📈 Markets, Property, and Income

Why Markets Can Be Measured but Not Predicted

Market Risk (Measurable):

• Historical returns: NZ shares averaged 7-9% annually over decades
• Volatility: Standard deviation ~15-20%
• Can estimate: 95% of years returns between -10% and +30%
• This is measurable risk - variation around known mean

Market Uncertainty (Immeasurable):

• 1987 crash: 20%+ decline in single day (no warning)
• GFC 2008: 50%+ decline (few predicted timing/severity)
• COVID crash 2020: 35% decline in weeks
• These are uncertainty - unpredictable black swans

How Investors Handle Both:

For risk (measurable volatility):

• Diversification across companies, sectors, countries
• Long investment horizon (time reduces impact of volatility)
• Asset allocation based on risk tolerance

For uncertainty (black swans):

• Never invest money needed in next 5 years
• Maintain emergency fund separate from investments
• Don't use leverage (borrowed money) - amplifies losses
• Accept that crashes will happen but timing unknowable

Property Market Example

Property Risk (Measurable):

• Historical Auckland house price growth: ~7% annually long-term
• Year-to-year variation: Some years +15%, others -5%
• Can measure this volatility
• Rental yields: 3-5% historically

Property Uncertainty (Immeasurable):

• Wellington earthquake: No one knows when, but could devastate values overnight
• Government policy changes: Tax law changes, zoning, subsidies - unpredictable
• Economic shocks: Global recession, pandemic affecting demand
• Neighborhood changes: Infrastructure, demographics shifts

Practical Implications:

Managing risk:

• Diversify: Don't put all wealth in one property
• Insurance: Covers fire, earthquake (partially)
• Location research: Understand local market trends

Managing uncertainty:

• Don't over-leverage: Keep loan-to-value reasonable
• Buffer in budget: Don't max out what bank will lend
• Alternative plans: Can you afford if must sell? Rent out?
• Accept: Cannot predict earthquakes, policy changes

Personal Income Risk and Uncertainty

Employee Income:

Risk (measurable):

• Redundancy/layoff probability: ~5% annually (varies by industry)
• Average time to find new job: 3-6 months
• Salary progression: Predictable based on experience

Uncertainty (immeasurable):

• Company bankruptcy (employer disappears)
• Industry disruption (entire sector becomes obsolete)
• Health issues preventing work
• Skill obsolescence from technology

Self-Employed/Contractor Income:

Higher uncertainty:

• Client loss: Can happen anytime, any reason
• Market downturns: Discretionary spending cut first
• Competition: New entrants, price pressure
• Regulatory changes: Affect business viability
• Personal factors: Illness, burnout, life changes

Example: IT contractor

• Risk: Some months busy, others slower (measurable seasonal pattern)
• Uncertainty: Major client suddenly terminates contract, pandemic stops all contracts, new technology makes skills obsolete

🛡️ Protection Strategies and NZ Scenario

How to Protect Against Uncertainty

1. Emergency Fund (Critical):

• Purpose: Buffer against unknowable events
• Amount: 6-12 months essential expenses
• Employees: 3-6 months often sufficient
• Self-employed: 6-12 months recommended (higher uncertainty)
• Location: High-interest savings (accessible, not invested)

2. Diversification:

• Income sources: Don't rely on single employer/client
• Investments: Spread across asset classes, countries
• Skills: Develop multiple revenue-generating abilities
• Relationships: Network across industries

3. Conservative Debt Levels:

• Fixed expenses (mortgage, loans) create rigidity
• High debt = vulnerable to income shocks
• Keep debt serviceability comfortable not maximal
• Don't borrow assuming best-case scenarios

4. Skills and Adaptability:

• Continuous learning (technology, market changes)
• Transferable skills valuable across industries
• Network maintenance (opportunities come through people)
• Side projects/income streams (test alternatives)

5. Insurance (Covers Some Uncertainty):

• Health/medical insurance
• Income protection (if ill/injured)
• Life insurance (family protection)
• Property insurance (earthquake, fire)
• Limitation: Only covers defined events, not all uncertainty

6. Avoid Concentration:

• Single employer (job loss = 100% income loss)
• Single property (all wealth in one asset)
• Single investment (company bankruptcy)
• Single country (geopolitical risk)

NZ Scenario: Mike, Self-Employed Contractor

Background (Pre-COVID):

• Mike: 38, IT contractor in Auckland
• Income: $120,000/year ($10,000/month average)
• Steady work 2015-2019 (5 years of reliability)
• Lifestyle: $7,000/month expenses
• Mortgage: $450,000 ($2,500/month)
• Savings: $15,000 emergency fund

Mike's Risk Assessment (Pre-COVID):

• Felt secure - 5 years consistent work
• Multiple clients (3 main, several small)
• Emergency fund = ~2 months expenses
• Thought: "This is manageable risk"

March 2020 - Uncertainty Strikes:

• COVID-19 lockdown announced
• All 3 main clients pause contracts immediately
• Small clients cancel projects
• Income drops from $10k/month to $500/month (near zero)

Mike's Situation:

• Fixed expenses: $7,000/month continue
• Emergency fund: $15,000 = 2 months only
• No "slow decline" to adjust - immediate stop
• This was uncertainty, not risk (couldn't have predicted/measured)

Mike's Actions:

