Besieged by the non-stop promotion of the consumer life-style everywhere we look and everywhere we go, many people are struggling to cope with consumer debt and the pressure to live a lifestyle that is, to be honest, beyond the means of their available income. However, if you look back at how our grandparents are earlier generations lived, we are currently living in a "golden age". To quote an article in the SMH:
"A couple of decades ago, the language of prosperity was almost like a foreign language ... Now, phrases like full employment, stock market highs and the commodities boom roll off the tongue.
Across the board, jobs are plentiful, wages are high and individual wealth continues to rise. There's no doubt this is a golden age of prosperity - possibly the best of economic times Australia has experienced.
And there's no doubt, either, that the economy is surging. The latest figures for the June quarter showed annual growth of 4.4 per cent, the highest for three years. Non-farm GDP growth, which removes the impact of the drought, was at its fastest in almost 13 years at 5.2 per cent."
At the same time, looking forward there are problems with "the limits to growth" that could quite possibly make living conditions much more difficult for our descendants. The apocalyptic prophesies of Malthus and, much more recently, the "club of Rome" turned out to be wrong (or at least premature). But the more recent concerns about climate change (whether or not they are caused by human activity) could mean we run into problems supplying food and water at reasonable cost to everyone. And the commodity boom has some chance of turning out to be a supercycle (or a "peak" in production of many commodities, not just oil) which could lead to ongoing real price increases in resources.
Therefore, there is a least some chance the our current economic situation is just about "as good as it gets". If so, we'd better make the most of this opportunity to build up of families wealth so we have some store of wealth put aside to tide us, or our kids and grandkids, over where the hard times come again. Make hay while the sun shines, for there may be some hard winters ahead for our descendants.
Copyright Enough Wealth 2007
Viewing the 'investment strategies' Category
Besieged by the non-stop promotion of the consumer life-style everywhere we look and everywhere we go, many people are struggling to cope with consumer debt and the pressure to live a lifestyle that is, to be honest, beyond the means of their available income. However, if you look back at how our grandparents are earlier generations lived, we are currently living in a "golden age". To quote an article in the SMH:
Back on the 12th of August I posted my thought that it might be a good time to buy some stocks for DS2. At that time the All Ords Index had dropped sharply to 5,965.2 - since then it has rebounded at today was at a new all time high of 6,808.2 (a gain of 14%). Goes to show that you never can tell which way the market will move in the future, but you can be 100% certain where it has been. Looking at a long term plot of the stock market accumulation index, buying when the market had dropped 15% below its recent long-term trend line would almost always turn out to be a good buying opportunity.
However, there are a few problems with this as an investment strategy:
1. When the market has rapidly dropped more than 10-15% you're always worried that it's the start of a bear market that could last several years. As in this case - I delayed buying any stocks for DS1, and could very well never get another opportunity to buy in at those prices.
2. You have to have some spare cash to invest when such opportunities arise - this generally would either mean that you've been sitting on a large cash allocation during a bull market (which would have cost you significant profits), or you'll need to borrow more to invest. And increasing your margin loans when the market has dropped is often very difficult, as it the time when you are most likely to be close to getting a margin call.
Looking at the chart the other thing that comes to mind is that I need to buy some more XAO put options when my current ones expire in December! Although the p/e of the Australian stock isn't out of line with historic averages, and company profits are continuing to grow, the chart does look remarkably similar to previous bubbles - and even just thinking "this time it's different" sends a shudder down my spine.
Copyright Enough Wealth 2007
In an ideal world my investment asset allocation would be done in the following manner:
1. Determine what initial amount to invest and ongoing savings plan
2. Determine my risk tolerance and any constraints regarding what investment types I choose to invest in (eg. ethical funds, hedge funds etc)
3. Decide my timeframe and investment targets (eg. final amount for retirement, target ROI or whatever)
4. Select an appropriate asset allocation to meet my investment return target with minimal risk (ie. aim for the efficient frontier)
5. Select individual investments to meet my overall asset allocation with consideration of fees, diversification.
6. Rebalance the investments periodically (eg. every year) or when the actual asset allocation differs too much from the target allocation - either by selling investments and reinvesting, or by adjusting what assets new savings are directed into. Bearing in mind transaction costs and capital gains tax effects.
In reality I have a ROI target of 5%-15% for my total networth, excluding annual savings of around $30K. Assuming a CPI of 2%-3% this would mean a real return of around 2% - 12%. But I don't have an overall asset allocation target as I have a large chunk of my net worth tied up in real estate via our home and our rental property, despite preferring to be largely invested in Australian and international shares. The rental property investment was mainly chosen because DW wanted to invest in the property market, and the house - well we both prefer to own our own home rather than rent. I therefore tend to only manage asset allocations within our superannuation account and by having the remainder of my investible assets in stock investments plus some alternative investments (hedge funds, agricultural investments, coins, bullion etc). Given that I have a much larger proportion of my assets in real estate than I would prefer, you'd expect that any additional investments would have been directed towards additional stock purchases, or perhaps some alternative investments. In reality although my personal savings have been directed towards direct stock investments or into my superannuation fund, until recently we had actually been increasing the proportion of our networth tied up in real estate due to our home loan payments reducing the property loan principal over time. We've now got both our home loan and rental property loan setup as "interest only", mainly because DW can't afford her half of the normal P+I loan payments while working part-time, so this will shift our asset allocation
more towards stocks over time.
As you can see, my overall asset allocation is therefore a pretty hit-and-miss affair. So for that reason worrying about fine-tuning asset allocation by rebalancing is a moot point.
Copyright [url=http://enoughwealth.comlEnough Wealth[/url] 2007
An article in today's SMH shows that the expected boom in superannuation contributions is occuring. Under the rules announced for the introduction of the "Simpler Superannuation" reforms to the Australian retirement savings tax laws, there is a one-off window of opportunuity to contribute up to $1m into your superannuation account before 30 June 2007. This is to "compensate" for the removal of age-based contribution limits with a flat limit of $50K pa of pre-tax (concessional, aka undeducted) contributions and $150K pa of after tax contributions. The new maximum contribution amounts will be indexed to increase in $5K jumps to keep pace with inflation.
This got me thinking about what the maximum amount that can be accumulated during your working life be under the new "Simpler Super" rules. Unlike the model of a minimum wage worker I posted a couple of days ago, this model has to make a few "bold" assumptions:
* the maximum contributions are made each year from age 18 to 65 ie. $50K pa pre-tax contribution via the SGL and salary sacrifice, and $150K pa of undeducted contributions. Although the $50K pre-tax and $150K undeducted contribution limits could easily be reached by a middle-aged, upper-management employee this is unrealistic for the under-30s worker. So this contribution rate would require some outside source of income. For example rich kids with an inheritance or a trust fund. I'm not fussed that very few people would possibly meet this requirement, we're just looking at what the extreme case could be under the new Superannuation rules.
* undeducted contributions aren't taxed on entry into a Superannuation account and pre-tax contributions are taxed at the concessional 15% rate
* the superannuation account is invested in a high-growth asset mix, achieving a real (inflation adjusted) net return (after fees and taxes) of 5% pa average for the 47 year investment period (up to age 65)
So, how much would this theoretical "rich kid" accumulate in their Superannuation account by age 65? Just over $37 million in today's dollars! And this amount can be withdrawn tax-free as a lump sum or a pension after age 60 (when "retired"). And this amount is per person, so a rich couple could accumulate a total of $74 million in this tax-sheltered environment.
As there is no gift tax in Australia, I imagine many rich households will be gifting $150K pa to each of their adult kids each year to put into their SMSF. The main downside of implementing such a strategy would be the legislative risk involved with locking this investment away until age 65. There could easily be further changes to the tax treatment of superannuation in the future.
I've been posting about investment topics that appeal to me, and outlining my current strategies and tactics. But I realise that this may not be terribly relevant to someone just starting out. So, what would I do if I in my early 20s and was just starting out, knowing what I know now?
1. Draw up a budget and spend less than I earn, so I'm able to put a savings plan into effect. Save up and pay cash for car, holiday etc. than is within my means. Brown bag my lunch, have a 'free' mobile on a $10-$14 a month plan. Don't use SMS, WAP or other services that cost a fortune. Don't waste money on designer clothes or trendy footwear.
2. Have my salary paid directly into an online savings account that pays a high interest rate and allows me to make bill payments via BPay. I have my salary paid into a savings account with Qantas Credit Union which doesn't charge an account keeping fee, provides a free cheque book, provides free ATM access using any bank's ATM machine, provides free online payments via BPay and online transfers to other financial institutions. I can also make a certain number of deposits via Westpac branches for free, which is vital when I receive some income via cheque. The credit union also has a high interest rate online savings account that can be linked to the main savings account. I get all my dividends paid into this account electronically, which makes it easy to keep track of dividends for my annual tax return.
3. Make an undeducted (ie. out of my after tax income) contribution of $1000 pa into my superannuation account (this assumes I'm earning less than $28K so can get the maximum co-contribution of $1500. If I earned more than this, but less than the $58K cut-off, I'd contribute a smaller amount that entitles me to the maximum possible co-contribution. To work this out I use the calculator provided by the ATO here.
4. Shop around for the best superannuation fund - one with low admin fees, no contribution fees, and suitable investment options. eg. An industry super fund or perhaps a Vanguard Super fund.
5. Invest my super in the high-growth options. With 40 or more years for the investments to grow I'd put 50% in domestic equities, 30% in global equities, and 10% each in real estate and bonds.
