Wednesday, February 28, 2007

The Good, The Bad, and the Bull Run

It was only yesterday that I posted on how we have had an incredible Bull Run over the last 4 months, and it was only a matter of time until there was a slip up along the way.

Quite often, it only takes one small trigger for the domino effect that is falling share markets across the world. Today we saw after whispers that the Chinese Government, in an attempt to slow down growth, will begin taxing capital gains on shares bought and sold on the Chinese share market. This triggered the largest sell off on the Chinese market in 10 years, followed by the largest in the US and Australian markets since September 11.

So, investors that have panicked to sell off their investments and place them in super (of which possibly close to 50% is invested in Australian equities), today saw thousands wiped off the values of their super. I am now kicking myself that I didn't practice what I preach and Short Sell the S&P ASX 200 Index yesterday.

What is Ironic is that those cautious investors who have been sitting on the fence, waiting for the legislation to be passed through Parliament finally got the news they have been waiting for this morning. The super changes that have been proposed have been signed off by the Senate and are now Law. Good news coming to those who wait, or just a fortunate coincidence of events?

Is the Bull Run finally over? Most think not. The market is likely simply correct to more sustainable levels, consolidate for a while, and run again when we've all forgotten about the issues of today. Such is the nature of the beast.

Monday, February 26, 2007

Financial Planner minimum education not substantial

John Collett has uncovered a sad truth about the Financial Planning industry in his article "Minimum training for planners is not enough".

The Diploma of Financial Planning, which you are required to complete to be a licensed Financial Planner, is quite frankly a joke. It requires the completion of 4 modules. Each of these modules require completion of an assignment and an exam. The assignments are rarely updated, and therefore plagiarism is rife. The assignment requires completion of an open book multiple choice test. Yes that's right, open book AND multiple choice! This is often likened to a game of hide and seek, the answers are there, you just have to find them.

After completion of a University Degree, I was amazed the requirements to be a Financial Planner were so minimal, and after doing this course (which can be fast tracked in about a week), you are legally able to tell people how to invest their life savings! I can honestly comment that the Diploma of Financial Planning did teach me very little and most of my skills came from other avenues, including a 3 year University degree (whilst it wasn't in the financial planning field, it was heavily biased towards Economics and Finance which made it easy to apply Financial Planning knowledge), as well as learning as I went. The diploma also fails to attack real life scenarios, with its examples all based around the all too perfect 'client'.

The Financial Planning Association is working hard to promote the Certified Financial Planner (CFP) qualification. From now on to enrol to the CFP program you must hold a relevant University Degree, however grandfathering means that anyone who was advising in the 90' and early 00's was automatically granted CFP status after 3 years advising. Whats more, a CFP has exactly the same rights as a regular Financial Planner, so there isn't huge motivation to become a CFP.

I'm not saying you should avoid advice. Financial Advice is important, however, suss out your adviser. I'm not saying they require a uni degree or CFP, some of the best advisers I know have neither. Talk generally about the economy, financial markets and current affairs in finance. If you're a good judge of character you will soon work out if your adviser is the real deal!

The industry to be taken seriously, must get serious about making it tougher for Financial Planners to get qualified. It is an industry that is already tainted, and does not need any more bad publicity. Until then we will remain the laughing stock of our professional peers.

Sunday, February 25, 2007

A mad rush out of the bricks and mortar

When the Federal Government announced the transitional arrangements to super, with up to $1,000,000 per person being able to be contributed between 9 May 2006 and 30 June 2007, we all expected a mad rush on the Boomers selling up their assets and dumping the proceeds into super.

Well it looks like it's started. Carrie LaFranz reports on how Real Estate listings are well and truly on the rise, with a large number of listing reportedly being made purely to take advantage of the new rules. The proceeds, when thrown into super, are helping contribute to the Bull Run that our market is currently having.

All of a sudden the Baby Boomer's love affair with bricks and mortar has shifted, thanks to Mr Costello offering them tax free retirements. It goes to show, the "property is the best form investment" mentality that many Boomers exhibit is soon forgotten when they are presented with the opportunity to save a few dollars in tax.

However, before you get rid of your investment property, which is apparently about to increase its yield by up to 20%, at a possible discount due to a glut of For Sale signs in front yards, there may be alternative strategies available to you.

1. Sell your properties later. If you're part of a couple, you can contribute $150,000 each to super every year until you turn 65. This can be averaged out over a 3 year period, effectively allowing a one off $450,000 contribution each. Now lets assume you sell a property just prior to July one year, you can put in $150,000 each before July, and then $450,000 each after July. This is a total of $1.2 million.

2. Borrow to contribute. This one should be treated with caution. However, if you think your property would fetch more after July, when the glut of sales declines, you could borrow against your property now, and contribute this to super, paying the loan off when you sell the property. However, you will be liable to pay interest on this loan which is not deductible.

