SMSF lessons from the Beardstown Ladies

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One of the big problems for investors considering different approaches to super is the ability to accurately compare returns.

Returns from collective funds – whether super funds or unit trusts – have to be prepared according to an agreed methodology so that one fund can be easily compared with another.

Calculating the returns from a discrete portfolio takes more effort. It’s tough enough for institutional managers which have powerful software at their disposal. For an individual investor, calculating the return from their portfolio or overall SMSF, which is not unitised, can be much harder than it appears.

The first problem is classic decision biases which make it difficult for investors to objectively assess their performance, including:

The majority of investors think they achieve above-average outcomes, which by definition cannot be the case.

Confirmation bias leads investors to interpret information in a way which confirms their beliefs.

Regressive bias means that the frequency of low probability events (such as crashes and booms) is overestimated.

Loss aversion results in the pain of a $1 loss being greater than the pleasure of a $1 gain.

Even if such biases are overcome, the next challenge is correctly calculating the numbers. In particular, investors often fail to include all the costs of their strategy.

Real estate is a classic. Too often the return from an investment property is calculated like this:

Bought investment property for $400,000, sold for $480,000. 20% profit, right?

But what about stamp duty, agent’s commission, legal costs on purchase and sale, rates, repairs and maintenance, land tax, net interest costs? If these had been included, it would have been more like:

Bought apartment for $400,000 plus $20,000 in acquisition costs. Sold for $480,000 less $15,000 in selling costs. Paid $2,000 in land tax during the year and net running costs of $8,000. Actual profit 8%.

Working out the impact of cashflows is even tougher. A famous US example – the Beardstown Ladies – illustrates the issue.

The Beardstown Ladies was a sharemarket investment club of, not surprisingly, ladies (average age 70), based in the town of, you guessed it, Beardstown in Illinois. No, I did not make this up.

The club was formed in 1983 and became famous in the early 1990s for having achieved returns of well over 20% pa, easily beating professional fund managers and the S&P 500. The club and its ladies became famous – TV appearances, book launches etc. The gurus of their day.

Except that it didn’t add up – literally.

By the mid-1990s it had been pointed out that, like our SMSF gurus, there was no documentation to back up the performance claims, let alone an audited track record.

In 1998 it was shown that the club’s claimed returns had included the regular investments that members were making each month; the capital base was increasing but this had not been counted. Auditors were called in, which confirmed that the claimed 23% pa returns were just 9% pa.

It was an honest mistake, but it showed how hard it can be to work out the real, net, return from a non-unitised portfolio. In this case the error destroyed the credibility of the people involved, which was a pity because the Ladies subsequently actually performed quite well.

It’s one of those basic but critical mistakes that individual investors are liable to make. Given that we know many members are considering SMSFs, it’s yet another trap that funds need to alert them to, and help them avoid, if they decide they need to move on from the collective construct.

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