6. If investing in real estate I'd save 20% deposit to avoid having to pay mortgage insurance. I'd buy my own home before any investment property so I can qualify for a first owners grant and get stamp duty concessions. I'd check out the property cycle for my city to make sure I'm not buying at the top of a boom phase. A couple of years after prices have dipped in real terms and stabilised is a pretty good time. I'd get a price guide for the suburb I'm looking at (cost around $30) to know what similar properties have sold for in the past year. I'd always inspect a property several times before making an offer. I'd never believe a real estate agent that says he/she has other interested parties coming back later today to make an offer. In fact I'd always check everything that a real estate agent tells me. And I'd make sure I get a building inspection done before exchanging contracts.
7. If investing in stocks, I'd start out investing in index funds. If I wanted to invest in managed funds, I wouldn't pick last years best performers as they seldom stay top for many years in a row. I'd pick ones with low ongoing fees and invest via a discount broker that rebates 100% of the initial fee. If I wanted to invest directly in stocks I'd make sure I diversify by buying 10-12 stocks in different sectors. I'd know that I have to spend time reading and understanding the annual report for each company, comparing basic fundamental ratios to what is reasonable for the sector. I'd be wary of any "bargains" as there's often a reason the market has priced stocks at a discount or a premium. I'd ignore any broker "research", tips, investment newsletters, or investment magazines. But I'd read many investment books, investment magazines and the investment section of newspapers to get an understanding of investment principles and strategies. I'd bear in mind that you can't believe everything you read - be it investment advice in magazines, or the "hard facts" reported in annual reports.
8. I'd read up on asset allocation, the efficient frontier, the history of investing (eg. tulip mania, southsea bubble, UK railway boom, hunt brothers silver corner etc.), and historical average returns and variability of the various asset classes.
9. When my income moved into the higher marginal tax rates I'd look at salary sacrifice into superannuation of any money I wished to invest until retirement age. For shorter investment periods (or to have some money available in case of emergencies or changed life circumstances) I'd use a margin loan (with a modest LVR of less than 50%) to negatively gear a stock portfolio. Where the dividends are less than the tax deductible interest charged on the margin loan balance I'd reduce my taxable income (at the top marginal rate) and 'convert' it into tax-deferred capital gains, that are only taxed at half my marginal tax rate when gains are realised.
10. I'd continue to invest in my education and cross-skill into areas that are in high demand and well remunerated.
I had planned on selling off my portfolio of Australian stocks during the next financial year to reinvest the proceeds within our SMSF, but I've decided against this course of action as the realized capital gains would minimize the benefits of shifting the investment into the tax-sheltered SMSF. Instead I'll just salary sacrifice a large part of my salary into super each year (up to the A$50K deductible contributions limit). Since I'm not planning on selling off my portfolio in the next year I've decided to prepay 12 months interest on the bulk of my margin loan balances, so that I can take the usual tax deduction this financial year. For my Comsec loan I've sent in the paperwork to prepay $100K out of the $116,612.16 loan balance, at an interest rate of 8.75%. If I have any spare income during the year (eg. from takeovers) I'll pay off the remaining $16K of variable rate loan remaining. I'll also prepay $120K of the $150K loan balance on my Leveraged Equities margin loan before the 30th June.
For the next two years I'll be supplementing my salary income with the $34K I withdrew from my superannuation account. This will allow me to salary sacrifice at a high rate for those two years. After that time I'll look at slowly selling some of my Australian stock portfolio each year to allow me to continue salary sacrifice into our SMSF. If I get enough pay rise in the next couple of years to offset the amount I wish to salary sacrifice, I'll retain the existing stock portfolio holdings until I retire, at which time I'll have a very low assessable income (under the new Simpler Super rules pension income isn't taxed after you turn 60) and I could then sell off a portion of my holding each year without accruing much CGT liability. Until 75 I would still be able to contribute the proceeds into super while drawing a pension. After 75 I wouldn't be able to contribute into my own super, but I could start to contribute any excess funds into the super accounts of DS1 and DS2. Under current rules up to $150K a year of undeducted contributions could go into each of their accounts each year. As they will be in their 30s by that time I don't expect that they would be contributing that much into their super accounts yet.
All this planning assumes that the superannuation tax rules don't change much in the next 30 years - a most unrealistic assumption! This plan will obviously have to be updated as the rules and our financial situation changes over time.
Leveraged Equities Account (loan balance $150,000.00, value $316,303.73)
stock qty price mkt value margin
AAN 295 $15.22 $4,489.90 70%
AEO 1,405 $2.04 $2,866.20 65%
AGK 510 $15.32 $7,813.20 70%
AMP 735 $10.01 $7,357.35 75%
ANN 480 $12.00 $5,760.00 70%
ANZ 1,107 $28.78 $31,859.46 75%
BHP 748 $31.06 $23,232.88 75%
BSL 781 $11.27 $8,801.87 70%
CDF 6,943 $2.02 $14,024.86 70%
CHB 118 $51.01 $6,019.18 65%
DJS 2,000 $5.13 $10,260.00 65%
FGL 3,751 $6.27 $23,518.77 75%
LLC 481 $19.82 $9,533.42 70%
NAB 316 $42.40 $13,398.40 75%
QAN 2,175 $5.06 $11,005.50 70%
QBE 983 $31.56 $31,023.48 75%
SGM 830 $27.08 $22,476.40 70%
SUN 963 $21.16 $20,377.08 75%
SYB 2,880 $4.37 $12,585.60 70%
TLS 5,000 $4.78 $23,900.00 80%
TLSCA 3,000 $3.31 $9,930.00 80%
VRL 1,500 $3.20 $4,800.00 60%
WDC 783 $20.77 $16,262.91 75%
Comsec Account (loan balance $116,612.16, value $229,848.59)
stock qty price mkt value margin
AGK 240 $15.32 $3,676.80 70%
AAN 139 $15.23 $2,116.97 70%
APA 4,644 $4.22 $19,597.68 70%
ASX 200 $48.39 $9,678.00 70%
CBA 130 $55.03 $7,153.90 75%
CDF 43,997 $2.02 $88,873.94 70%
IPEO 54,000 $0.019 $1,026.00 0%
IPE 8,000 $0.995 $7,960.00 60%
IFL 1,300 $10.25 $13,325.00 60%
LDW 1,350 $7.81 $10,543.50 0%
NCM 300 $21.68 $6,504.00 60%
OST 2,000 $6.52 $13,040.00 70%
QBE 607 $31.60 $19,181.20 75%
RIO 60 $94.55 $5,673.00 75%
THG 4,000 $1.02 $4,080.00 50%
WBC 300 $26.03 $7,809.00 75%
WPL 220 $43.68 $9,609.60 75%
Changes to portfolio since last update:
I sold my Qantas shares on the market for $5.39 on the last day before the takeover offer closed. I guessed correctly that the APA offer would fail to reach the required acceptances to proceed, and over the next few days the QAN share price dropped, as had been expected. However I had expected the price would drop to under $5.00. In fact the stock price has since increased after the Qantas management released an upbeat assessment of their prospects, and is now trading around $5.60. The proceeds of the sale reduced my loan balance below the $150K I had prepaid interest on for this financial year, so Leveraged Equities automatically moved the surplus amount into the linked Cash Management Account so I'm at least getting some interest on this bit of borrowed money.
My AMP holding increased by 15 shares due to a dividend reinvestment. I no longer enrol in DRP for new stocks I buy as there is little if any price discount and the hassles of keeping records for CGT calculation outweighs the benefits. I simply use dividends to help pay the interest on my margin loans.
My QBE holding increased by 17 shares due to a dividend reinvestment.
My SUN holding increased by 113 shares due to a Share Purchase Plan offer I took up.
My SYB holding increased by 32 shares due to a dividend reinvestment. This company is currently subject to a take over offer, which pushed the price up from $3.70 to $4.37. As the offer is a cash plus stock mix I may decide to sell my holding on the market rather than accept the offer.
I happened to come across the website for Shearwater Capital the other day. Their investment approach seems sensible and their published fees reasonable, but that isn't what caught my eye. I was more interested in their model portfolios and using the data on the 20-year performance to evaluate the effectiveness of gearing as an investment strategy.
Looking at their "Aggressive" portfolio (80% stocks/20% bonds, which is similar to my target asset allocation) you have a Twenty Years Annualized Return of 12.3% with a Thirty Three-Year Model Annualized Standard Deviation 11.8%. The "Very Aggressive" portfolio (100% stocks) has a Twenty Years Annualized Return of 13.7%, but the Thirty Three-Year Model Annualized Standard Deviation shoots up to 14.6%.
This shows that, as can be expected from modeling of the efficient frontier of a portfolio composed mainly of stock and bonds, the optimum return-risk outcome is achieved from a portfolio comprised mostly of stocks, but with some bonds included. The mix within the stock component is usually around 60% domestic:40% foreign, although in various ten-year periods you would have done better with the opposite ratio (so a 50:50 split may be a good bet).
Moving from the "Aggressive" to "Very Aggressive" asset mix boosted returns by 11.38%, but the "risk" (variability of returns, as measured by the Standard Deviation) increased by 23.73%.
For this reason, if you are seeking higher returns over long time periods, it seems a better strategy to use gearing of an "Agressive" portfolio, rather than moving to a "Very Agressive" portfolio.
