this weeks elephant rider training is:

Veronica: well further to one of the topics that we talked about with Belaji was around this sort of fads investment fads and uh, you know, obviously when you're talking about ETFs and index funds then you have to be wary of uh, I guess new providers of fads. They may well be called strategies and in property there is no difference here we get the same thing. One of them, I'll give you one example of a fads or a property strategy. You know, I use that word in inverted commas was the granny flat strategy. Now, Chris and I probably have spoken about this on the podcast at times, but you know, there's been a whole bunch of buyers agents actually have packaged up a strategy around this. There's been a lot of people that had been buying houses out in Western Sydney and uh, wrapped up in the services contract with somebody to build a granny flat and then all of a sudden, you know wooshka your yield goes up and suddenly you, you're bragging to your friends at the barbecue that you've made a great investment because you're getting this really, really high yield. Maybe nine or 10% you're on whatever your investment was. And the problem is with that is that your, you know, you haven't, you probably ruined your asset really in many cases. I've gotta be in an analogy here it is like sowing an extra leg on an old nag because you think that a five legged horse could run as fast as a thoroughbred.

Veronica: Do you like that Chris? Do you like that? Because this is a thing. You buy a house on a big block of land and in a sort of an older established area and you plonk a granny flat at the back just so you can get more rent. Now what happens when you go to sell that house? Is that the only person that wants to buy it, he's an investor. He wants to get all that rent. The families don't want to buy it because they would rather a swing set and a trampoline in that backyard rather than a granny flat. The other investors like you won't buy it because there's no strategy. You know, the granny flat's already been put there. It really severely limits your resale market, which in turn limits your capital growth potential. So you've actually effectively you've gone and sewn a leg on a nagg. You know.

Chris: I'm not a fan of granny flats at all. Um, I mean Domain did an article, um, this week is double income, the holy grail of investing. Um, what is the title of the property? The, the article. And um, it's not, in saying that though. If you have got an amazing block of land, um, and you've got a big block of land and you can put a granny flat on that doesn't detract too much away from the, the front house and you haven't got, you've got duel access. Um, and it can make sense. 100% agree BUT potentially for the majority of the cases. No. Um, and also if you're gonna hold it short term, um, it's probably not a good idea as well. Um, sell it with the potential for a granny flat. Don't build it yourself. But if you got to hold it for say 30 years and you can increase the income and it doesn't detract from the front, then maybe you should do it. But a lot of the time it's a no deal.

Veronica: Yeah. So I just think the fundamental here is we remember longterm, we don't buy for cashflow. We buy for capital growth. And also that, you know, if you chasing one of these little, these little fads, you know, it can go out of fashion and you can get stuck with an asset. You've actually spent money, you know, devaluing it.

Chris: And I'm not a fan of horse racing.

Veronica: Neither am I.

Veronica: Please join us for our next episode when we talk all things global and a lot about China and trade wars. We interviewed Douglas Isles, he's an investment specialist at Platinum Asset Management. So yes, we're back on that theme of talking about equities and comparing equity investment to property investment. Lots of really interesting insights that we have not uncovered, nor in previous episodes. So please join us.

Chris: Don't forget, we're on all the social channels. We're on Facebook, we're on Linkedin, we're on Twitter.

Veronica: Or you can connect with us on the elephant in the today, you, the links are all there for you.

Chris: Please connect and send us a message we'd love to hear from you.

Veronica: The elephant in the room property podcast is recorded at the Sydney sound brewery. This week's podcast was recorded by John Rhesk, editorial by Gordie Fletcher. Until next week. Don't be a dumbo.

Veronica: Now remember, everything we talked about on this podcast is general in nature and should never be considered to be personal financial advice. If you're looking to get advice, please seek the help of a licensed financial advisor or buyer's agent who will tailor and document their advice to your personal circumstances with a statement of advice.

Veronica Morgan