• Month 1: Used emergency fund, applied for wage subsidy
• Month 2: Mortgage holiday (6 months available), cut non-essential spending
• Month 3-6: Took any work available (much lower rates), applied for permanent roles
• Month 7: Accepted permanent job at $95k (lower than contracting but stable)

What Mike Learned:

Mistook uncertainty for risk:

• Thought income variation was risk (sometimes $8k, sometimes $12k month)
• Measured this and felt comfortable
• Didn't consider uncertainty (income could go to zero)

Insufficient buffer:

• 2-month emergency fund inadequate for true uncertainty
• Self-employed needs 6-12 months (learned hard way)
• Fixed high expenses (mortgage) created vulnerability

Concentration risk:

• All income from contracting (no side income)
• All clients in same sector (all cut spending simultaneously)
• Should have maintained diverse income sources

Mike's New Approach (Post-COVID):

• Permanent job provides base income ($95k)
• Building 12-month emergency fund (~$70k goal)
• Developing online course (passive income stream)
• Paying down mortgage faster (reduce fixed obligations)
• Accepts: Future uncertainty unknowable, must build resilience

✅ Risk Awareness Checklist

Understanding Your Exposure:

Income Assessment:

• ☐ Identify income sources (salary, contracts, investments, side hustles)
• ☐ How many sources? (1 = high concentration)
• ☐ What % of income from largest source? (>80% = risky)
• ☐ How quickly could income disappear? (immediate vs gradual)
• ☐ Job security: Permanent vs contract vs self-employed
• ☐ Industry stability: Essential vs discretionary sector

Fixed Obligations:

• ☐ List all fixed monthly costs (mortgage, rent, loans, insurance)
• ☐ Total fixed obligations: $____/month
• ☐ As % of current income: ____%
• ☐ Could you reduce these if income dropped? Yes / No
• ☐ Debt-to-income ratio: ____% (under 30% preferred)

Emergency Reserves:

• ☐ Current emergency fund: $____
• ☐ Months of expenses covered: ____ months
• ☐ Target based on employment type:
  • Permanent employee: 3-6 months
  • Contract worker: 6-9 months
  • Self-employed: 9-12 months
• ☐ Funds accessible without penalty? Yes / No

Risk vs Uncertainty Identification:

Measurable Risks (can quantify):

• ☐ Job loss in stable industry (5-10% annual probability)
• ☐ Car accident (insurance actuarial data available)
• ☐ Investment volatility (historical standard deviation)
• ☐ Rental income variation (typical vacancy rates)

True Uncertainty (cannot quantify):

• ☐ Industry disruption (technology, regulation)
• ☐ Health crisis (personal or pandemic)
• ☐ Economic shock (recession, crisis)
• ☐ Geopolitical events
• ☐ Natural disasters

Protection Strategies in Place:

Against Risk:

• ☐ Income diversification (multiple clients/employers)
• ☐ Investment diversification (across asset classes)
• ☐ Insurance coverage (health, income protection, life, property)
• ☐ Skills development (remain marketable)

Against Uncertainty:

• ☐ Adequate emergency fund (6-12 months)
• ☐ Conservative debt levels (can afford if income drops)
• ☐ Flexible lifestyle (can cut expenses if needed)
• ☐ Adaptable skills (transferable across industries)
• ☐ Strong network (opportunities come through relationships)
• ☐ Multiple income potential (can pivot if needed)

Red Flags:

• ☐ Single income source (no diversification)
• ☐ Emergency fund < 3 months expenses
• ☐ Debt service > 40% of income
• ☐ All wealth in single asset (one property, one stock)
• ☐ Assuming "this time is different" (historical trends will continue)
• ☐ Maximal leverage (borrowing to limit)
• ☐ No insurance despite dependents

Action Plan:

• ☐ Calculate true emergency fund need
• ☐ Set up automatic savings to build buffer
• ☐ Review insurance coverage (adequate?)
• ☐ Assess income concentration (too reliant on one source?)
• ☐ Consider debt reduction (lower fixed obligations)
• ☐ Develop backup income skills/streams
• ☐ Build professional network
• ☐ Avoid over-optimization (leaves no margin for error)

Final insight: Risk vs uncertainty: risk is measurable (dice roll, insurance probabilities, market volatility), uncertainty is immeasurable (pandemics, disruption, black swans). Risk can be quantified and managed through diversification, insurance, hedging. Uncertainty cannot be predicted - must build resilience through emergency funds (6-12 months), multiple income streams, conservative debt, adaptability. Markets demonstrate both: can measure historical volatility (risk) but cannot predict crashes (uncertainty). Property: can measure price trends but not earthquake timing or policy changes. Personal income: employees have measurable layoff risk (~5% annually), self-employed face higher uncertainty (client loss, market changes). Protection strategies: emergency fund critical (larger for self-employed), diversify income/investments/skills, avoid concentration, keep debt conservative, maintain flexibility. Mike contractor scenario: earned $120k, felt secure with 5-year track record, had only 2-month emergency fund. COVID-19 struck (uncertainty) - income dropped to near-zero immediately, learned hard way that self-employed need 6-12 month buffers, took permanent job for stability, now building resilience. Risk awareness checklist: assess income sources, measure fixed obligations, calculate emergency fund adequacy, distinguish risk from uncertainty, implement protection strategies. Don't confuse measurable variation (risk) with unknowable events (uncertainty) - both require different approaches.