Taking the Twenty Years Annualized Return of the "Very Conservative" portfolio (100% bonds) as a proxy for the interest rate cost of gearing (via margin loans or a real-estate backed investment loan such as a HELOC), one can make a rough estimate of the Twenty Years Annualized Return and Thirty Three-Year Model Annualized Standard Deviation that would result from a 100% geared (50% LVR) "Aggressive" portfolio:
Return Std Devn
Ungeared "Aggressive" 12.3% 11.8%
Estimated Cost of Loan 5.9% 2.4%
Estimated 100% geared 18.7% 23.6%
Estimated 22% geared 13.7% 14.4%
Ungeared "Very Aggres." 13.7% 14.6%
Using gearing could therefore increase your average returns by 52.03% at the cost of increasing standard deviation by 100%. This is somewhat better than shifting your asset allocation from "Agressive" to "Very Aggressive". However, the absolute "risk" has increased 100% compared to 23.73%, so the strategy of making use of 100% gearing ratios should probably be called "Hyper Aggressive". A more modest use of gearing (say, 22%) would produce similar average return as a "Very Aggressive" asset allocation, but with a slightly lower standard deviation.
It was interesting to see that the returns for the 100% geared "Aggressive" portfolio are very similar to the long-term increase in value of my own investment portfolio. When I started out I didn't use gearing and had a more conservative asset allocation, but this was offset by the relatively large impact my savings had at that stage. These days my savings have a more modest impact on my overall increase.
One final note, when using gearing the cost of funds (interest rate and any annual fees) can have a major impact on the long-term performance of this strategy, so it is worth shopping around.
I don't know where the expression comes from originally, but I'm sure most people have heard that "the first million is the hardest". The funny thing is that when you're starting out on the road to accumulating wealth, it somehow seems to be a bit of a put down - you think it's just a throw-away line of the mega-rich, along the lines of "Let them eat cake!" Of course, it's easier to save once you have a million dollars and are living on easy street!
However, once you get closer to having $1m net worth you realise that this truism, like so many in personal finance, does actually encapsulate some fundamental truths.
Some reasons why it really is true that "the first million is the hardest":
* When you start out, your income is generally at the lowest point of your working life. So even saving 25% of your gross income will only build up your net worth very slowly. For example, I started full time work on a salary of under $20K, so saving 25% of my gross salary only added $5,000 to my net worth over one year.
* When you start out you generally know very little about investing. Even if you study some economics and financial analysis subjects in High School or University, you often won't gain a practical knowledge until you've been "hands on" investing for several years. When I started saving I was focused on bank savings accounts, and slowly progressed through government savings bonds, term deposits, and later into shares and property investment.
* When you're starting out you have smaller amounts to invest. This makes many avenues of investing unavailable or uneconomic. Although things are much better these days than when I started out - the advent of the internet and discount brokers has made many more types of investment accessible to beginners.
* Once you have a substantial investment portfolio built up, the "passive income" flowing from your investments becomes a large component of your "savings" in relation to your salary income. However, this only holds true if you stick to "reinvesting" your investment income, rather than using it to supplement your lifestyle spending.
* Some aspects of financial planning such as asset diversification and efficient asset allocation ("efficient frontier") only become applicable when you have larger amounts to invest.
* Any "emergency" that causes you to dig into you savings will have a much larger impact on your net worth when you are starting out. Conversely it is much more important to pay for various types of insurance when you are starting out - for example, starting a family it is important to have life insurance in case the main bread winner dies unexpectedly. Later on, the expensive of life insurance may be avoidable if you have paid off the mortgage, the kids have left home, and you have built up an investment portfolio.
Looking back to when I started out saving it was incredibly hard for very little result. For example, in High School I would work 9 hours at a market garden weeding or sorting and rebagging potatoes (ie. removing the stinking rotten ones, washing off the others and rebagging the remainder for sale). I earned around $10 for the whole days work, and spend $1 on lunch and $1.20 on busfares to and from work. In the end a whole day of my life resulted in adding less than $8 to my net worth. However, that initially stage of developing my finances provided a basic understanding of the value of money, and provided the "seed capital" required to start saving and investing. If you try to take a shortcut from McDonalds worker to property tycoon you are liable to end up another Casey Serin.
The paperwork from eSuperFund confirming the establishment of our Self-Managed Superannuation Fund (SMSF) arrived today. Overall the process has been very quick and efficient. The initial online application only took five minutes to complete and gave a false sense of simplicity - when the actual "paperwork" to create the SMSF arrived it was a very thick package with FIFTY of the little, yellow "sign here" stickers attached! Anyhow, the paperwork has now been processed by the ATO (Australian Tax Office) and everything is now in place. In total we received:
* A TFN (Tax File Number) for the new fund from the ATO
* An ABN (Australian Business Number) for the new fund
* A "V2 Plus" Bank Account with the ANZ (to handle all deposits into the fund)
* A Share Trading account with E*Trade for the fund
* A second ANZ Bank account to hold funds to settlement of SMSF share trades
The next step is to visit the local ANZ Bank branch and present passport, drivers licence etc. for myself and DW (the trustees of the SMSF) to complete the 100 point identity check required for any new bank account. At the same time I'll get a CRN (Customer Registration Number) and "telecode" from ANZ so we can register online for online access to the ANZ Bank accounts.
This should all be in place by next week, at which time I can do the paperwork required to transfer funds out of our current Employer-sponsored Superannuation fund (run by Westpac/BT) and into the new SMSF. DW has around $50K in her account, so we'll transfer the entire amount and arrange for future SGL (Superannuation Guarantee Levy) amounts to be paid from our employer into the new account. This will mean she loses the current life insurance cover we have via the BT Super Fund, but she only had a nominal amount of cover anyhow. I have a $400K policy through the BT Super Fund, so I'll probably transfer the majority of my balance into the new SMSF, but leave a small amount there to maintain my life insurance cover. I'll also let my future employer SGL deposits go into the 'old' BT account to cover the ongoing insurance premiums. I can always withdraw the remainder of the balance if I change jobs or have a large balance build up in that account. I wouldn't want to do too many transfers out of the BT Fund though, as they charge $35 for each withdrawal! There will also be the ongoing annual member fee if I keep my BT Super account open (around $55 pa), but at least I'll be avoiding the fairly high fund management fee of around 1.25% (even after our employer's fee rebate has been applied). Overall, with a combined Super balance of around $350K in the SMSF we'll save around $3,500 each year in management fees, even after deducting the $600 pa management, audit and reporting fee charged by eSuperFund on our SMSF.
In the future we will probably add any future savings into the SMSF as the tax benefits are considerable, especially under the new "Simpler Super" changes that apply from 1 July. With a maximum annual contribution limit of $400K ($50K each of pre-tax contributions (SGL and salary sacrifice), and $150K each of post-tax contributions) we would be able to put all our future investments into the SMSF if we want to (the only significant draw back of this strategy is that we can't get money back out of superannuation until we reach 60).
Amid all the hoo-ha about the changes to "Simpler Superannuation" from July 1 this year are some less-pleasant, little-know aspects. For example, from 1 July all payments made out of superannuation will be treated as a mixture of undeducted and deducted amounts per the overall mix across all your superannuation accounts with a particular trustee. For example, if you had a total balance of $400,000 and $100,000 of this was due to "undeducted" contributions, any withdrawal after 1 July will be deemed to be 25% undeducted and 75% deducted.
What does this matter? Well, some people will have amounts within their superannuation accounts that they can withdraw at any time. Called unrestricted, non-preserved amounts, I think these are generally undeducted contributions made into superannuation prior to 1999. (All contributions after then are preserved until retirement age). Currently, if you decide to withdraw an unrestricted, non-preserved amount you can nominate how much of the withdrawl is to be from the deducted and undeducted components of your superannuation account.
For example, of the $335,000 in my superannuation account, $55,000 is an unrestricted, non-preserved amount that I can withdraw at any time. My undeducted amount is $34,000, so under the current rules I can withdraw $34,000 as an unrestricted non-preserved amount and don't have to pay any tax on that amount. If I withdrew the maximum possible ($55,000) I'd have to pay some tax on the $21,000 "deducted" component (which was contributed into the fund out of pre-tax salary).
However, if I withdrew the same $34,000 unrestricted amount after the new rules come into force on 1 July, the amount would be treated as roughly 90% (34K out of 335K) "deducted" and only 10% "undeducted" - and I'd have to pay around 20% tax on the $31,000 undeducted component. So, withdrawing this $34,000 after 1 July would cost me an extra $6,000 or so in tax!
But wait, there's more...
Another other benefit of withdrawing $34,000 tax-free from my superannuation account before 1 July is that I could then use this amount over the next two years to replace around $48,500 of my taxable income (with a marginal tax rate of 30%), and I could therefore afford to salary sacrifice an extra $24,000 pa  into superannuation without reducing how much cash I have available to pay my bills. The benefit of doing this is two-fold. Firstly, the salary sacrificed amounts will only be taxed at the 15% superannuation contribution rate, rather than my expected marginal tax rate of 30% (which applies to income between $25K-$75K). The second benefit is that be doing this large salary sacrifice my taxable income should be reduced from around $55,000 to around $30,000 and I'll then be eligible to get a government co-contribution of up to $1,500 if I make a $1,000 undeducted contribution into my superannuation account.
Current Situation If salary sacrifice an
extra $24,000 pa
Taxable Income $55,000 $31,000
Salary Sacrifice $10,400 $34,400
SGL contribution $ 7,400 $ 7,400 
Income Tax due -$11,850 -$ 4,650
Super Tax due -$ 2,670 -$ 6,270
Super co-contrib $ nil  $ 1,300
(if make a $867 undeducted contribution)
Total after tax $58,280 $63,180
This means I'd end up with an extra $4,900 pa (tax saving and co-contribuction) by making the increased salary sacrifice. However, this is only possible as I have the extra $34,000 tax-free withdrawal from my superannuation account to supplement my income for the next two years. Otherwise my after-tax "take-home pay" would have been reduced from $43,150 to only $26,350.
By making these arrangements I'll end up with the following over the next two years:
Current Situation New Situation
Super Balance $335,000 $301,000 (withdraw $34,000)
Take-home pay $43,150 $31,000 (salary sacrifice)
Super withdraw nil $17,000 pa (split over 2 years)
Total cashflow $43,150 $48,000
Super contrib. $17,800 pa $43,100 pa
Super tax. -$ 2,670 pa -$ 6,270 pa 
Super balance $365,260 $374,660
after two years (ignoring earnings)
The only material impact of thisarrangement will be that the ratio of undeducted:deducted money in my superannuation account will be higher if I withdraw $34,000 of undeducted funds and recontribute via salary sacrifice (deducted funds). However, as all pension payments made from a superannuation account after you retire (and are over 60) are tax-free under the new "Simpler Super" rules, this shouldn't have any real effect in the long run.
 Under "Simpler Super" there will be an overall cap of $50K pa in deducted contributions - so you have to make sure your total of salary sacrifice and employer SGL amounts doesn't exceed this.
 My employer calculates the required 9% superannuation contribution levy based on my original salary (ie. before salary sacrifice is deducted). Legally it is possible for an employer to only contribute 9% of the actual salary paid (ie. after deducting the amount salary sacrificed). So it's important to check this with your employer before making salary sacrifice arrangements.
 The government superannuation co-contribution (up to $1500) is available on a 1.5:1 basis for undeducted contributions made into superannuation by employees with incomes up to $28,000. For incomes above $28,000 the maximum amount reduces until for incomes over $58,000 you're not eligible.
 There's no 15% contribution tax on the government co-contribution
DISCLAIMER: I'm not a financial planner, accountant, tax lawyer or in any position to give advice. This is just information about what I'm currently planning to do, and what I *think* the implications are. I checked my superannuation details (unrestricted non-preserved balance and undeducted component) with my superannuation fund, and I asked the Australian Tax Office "Simpler Super" help line about whether the new rules treating all withdrawals as being in the same undeducted:deducted ratio as the overall account would apply to unrestricted, non-preserved amounts. The ATO help line rep didn't know, and he had to go ask a "specialist" in this area to come back with the opinion that yes, this rule seemed to apply to all withdrawals by persons under age 60. As the ATO only gives binding private rulings about income tax questions and not superannuation, this seems about as definitive an answer as I can obtain. You could get professional advice from a financial planner, if so make sure that they really know the answer (since the ATO wasn't even sure!).
With the US and Australian stock markets at, or near, all time highs, many pundits are predicting an imminent plunge. The fact of the matter is that the market will always be hitting "all time highs" as it follows its long-term uptrend over the centuries. The question is whether or not a particular high is associated with the excessive exuberance, or if it is supported by fundamental values, profitability and projected continued economic growth.
Alan Kohler had an interesting article outlining the case for viewing current market levels as reasonable, and even provides a rationale for a further gain of 25% or more in the next couple of years:
In 1987 the trailing price-earnings ratio of the Australian market was 20.4, which produces an earnings yield of 4.9 per cent. The 10-year bond yield was then 12.5 per cent. Today the earnings yield is 6.4 per cent and the bond yield 5.9 per cent.
As we stand here with the Dow at 13,000 and the ASX S&P 200 at 6150, shares are cheap.
It is now equivalent to about December 1986. History never repeats itself exactly of course, but if it did, the Australian index would hit 13,000 next January - before crashing spectacularly.
The point is that the sharemarket has not yet had the price-earnings multiple "blow-off" that usually marks the end of the bull market.
The 1987 blow-off took the average P/E ratio to only 20.4 because inflation was 8.5 per cent and the bond yield was 12.5 per cent - more than double what it is now. But that P/E was double the then 10-year average.
Now the trailing P/E is 18 times, but inflation is 2.7 per cent and the bond yield 5.9 per cent (3.2 per cent real versus 4 per cent real in 1987). Times change, but in my view people do not. At the end of a long bull market, with abundant cash and rampant optimism, people tend to go nuts. They start extrapolating existing growth forever and price assets accordingly.
So far that has not happened: share prices have merely kept pace with earnings as they are now, not what optimistic forecasters think they might be.
While I don't necessarily think Alan is right, it's nice to read that your stock market portfolio could increase another 25% by the end of next year. Of course, if it did increase that much, I'd be even more tempted to abandon my long-term asset allocation and lighten up on my stock holdings in an attempt to "time the market". The only justification for such a radical change of investment strategy would be that having experienced many years of exceptionally high growth, my net worth would be well above where I need to be to attain my retirement and investment performance targets, so I could shift to a lower-risk, lower-return asset mix and have greater certainty of reaching my original goals. The alternative would be to stick with my original asset allocations, and hope that the returns reverted to average performance which would result in my final outcome exceeding my initial expectations.
Some simple scenarios I've run on excel to illustrate various retirement situations that might arise depending on how much one saves, rate of salary increases, ROI, and % of final salary spent each year during retirement. They're only meant as rough indications of how these variables can effect the final outcome.
General assumptions used throughout:
* all figures are in today's $
* all % are real, after-tax rates eg. to get the 5% ROI you'd have to make maybe 10% gross return.
* a $40K starting salary at age 20
* starts working F/T at age 20
* works F/T until retirement at age 65
* salary increases x% pa until age 54, then remains constant
* earns 20% of age-20 salary when 18, 25% of age-20 salary when 19 (eg. casual work)
* saves y% of gross salary each year (ie. any debt repayments student loan/home loan are in addition to this)
* spends p% of final salary each year during retirement phase
ROI x% y% p% Comments
A 5% 3% 10% 100% "Typical" situation. Comfortable retirement with all NW consumed by age 80.
B 5% 2% 10% 100% Lower rate of salary progression. There is actually a residual NW at age 80
in this case as final salary (and hence pension) is lower as a % of starting
salary and savings in early years were thus relatively higher.
C 5% 3% 15% 100% A "PAW" - saves 15% of gross salary. Has a high NW at age 65 so ends up with a
large residual amount at age 80. Could either leave a large estate, or could
spend more than 100% of final salary during retirement years. (see D below).
D 5% 3% 15% 150% As above, but spends 150% of final salary during the retirement phase.
E 5% 3% 20% 100% "Super Saver" - consistently socks away 20% of gross salary while working.
F 8% 3% 20% 100% High-risk, high-return (8% real ROI), super-saver. This is my model
I can meet the 20% savings target and so far have met the 3% real salary rise
and 8% real ROI hurdles. This is the most uncertain model as it would need
everything to work out in order to achieve 3% real wage rises and 8% real,
after-tax ROI for the next 20 years.
One of the catchiest phrases I ever heard at an "investment seminar"* was "tax is optional". Despite the common confusion between legal tax minimization, and illegal tax evasion, there are some relatively straight forward methods to protect one's hard earned income from the ravages of taxation. Now, the following is simply a couple of scenarios I've been thinking about, it is not professional tax advice as a) I'm not qualified to give any, and b) you'd be an idiot to base your investment planning purely on something you read on a blog - always check it out yourself against reliable reference material, or get professional advice. Having got past all the disclaimers, let's look at a few rough examples.
a) The obvious one - if you're over 60, come 1 July this year the new "simple super" legislation will make all income coming to you from your superannuation fund tax exempt - it doesn't even have to be included on any tax return you fill in. Hence retirees with adequate retirement savings will easily be able to pay no tax on a $100,000 annual income if it's coming to them from their taxed super fund.
b) If you're earning $100,000 salary in Australia the 2006/2007 tax rate for a resident single person would mean you normally would pay $27,850 in income tax (not counting the medicare levy), leaving $72,150 after tax income. This could be reduced to zero by arranging a salary sacrifice of %92,500 into superannuation. This would reduce your taxable income to $7,500. The tax rate on the first $6,000 of income is 0%, and the $235 low income tax offset would mean you could earn at least $7,500 taxable income without actually paying any income tax. Of course you'd probably need some other way to finance your living expenses if you reduced your taxable income to only $7,500! There is also the superannuation contribution tax of 15% on salary sacrificed contributions, so to some extent you'd simply be replacing $27,850 income tax with $13,875 contribution tax. This makes salary sacrifice of taxable income below $25,000 (the threshold for the 30% income tax rate) generally not worthwhile.
BTW This option would not longer be available after the new "simple super" rules come into force on 1 July - the max. salary sacrifice + SGL contribution total will be $50,000. And under the current rules, there is an age-based maximum that would make this option only work for older employees.
c) Have large tax deductions from investment interest expenses to reduce your taxable income to the extent that it entirely offset by franking credits from your stock dividends. This is theoretically possible, but would only be possible for some investors with large existing investment portfolios. For example,
Person X has a $1,000,000 stock portfolio yielding 3% ($30K) in fully franked dividends and earns $70,000 in salary. The stock portfolio averaging 6% capital growth.
If this person borrowed $2,000,000 via a margin loan at 8% interest and used it to expand the existing stock portfolio. The new situation would be:
$70K salary + $90K dividends.
Dividend franking credit $38,571.
Gross income = $198,571
Tax deductible interest = $160,000, paid for by salary and dividends.
Taxable income = 198,571 - 160,000 = 38,571
Tax on 38,571 = 6,921.30
Refund due = franking credit - tax liability = 38,571 - 6,921.30 = $31,649.70
The extra capital gain from the $2m extra invested is worth an average of $120,000. As it is eventually only taxed at half the applicable marginal income tax rate, the eventual after tax gain would be more than the decrease in current income.
Of course this would only work if you could live on $31K of after tax income, ie. you were going to invest $40,500 (56%!) of your after tax income anyhow. Otherwise you'd be short of income for living expenses.
Now, none of these options are practical or advisable for most people. And the ethics of paying nil tax is very personal - after all, someone has to pay for roads, schools, hospitals etc. And the use of gearing, especially using margin loans, increases risk - you may end up with investments that perform way below "average" during your holding period. But some combination of the above can be used to reduce the amount of income tax paid, provided you are currently spending less than you earn and are investing some "after tax" dollars.
There also some further benefits possible by lowering your taxable income - for example, reducing the amount of medicare levy payable, qualifying for the government superannuation co-contribution, and so forth. You have to be a bit careful if you are married with kids and getting some "family tax benefit" payments (A or B) - the rules for calculating income differ between the ATO and centrelink.
It's probably best to end with another catchy quotation - "tax reduction should not be the key factor behind any investment decision." After all, it's no good getting a big tax break on an investment that ends up worthless.
* ie. high pressure sales talk for an investment scheme
The paperwork from ESuperFund.com for setting up our new Self-Managed Superannuation Fund (SMSF) arrived in the post yesterday. A very thick envelope of "personalized" boiler-plate, with sixteen(!) little yellow tags showing where DW and I have to sign our names. I'll take a stab at wading through the details of the more relevant parts (the Trust Deed and the Investment Strategy) this weekend, between doing my university assignments and hiding Easter eggs* for DS1 to find, and hopefully we can get it all signed and sent back next week. Transferring DW and my super from BT super into the SMSF will save at least $1,670 in annual admin fees as far as I can tell**. I'll invest in the same asset mix within the SMSF as I had selected in the BT super scheme, just via Index funds instead of actively managed funds in some cases. If the capital gains tax liability caused by liquidating my stock portfolios isn't too high I'll also look at shifting my direct share investments into the SMSF as well, as there will be considerable tax savings over time within the super environment (especially NIL capital gains tax on super assets sold when the SMSF is in pension mode). You can't use gearing within a super fund (they're not allowed to borrow, except for very limited cases, such as when settling share trades) but, apparently it is OK to buy CFDs.
* They're actually lots of little packets of Trolli "bunny surprise" sweets (a bit like gummi bears), as DS1 is allergic to both milk and soy, so chocolate eggs are a no-no, even the "lactose free" ones. Just as well that he loves gummi bears
** The SMSF admin fee is AUD$599 pa. The BT fund charges a $53 pa member fee, plus an admin fee of around 1.5% pa. Our employer has arranged for a "member fee rebate" of about 0.9% pa but this still means that on the combined balances of DW and myself (around $370K) we're currently paying a net admin fee of around $2,270 pa to BT.
The login details finally arrived by email from CMC Markets today. After sending in another email to setup the initial password I was ready to install the MarketMaker software. The installation went well, with no hick-ups installing it under Windows XP. It took about 5 minutes to download and install. One annoying feature (which also happened when I installed Comsecs ProfessionalTrader software) is that the first time you run the installed application it checks for any updates - and finds heaps. Installing all the "updates" to the installed application took longer than the initial installation. It seems as though once a version is rolled out, it gets used as the installation version for ages. All subsequent updates are just cobbled together as they arise over time, so if you install the application a fair while after its been released there's a huge amount of outdated code to be replaced. A more customer friendly approach would be to keep the "installation" version always updated with the latest updates, so that new users wouldn't have to go through a lengthy update of their newly installed application.
Once it was finally ready to go, I started to have a play around. I doesn't have an intuitively obvious interface, but that's probably due to it providing heaps of functionality and trying to keep the default layout clean and simple. I had a quick read through the online manual, and I'll have to read it all the way through before starting to use the application to its full potential. CMC Markets has a "free 1 day course" available to new clients. I'm sure it will mainly be a lot of "how to easily make huge returns with absolutely safety" bumpf, but it might provide enough training on how to use the software efficiently to make it worthwhile taking a day off work to attend.
My first daily account update arrived by email from CMC Markets today. Nice to see the $1,000.00 balance with no fees taken out. There is an online account funding option available within the trading application, but you can only make payment by credit card and they charge a $1.50 fee per transfer. I'll do any funds transfers by BPay instead and save the cost. I still have to fill in and mail by bank account details to CMC Markets so I can get funds paid back out again.
Hopefully I'll have worked out everything by the start of next month when I'm scheduled to make my next monthly US stock purchase to add to my "Little Book" portfolio. I'll do a normal $5000 stock purchase through Comsec-Pershing, and at the same time duplicate the transaction trading a long CFD in the same stock via CMC Markets. As the US CFDs trade on a 5% margin, the extra cost will only be around $500, but it will, of course, be doubling my exposure to any rises and falls in the stocks I purchase. I'll do the dual trades for 18 months and compare the costs of both trading systems.
Just as well I didn't believe the CMC Markets Rep on Friday when he said that if I transferred the initial $1000 into my new account that day, an "automated" email with my login details would arrive on Monday... we'll see if the account email arrives tomorrow. I won't make an intial CFD trade until next month, but I'd like to install and "play" with the trading software asap.
Meanwhile some dividends were deposited into my account today, $442 from SUN, $144.60 from ASX, and $326.25 from QAN.
And I finally got around to setting up the automated payments of the minimum monthly amounts due on the HSBC and BankWest Credit Card accounts that I've taken 0% balance transfers from. I set up the minimum amounts ($300 for BankWest on a $12,500 balance transfer, and $270 for HSBC on a $10,000 balance transfer) to happen a few days before the due date each month to allow for when the due date falls on a public holiday or weekend. I'll still double check each months statement to make sure the payment will happen before it's due - I've previously had experience of a CC company changing the monthly due date without notice!
Aside from this I'm making slow progress sorting 2,000 rows of portfolio transaction data from my old Quicken backup into a capital gains transaction log. I'm 75% done so I should be able to finish it off tonight and merge it with my CGT spreadsheet I'd already setup with transactions since 2000. Hopefully the calculated final stock holdings will mostly reconcile with my current CHESS and margin loan account statements, so I won't have to go fishing through filing cabinets to verify 20 year old broker statements.
If I get everything reconciled by the weekend I'll be in a position to evaluate a few pending decisions around stock buy-backs, selling stocks and realising capital gains so I can move the funds into a SMSF, and what end-of-financial year arrangements I'll need to make regarding tax deductible loan pre-payments etc. in order to manage my taxable income and hence Capital Gains tax rates for this year.
When I started out investing in stocks I could only afford to purchase relatively small amounts ($2000 at a time) - and it took me several months to save up enough to make another purchase. I'd have bought a more diversified portfolio of stocks and in smaller amounts, but in those days there were no online brokers and "full service" brokerage often had a minimum fee of $50, which made trades of less than $2000 uneconomic. One way to avoid the cost of brokerage while adding to my stock holdings was to participate in the Dividend Reinvestment Plan (DRP) available from many companies. Aside from the benefit of not having to pay any brokerage, in those days many of the DRPs issued new shares at a discount to the prevailing market stock price of 2%-5%. These days the discount has been reduced or eliminated completely, which makes these DRPs less attractive. [BTW - it pays to read the "fine print" of all available DRPs if you are a small shareholder. Most plans issue whole numbers of shares at the applicable price, and rollover any surplus dividend amount in a DRP account until the next dividend date. However, a few plans "round up" the number of shares being issued to the next whole number. This can boost dividend rates significantly if you have a small share holding and end up being issued, say, 5 shares instead of 4.53)
However, these days I tend to get all dividend paid out as cash, and simply use the dividends to help pay the interest on my stock margin loans. Looking back at the DRP share purchases from my early days as a stock investor I'm amazed at the tiny dividend amounts and corresponding stock purchases that I was accumulating. Now I'm left with a major headache going back through all the trading records and DRP statements to work out the "cost base" for my current stock holdings if they include DRP stock purchases. If I didn't spend the time doing these calculations myself and instead paid an accountant to do my tax returns the extra cost would definitely outweigh the price discount and brokerage benefits of using a DRP. For example,
Date Tran QTY PRICE FEE TOTAL Cost QTY
15/06/1993 BUY 1,200 $2.45 $- $2,940.00 $2,940.00 1200
20/07/1993 SELL -400 $2.45 $- -$980.00 $1,960.00 800
30/11/1993 DRP 16 $2.95 $- $47.22 $2,007.22 816
29/04/1994 DRP 17 $2.89 $0.01 $49.06 $2,056.28 833
30/11/1994 DRP 19 $2.61 $- $49.49 $2,105.77 852
28/04/1995 DRP 19 $2.72 $- $51.72 $2,157.49 871
17/11/1995 DRP 24 $2.90 $0.01 $69.50 $2,226.99 895
26/04/1996 DRP 22 $2.87 $- $63.03 $2,290.02 917
12/11/1996 SELL -900 $2.91 $64.05 -$2,554.95 -$264.93 17
12/11/1996 DRP 28 $2.58 $0.01 $72.33 -$192.60 45
24/04/1997 DRP 1 $3.22 $- $3.22 -$189.38 46
15/10/1997 DRP 1 $3.94 $- $3.94 -$185.44 47
Just how hard it can get keeping track of all the DRP transactions is shown by the Sale on 12 Nov 1996. I'd gathered together all the share certificates and taken them to my broker to sell my entire holding. Unfortunately I didn't realise that I'd mislaid one DRP stock certificate, and ended up with a small residual stock holding which was worth less than the brokerage would have cost to sell them! These days with electronic stock records (CHESS) having replaced certificated holdings in Australia, this is less of an issue.
It's also slightly easier to calculate the CGT cost basis for stock holdings under the current rule of taking the (sale proceeds - issue cost) as the capital gain, and applying a 50% discount when calculating the Capital Gains tax using your marginal income tax rate for stocks held more than 12 months before sale. Under the previous CGT regime you have to work out an adjusted cost basis for each stock lot individually based on the CPI index at the time of purchase and the CPI index at the time of sale!
A final draw-back of using DRPs is that each DRP stock purchase has to be taken into account as an additional investment if you ever want to work out your overall portfolio rate of return. This is one of the reasons I've never done to sort of detailed analysis of my investment performance the Moomin Valley has been posting about. At best I've made rough estimates of my annual portfolio ROI based on starting and final valuations and an approximation of how much additional money I've contributed during the year in terms of stock purchase, retirement account contributions and interest payments on my stock and real estate investment loans. I'm sure if I ever tried to calculate the try ROI over the past 10 or 20 years I'd stuff it up and miscalculate like the Beardstown Ladies Investment Club!
Both BHP-Billiton and Foster's Group have sent out the paperwork for an off-market share buy-back. It's a bit hard to calculate the exact benefit of taking up these offers as
* the number of shares accepted may be scaled back, leaving me with a smaller parcel of shares in the company
* the final buy-back price will be determined in the tender proces, and will be at a discount to the market price of between 10%-14% (BHP) and 5%-14% (FGL)
* the amount of the buy-back price subject to capital gains tax will depend on the final buy-back price, as the "capital component" PLUS an "excess tax value" equal to the difference between the "tax value" of the shares at the time of the buy-back (as determined by the ATO) and the final buy-back price
* the amount of the buy-back price assessed as a fully franked dividend will be the difference between the final buy-back price and the "capital component"
As I'll probably have a marginal tax rate of 30% this year (it depends what tax deductions I arrange through pre-payment of 12 months of my margin loan interest) the franking credit of 30% with offset the tax due on the "franked dividend component" of the buy-back. This will mean that I only have to pay 15% CGT on the amount by which the capital component and excess tax value exceeds the orginal purchase price of my shares. As I haven't got all the old paperwork sorted for my BHP and FGL share purchases I don't really know if I'll likely make a net capital gain or capital loss on these buy-backs, but in any case it will be a much lower CGT liability than if I sold these shares for full market price. Exactly how beneficial the buy-back is compared to selling the shares for full market price will depend on the popularity of the buy-back, and hence what the final tender price discount is.
I'll have to sort out the cost base my BHP and FGL shares this weekend so I can decide whether or not to accept the buy-back offers before the tender period closes (23 March for BHP, 5 April for FGL).
If the after tax proceeds of the buy-back look better than selling the shares on market I'll probably take up the offer for all my shares (3,751 FGL and 748 BHP) as I was planning on liquidating my stock portfolio of the next few years and reinvesting the funds in a DIY retirement fund (SMSF). I also have to do some estimates of how beneficial it will be to sell and reinvest the after CGT funds in stocks within a SMSF compared to retaining my current geared portfolio outside super and selling it off during my retirement when I should be able to restrict capital gains tax rate to around 10% anyhow.
Moom asked what date the ASX200 Put Options that I mentioned in my previous post expire - they are the 5500 options which expire on 20-Dec (XJOQT). I bought them on 9-Feb at 158.00, so the 3 contracts (each contract is for 1,000 options) cost $4,795.77 (including brokerage).
For interest I looked up the ASX200 index (XJO) closing value and plotted it against the "market price" for the XJOQT options that Comsec has been emailing me each day since I opened my position. As you can see, the option price has a negative correlation to the ASX200 Index, but the correspondence isn't perfect as the market for the options is quite thin and the buy-sell spread is larger than you'd get trading stocks. As the Options don't expire until Dec-20 their current price is a combination of the strike price relative to the current Index value, and the "time value" of the option until expiry. At the moment it appears (from the graph of option price vs. index value) that each contract would be worth around $5,000 if the index dropped to the 5500 level (another 5.5% drop from current levels), but at the expiration date of 20-Dec the options would have no value above the 5500 level, and will be "cashed out" for $10 per 1 pt below 5500 on 20-Dec (if I hold them until expiry).
As my entire direct investment in the Australian stock market is around $600K each 1pt decline in the market costs me around $100. Therefore I'd have to be holding 10 of the Index Put Option contracts to be fully covered for losses below the contract strike price. With only 3 contracts I'd be making $30 profit on the contracts for each 1 pt decline to offset against the $100 loss on my stock holdings. As my stock portfolio is currently geared around 100% I'd need 5 contracts to make my portfolio losses match the actual % market decline below the 5500 level, and 10 contracts to be fully "insured" against any loss if the market drops below 5500 prior to Dec-20.
I'll buy another 5 or 7 contracts if the market resumes it's bull run and goes above the 6100-6200 level. Hopefully I can get fully "insured" against drops below the 5500 level for a total cost of around $10K (around 1.7% of my portfolio value, or around 3.3% of my equity). This would "cap" my exposure in a bear market to a maximum loss on my Australian stock portfolio to around $35K, or about 10% of my equity in AU stocks. I'd still retain my exposure to any upside if the market continues it's bull run. If the market gains another 10% by the second half of '07 (around the 6400-6500 level) I'll look to start selling off half my AU stock portfolio and use the proceeds to eliminate my gearing until the end of the next bear market is in sight (ie. All Ords back down to around the 4000 level).
Although this all smacks of an attempt to "time the market" I think it's prudent to make use of Put options when the market has gone up around 20% for each of the past three years, and to look at reducing my use of gearing when the market's p/e appears to be getting stretched at the end of an extended bull run.
No matter whether you've been investing for a day or a decade, there's always the niggling thought that someone out there knows the "secret" to timing the market. So you may give your money to a professional to manage (eg. Actively Managed Funds), or read books or take courses on a technique to boost your returns above the market average. All these things will cost you time and/or money. Occasionally one method you try for a while (day/month/year) will actually produce good results, so you'll tend to think you've discovered the "secret" and stick to that method until it ultimately fails (and in the meantime possibly blog about it, tell your friends, write a book, or teach your "secret" in seminars).
I must admit that I've done this over the years, and I still will invest a portion of my money using particular techniques in attempt to boost returns - for example my "Little Book that Beats the Market" US Stock Portfolio (Value Investing), and toying with the idea of moving some of my domestic stock investments from my geared personal stock portfolio (stock picking) into a professionally managed individual stock account (with Direct Portfolio) within a self-managed super fund (SMSF). But my preference over time has shifted towards low-cost index funds where available (I'm thinking of moving my retirement account from my employer's default fund (Westpac/BT Employer Super) into a SMSF where I can invest in Vanguard Index Funds or ETF such as the Commonwealth Diversified Share Fund (CDF)
One of the main reasons I've drifted towards a preference for Index Funds is that although I recognise that some actively managed funds outperform for extended periods (eg. Berskshire Hathaway), most funds that outperform for a while (up to a decade) can be simply put down to "luck" or random chance. Similary, techniques such as charting, while always able to explain stock movements in hindsight, don't appear to have any real predictive power. If you ever need reminding that a LARGE component of stock price variations (and market variations) is purely random, despite the appearance of clear patterns or "trends" in the charts, just do a simple random walk simulation in excel.
For example, just as a reminder to myself, I ran a simulation in excel to model the coming year in the ASX All Ords using a few basic parameters and a random number generator:
Simulation Period: Daily Index Value for next 250 days
Starting Value: 5800 (around the current Australian market level)
daily movement formula: new value=P+(10%/250)*P+RAND()*200-100
where P=previous cell's value (eg. B4, if calculating value for cell B5)
I picked an overall 10% pa ROI as a typical stock market trend and a daily random move of + or - up to 100 points as a fairly "typical" market movement.
It's amazing how realistic the "chart" for this simulated market is every time you press F9 to recalculate the random numbers. For example, just from random numbers, you can get a continuing "bull market", a sudden "crash", a "bear market", or a "correction":
Crash: (just a little one)
Of course the market (and individual stock prices) isn't purely random - but key events that will shift the market in a particular direction by a significant amount aren't known in advance (otherwise the effect would already reflected in the price by other investors trades adjusting the price level).
Ultimately, I think the time spent trying to uncover "secret" techniques to predict the market would be better spent by a novice investor in a second job earning more funds to invest, and for a more seasoned investor with a significant amount already accumulated, just concentrate on diversification, asset allocation, tax-effective investment structures and try to avoid high fees, churning or other return-diminishing behaviours.
I've finally bitten the bullet (gently) and bought my first real "derivatives" - I placed an order today to BUY 3 contracts for the S&P/ASX-200 index PUT option, 20-Dec-2007 expiry date. Each contract is for 1,000 'shares' (a strange terminology when you're buying index options) and the price range quoted when I placed the order was $1.44-$1.63. I started out telling the broker to set my buy price at $1.50 but he advised that this would take a long time to fill. I asked if the price varied more with time (ie. as we get closer to the expiry date the price should drop) or with the current value of the index (once you are "in the money" the contract is worth $10 per point at the expiration date). He wasn't terribly helpful, so I decided to bid $1.60 - so hopefully this order was filled.
The whole options trading thing is a bit of a pain - rather than just login and place an order with my normal online broking service, they have a special "power trader" application that provides live option pricing, charts etc. I looks really cool, but unfortunately I can't install it at work, and options trading is only available during market hours, so I can't use the software to trade options at home anyhow. So I have to phone the broker during business hours to trade options. Probably a good idea to start with, as I don't really know what I'm doing.
My geared stock portfolio is worth around $525,000 at the moment, with margin loans of $264,000. Hence my equity is around $261,000 at present. Although my portfolio doesn't exactly track the ASX-200 index, it does have a high correlation with the index. A change in the ASX index of 1 point is worth about $90 to my equity. Thus at my current gearing level a 2900 point drop in the index (just under 50%) would wipe out my equity entirely (but I'd be getting margin calls long before that!).
As each 1 pt decline below 5500 is worth $10 at the expiration date of an ASX200 5500 20-Dec-2007 PUT Option, I'd have to own around 9 of these PUT option contracts to offset the losses on my portfolio entirely below the 5500 level. I've started out by buying just 3 contracts today, as the market still seems to have upward momentum, and I might be able to buy additional contracts in future at a lower price (or ones with a higher strike price for the same cost). The three contracts will cost around 3*1,000*1.60 = $4,800 plus $100 brokerage. This equates to an "insurance premium" of 1.87% of my current equity. These contracts will reduce my losses below the 5500 level by around 1/3:
Full coverage for losses below 5500 up to 20-Dec would cost three times this amount (ie. 5.61%), so this strategy isn't sustainable indefinitely.
I'm only doing it now as the market seems to have reached dangerously high levels, plus the fact that I don't want to sell off significant holding and realise capital gains this tax year. I expect to start selling off some of my stock holdings after 1 July to reduce my gearing and start shifting my equity investments into a self-managed superannuation structure. This will mean that by the time the PUT options expire in December I won't have much of a geared exposure to shares (you can't directly use gearing within a superannuation account), and may have diversified some of this investment into other asset classes (eg. foreign stocks, commercial property, bond funds).
We'll see how this works out over the next 6-10 months.
Your Credit Advisor has a good listing of "top" personal finance blogs. Rather than just list them based on alexa ranking or similar, YCA has provided a summary of each blogs focus and grouped them into meaningful categories. This listing also gets my tick of approval because enoughwealth is listed as #45!
The past month provided more good gains in my stock portfolio and retirement account, offset only slightly by a small drop in the valuations of my real estate assets:
* Average property prices were slightly down, dropping my property equity by $4,146 or 0.58%. We also had to redraw $3,500 from our home loan prepayments to meet our repayments as DW is on maternity leave and not earning any income at the moment.
* My stock portfolio equity went up another $19,568 (5.50%) this month and my retirement account also increased significantly, although it was boosted a bit by some extra contributions being deposited by my employer this month - up by $12,561 to $324,598 (up 4.03%).
My Networth as at 31 Jan now totals $1,058,372 (AUD), an overall increase of 2.48% for the month.
As discussed in a previous post, I'm looking into either buying Index Put options to protect against significant losses if the market drops, or else selling off some of my stocks to repay my margin loans and eliminate my gearing while the market is at the current high level. I'm leaning towards the Put Options idea as I don't want to realise capital gains this financial year, and most of my margin loans have had the interest prepaid until 30th June, so I should keep my investments until then (and keep my fingers crossed that the market goes up a bit more until then).
Although my preferred strategy is a "high-growth/high-risk, buy-and-hold, stick to your asset allocation" one, there comes a time when the market starts to look a bit too high to any dispationate observer. The pundits are still saying that the Australian stock market isn't cheap but isn't too expensive either, based on historic p/e ratios and company profitability outlook. Then again, they're saying that after three consecutive years of total returns of 20%+ the best they expect this year is around 10%, so the upside seems limited, while the downside risk has obviously increased from what it was four years ago. Looking at the chart for the All Ordinaries Accumulation Index since 1980 the current market rise looks a lot like 1987 - and we all know how that ended up!
Anyhow, the Superannuation (retirement) account for my son was invested with the following asset allocation:
80% Geared Australian Share Fund
20% International Shares Fund
This allocation has performed very well since I opened his account four years ago, with returns of:
FY 04/05 25.3%
FY 05/06 42.0%
I figure that having gotten off to such a good start DS1 can now afford to move to a more conservative, high-growth asset mix (even though at age 6 he has another half century before he reaches retirement age), so today I sent in the paperwork to change his investment mix to:
30% Australian Share Fund
10% Australian Small Co Share Fund
20% International Shares Fund
20% Property Securities Fund
20% Australian Bonds Fund
This is still a high-growth, high-risk allocation (with 60% in stocks) so it should provide a good rate of return over the next 50 years, but at lower volatility than the previous asset mix. If there's ever a significant (30%-50%) correction in the Australian Stock Market I'll think about moving some funds back into the geared Australian Share Fund again. I think this weak form of market timing is called "dynamic allocation" - but it's still just a guess no matter what you call it.
* * * *
The current market also has me a bit nervous about my Australian Share Portfolio. I have two margin lending accounts holding $540K of Australian Shares, with a loan balance of $263K, so a severe market correction would have a big impact on my Net Worth! I'm toying with the idea of buying some PUT options on the ASX200 Index as insurance against a major market correction occurring between now and the options expiry date (21 June 2007). For $12K I could buy enough Options to offset any losses where the market drops below 5500 (it's currently at about 5750). The simpler option (excuse the pun) would be to just sell off enough of my portfolio to pay off the margin loan balances - but the interest has been pre-paid until 30 June 2007, so I'd be throwing five months of interest payments down the drain if I paid off the loans now. I also have reasons for not wanting the realise a capital gain prior to 30 June.
I've been doing some research on Self-Managed Superannuation (Retirement) Funds with a view to setting one up for myself, DW, DS1 and DS2 (luckily the maximum number of members in a SMSF is a perfect fit to my "nuclear" family).
The potential benefits of a SMSF compared to my company-selected superannuation fund are:
* can invest in any "suitable" investment (eg. direct shares, index funds) rather than picking from the list of 20 or so managed funds available via my current Super Account.
* saving money on fees - although our employer has arranged for a "rebate" of part of the standard admin fee charged by the Super Fund (so it ends up being around 0.4% instead of 0.95%, plus the managed fund management fees of around 1-1.5%), this is still higher than the $500 pa "flat fee" available from eSuperFund.com.au for a SMSF (eg. on my current Super Account balance of $315K this equates to an admin fee of 0.16% pa)
There are some possible drawbacks though:
* I currently have life insurance via my Super Fund. If I changed funds I'd have to apply for cover again, and, for the amount of cover I currently have ($400K) I'd probably have to pass a medical exam
* As a member of a SMSF I'd have to be a trustee and be responsible for setting an investment policy and abiding by the rules regarding running a SMSF, otherwise the SMSF can lose it's tax-advantaged status. This shouldn't be too onerous though, as I previously acted as an employee-appointed Superannuation Fund trustee at my previous job.
The other thing I have to consider is shifting some of my assets that are currently held outside of Superannuation (ie. my geared investments in Australian shares) into a Superannuation account to save tax. Basically an undeducted contribution of up to $1M can be made before Sep 2007 (due to recent changes in the Superannuation rules) and there won't be any contribution tax. Once held by a Superannuation Fund, the assets income is only taxed at 15% (rather than my personal marginal tax rate of around 30%+) and capital gains are taxed at 10% (rather than half my personal marginal tax rate). Also, once I reach retirement age (65) all withdrawals from the Superannuation account are not taxable under the new rules.
The disadvantages of putting these assets into a SMSF are:
* Can't "borrow" for a Superannuation investment, so gearing is out. However, this isn't a big issue as I'm thinking of eliminating my gearing this year anyhow as the stock market has had a good run for 3 years and will eventually have a "correction" of 10%-30%, not a good time to be geared up. Also, Superannuation Funds can invest in "warrants" which give you similar effects as margin loans, but without the risk of margin calls (but the effective "interest rate" built into warrants is higher).
* You can't "roll" existing stock investments into a Superannuation account without triggering a CGT "event" - so I'd have to pay Capital Gains Tax on the currently unrealised gains in my stock portfolio. If I was just selling off enough of my stocks to pay off my margin loans I could probably offset a large part of the realised gains by selling off all the "losers" in my portfolio.
* I'll have to get all my CGT records up to date in Quicken so I can work out how much capital gains tax I'd be liable for (I have old records up to 1998 in my old Quicken backups, but need to trawl though the past 8 years of transactions to get my CGT records up to date! It's amazing how little time I've had "spare" to do my financial records in Quicken since I got married and started a family!). I wouldn't want to do the transfer till after the end of the Australian tax year (30 June) as DW is on maternity leave this FY and may get some family assistance money if our combined income is not too high this FY. So the "window of opportunity" to make a large (up to $1M) undeducted contribution into Super for me is between 1 Jul and Sep this year. After Sep the max undeducted contribution each FY is going to be $50K, so it would then take 6 years to shift my current Australia Share investment into Super.
* Once assets are in a Super Fund they can't be "released" until retirement (except in exceptional circumstances). Thus, I'll be keeping some other assets outside of Super to act as my "Emergency Fund".
I'm also looking into DirectPortfolio.com.au which offers a managed direct share service, which can be done within a SMSF. I like the fact that they run individual stock holdings for each account, so you avoid some of the unintended tax effects that can arise when investing in managed funds. But their admin/management fee is quite high (around 2%) and you have to pay a $1000 setup fee when open an account with them. The setup fee covers recording all your CGT history if you transfer existing stock holdings to them, so it would be reasonable if I transferred my existing stocks without triggering a CGT event. But if I transfer my shares into a SMSF CGT will have been paid on the date of transfer, so there's no CGT history data required - so the $1000 setup fee seems a bit high in that case. Looking at DirectPortfolios results for their various "mandates" they have achieved around 2.3% above the ASX200 accumulation index for this period, which means they "outperform" by slightly (0.35%) more than the fees are costing. But, they don't provide data on the "beta" of their "mandates" so it's hard to tell if their risk-adjusted return actually outperforms enough to offset the management fee. So, if I decide to move my stock assets into a SMSF I'll probably just sell them off and deposit cash into the SMSF, then use it to buy a Vanguard Index Fund (perhaps their "High Growth" Fund).
Lots to research and think about in the next 5-6 months!
As previously discussed, we bought an investment property in 1999, just when the "boom" in Sydney real estate took off. The property cost just over $400K, and we took out a standard 25-year variable rate mortgage. The property appreciated significantly until 2003, and is now valued over $700K, so we have significant equity in that property. As loan interest on your own home loan isn't tax deductible in Australia (but you don't pay any CGT when you sell it either), but loan interest on investment loans is, we recently converted the loan to a fixed rate 5-year mortgage, so we could maximise payments off our home loan instead. At the same time I also arranged to make use of the available equity via a Home Equity Loan and I'm investing the funds over a period of 18 months a portfolio of US stocks, selected from candidate companies listed on the magic formula investing website. This strategy allows you to put your home equity to work as an investment, but, of course, is fairly high risk so is not suitable for all investors. It will pay off handsomely though if my US stock portfolio performs as well as the long-term average for the S&P-500 and interest rates on my home equity loan average out less than this rate of return. As a bonus, the dividends from the US stocks are fairly low compared to the interest on the home equity loan, and the difference can be claimed as a deduction on my personal tax return. As long-term capital gains in Australia are taxed at half your normal marginal tax rate, this means that I am basically able to reduce the tax paid at marginal rates (up to 48%) on my wage income, and will instead pay CGT at half the marginal rates (ie. up to 24%), assuming I eventually sell the stocks at a profit.
Easy Change wrote to me with a good question in response to my Asset Allocation post:
"I was wondering if you would be so kind as to talk more about when you started investing and/or what age range you are in at this point in your life. I am coming up on thirty soon myself and I find the whole concept of getting to 100k before then (which is what several pfbloggers are shooting for) to be a huge undertaking."
I think I've covered most of this before, in bits and pieces, but to summarise:
I'm 45, live and work in Sydney, Australia. I have a wife, two young sons, a mortgage and no pets. My personal net worth has just hit one million Aussie dollars. I come from a middle class background, have degrees in IT, industrial math and applied chemisty, and have only ever worked as a "wage slave" - first ten years as a scientist for a private R&D company, and then for ten years as for a market research company - working my way up from an entry level quality assurance role to a junior management position. My salary package is currently $8x,000, but until 2 years ago I'd never been on more than $60,000.
I started out investing by saving my pocket money and earnings (paper round, market gardening, and supermarket shelf packer) during high school into a bank account. When I worked during the Uni vacations (as a process worker in a pencil factory) I saved via my bank account and occasionally invested a lump sump ($1000) into government bonds or unsecured notes from a bank-owned customer credit company (AGC).
I first learned a bit about the stock market doing a Business Economics subject at Uni, which included doing "paper trades". As this course ran in the second half of 1987 it was quite interesting! Once I completed Uni and started working full-time I began investing in Individual stocks (using broker research to choose them), and eventually bought my first investment property.
Over time I learned more about stock selection, minimising brokerage fees and choosing Mutual Funds (for overseas stock exposure) that didn't have exhorbitant fees. Later on I began to use gearing (via margin loans) to offset dividend income with tax-deductible margin loan interest - effectively "converting" current, taxable income into tax-deferred capital gains (which, in recent years, are taxed at half the tax rates of current income).
I sold my original investment property (at a slight loss), as it was in a very poor suburb and tenants proved very unreliable. I swore off direct property investment, but then bought another property after I got married, as my wife wanted to reinvest the funds she had from selling her unit back into real estate.
Recently I've diversified my investmenting to include hedge funds, agribusiness investments (pine, sandlewood and teak plantations) and some wine, coins and bullion. I started direct investment into US stocks last year - trying out the "Magic Formula Investing" method outlined in the "Little Book that Beats the Market".
I'll probably reduce my level of gearing this year, as the stock market has had a very good run for several years and I'm ahead of my projections - no point risking reversion to the mean, especially when using margin loans. I'll also add any future wage rises straight into my superannuation (retirement) account, as by doing a "salary sacrifice" it gets taxed at 15% rather than my marginal personal tax rate. They've also recently changed the tax treatment of retirement income from superannuation accounts in Australia, so that they will be tax exempt. This makes superannuation more attractive than gearing shares or property investments for accumulating assets, although there are some limits to what you can invest in via superannuation, especially if I stick with the company-selected retirement fund, rather than opening a "self-managed" super fund.
I reached $100K net worth by age 30. That was worth more than $100K in today's money, as it was way back in 1991. But it was also easier for me than for most people, as I was living at home still (not paying rent or board), and I had no student debt outstanding when I graduated (I paid the HECS (Uni) fees as I went along. And HECS fees in Australia are only around 25% of the full cost).
My accumulation of net worth over time was covered in a previous post.
Worst investment decisions:
* Spending the money I saved up working during uni vacations on a 10" meade SC Telescope. You can buy one today for about the same price I paid back in 1982, and I've probably only used it for a total of ten hours in the last 20 years. Then again, I always wanted to be an astronaut when I was a kid, so it was worth every cent. I just wish I'd got around to building that observatory up at my parent's farm...
* Spending around $1000 on a Sinclair ZX80 computer and accessories in 1980 - I should have bought some Microsoft shares when they listed instead...
* Buying $2000 worth of an unlisted internet stock (GEN) in 1995, which went broke before it could list on the NASDAQ. If only I'd waited and bought Google or Amazon.com instead...
Back in June I applied online for a $50,000 investment in Macquarie Equinox Select Opportunities Fund - a "fund of hedge funds". I used a Macquarie Structured Product Investment Loan for 100% of the investment amount so I'd be able to take a tax deduction for prepayment of the 06/07 interest. As it was near the end of the Australian tax year I had to do the application online, and I nominated my usual "no advice" Finacial Advisor Service as the financial advisor, so that I'd get a rebate for most of the Funds "entry fee".
Because I hadn't received a rebate cheque by October I contacted the Financial Advisor service to check that they'd received the fee from Macquarie - it turned out that Macquarie allegedly had no record of my advisor details (although I had a print out of my application so I knew I'd provided the correct info), but kindly would update the records and pay the advisor fee if I emailed them confirmation.
Well, today a rebate cheque for $1,200 finally arrived from the advisor, so it was well worth nominated an "advisor" on my application that rebates Fund entry fees! One funny thing about this whole business is that despite the entry fee being deducted from applications, the unit price listed for this Fund has never dropped much below the $1.00 per unit application price. Go figure.
I got an email from wealthcreator.com.au a few days ago announcing the launch of their "investment shop". The email included a $15 evoucher as a Christmas gift. So I checked out what was on "special" and found that the "The Bullseye Investment System, - Audio Tapes & WorkBook" was on clearance sale for $24.00 (RRP $240). After applying the discount this ended up costing me just $9.00 (there's free shipping on courseware, presumably because the profit margin is usually quite large on these products) - a 96.25% "saving".
The "Bullseye Investment System" course comes on 6 audio cassettes (my car doesn't have a CD player), so it will be good to listen to on the 1-hour drive to or from work. According to the marketing guff "The Bullseye System is designed to help eliminate poor investment choices, identify superior investment opportunities, maximize profit potential, minimize risk, and simplify portfolio monitoring."
An very interesting article in the NYT reminded me, again, of the four deadly sins of personal finance:
1. Greed - "just a little bit more" can easily become "too much", whether it be chasing higher investment returns, pinching pennies, or getting "top dollar" when selling or "a bargain" when making a purchase. Remember the old adage that if it "looks too good to be true it probably is". When looking for "overlooked" investment opportunities it's also worth bearing in mind that there are several billion other human beings out there, millions of whom are also looking for the "overlooked".
2. Sloth - most people apparently spend more time planning the annual holiday than they do on planning their finances. Aside from generally financial planning, you also have to put in sufficient effort to analyse each potential investment on its merits. Buy things purely on the say-so of a friend or relative and you will have no-one to blame but yourself if things don't work out.
3. Trust - yes, BLIND trust can be a very bad thing. As they say in auditor-land "trust but verify" - don't take anyone's word for something that you could verify. And if there is nothing to back-up someone's verbal assurance, flag this mentally as having an "unknown amount of risk"
4. Envy - just because every one else seems to be making a fortune investing by in "X" doesn't mean you should try it. It doesn't even mean that they are actually making any money from "X". Not only can appearances be deceiving, I'd say that they usually are deceiving.
personal finance, investing
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