3. Transfer your property to a self managed super fund. If you own commercial property, this can possibly be transferred to Self Managed Fund. Capital gains tax will be payable, as you are effectively transferring ownership to another entity. Unfortunately domestic property cannot be transferred to a SMSF.

Before you rush to sell your investments, have a think about the other options available. Tax should be at the front of your mind. If the capital gains tax you will be paying is going to be a lot, the tax free status of super in pension phase may not be worth it. There are ways to lower this tax payable, but that's for another time.

The Long and the Short of things

As the market currently on what seems like a day by day basis hits record highs, one has to wonder how long this record breaking bull run can last.

This chart plots the Australian All Ordinaries Index for the last 12 months (to 23 Feb 07). Apart from a couple of small blips, it's been all up hill since late September!

Now, if you're one of the increasing numbers who believes that there is only so long a run like this can go for and we're due for a correction, you might stick all of your money in cash until this correction happens.

However, investing in cash only provides you with limited returns. What would be great is benefiting from a correction when it happens. Or what if you think the market as a whole will keep going up, but think that Telstra shares are overpriced and are due to fall and want to benefit from this fall?

Well the answer is you can. You do this by "going short". There are numerous ways to go short, or sell a stock (or index) that you think will fall. You can purchase Call Options or Warrants, or sell Contracts for Difference (CFD's) or even short sell on the ASX. However, these strategies are risky, and not for the novice investor.

There are other ways to benefit from this strategy though. This involves investing in fund managers who can "go short". These are usually referred to as "Long / Short Funds". In a previous post I have written about how the after tax returns of actively managed funds often do not justify the extra risk and fees involved. However, a fund with the option to take on strategies like this can definitely provide value IF they get it right!

These types of funds are relatively new to the market. I have tried to find some returns on some tried and tested long/short funds, however they all seem to have existed for less than 12 months. Time will tell if these fund managers can predict when to go long and when to go short.

Some funds offering a long/short option are:

Acadian Australian Equity Long / Short
PM Capital Australian Share Fund
JANA Australian Share Long Short Trust
Macquarie Alpha Opportunities Fund
Perpetual Share Plus Fund

Time will tell what the success of these funds is.

It's all about time in the market AND timing the market

If you've seen a Financial Planner you are likely to have heard this one: "It's about time in the market, not timing the market". Basically this means don't worry about what the market is priced at, if its over or underpriced. This doesn't matter. Just get your money in the market for the long term and over time you will be better off than those who trade in and out trying to pick "peaks" and "troughs" in the market.

This definitely makes sense, as who can tell when the right time to invest is?

However, I have recently, as part of a Post Graduate Diploma, studied Technical Analysis. When I told my colleagues I was taking on this subject, they laughed at me. Technical Analysis goes against all the fundamentals that as a Financial Planner and Economist I should believe in. At university they talk about it like it's a black art of some sort . However, I've always been interested in charting and wanted to better understand how to analyse charts, so took on this course.

For the uninitiated, Technical Analysis involves examining price action to determine changes in the supply and demand balance. In other words, using charts to determine whether to buy or sell securities. A common misunderstanding is Technical Analysis uses past prices to predict future prices. There's definitely more to Technical Analysis than this, with Behavioural Finance a major factor in Technical Analysis.

My growing understanding of Technical Analysis, has led me to believe that Technical Analysis can be used to "Time the Market". It's definitely not foolproof, but if you pick the right triggers, you can use Technical Analysis as well as Fundamentals to invest. For example, lets say I like the fundamentals of BHP and want to buy them for the long term. I can undertake some Technical Analysis and decide that I think in the next month it will fall by 10%. Then wait around and get in at a discount to what I would get in otherwise. Obviously I could be wrong and it never reaches the low that I predict, but that's the risk you take.

I remember a client last year decided to invest $500,000 in Australian Share managed funds through his margin loan. This was in early May, 2006. If you think back a while you might remember a correction of around 10% soon after this. So within a matter of weeks, this guy's portfolio was now worth around $450,000. Now, assuming a return of 10% per annum, over 10 years, the portfolio invested prior to the correction would be worth $1,167,184, a gain of $667,184 over the period. If he had of waited a month or so, the portfolio would be worth $1,296,871, an increase of $796,871 over the period. This is a net gain of $129,687 more than the other strategy.

An extra 20% return just to pick the right time to enter the market? I'll take that thankyou!

Get rich quick - be a tight@r$e

To have $100,000 sitting in the bank, to do with what I please. That would be lovely. Unfortunately for me, I'm only a few years out of university, and whilst my savings (I like to call them investments, as I have very little in cash) are looking ok (a lot better than some my age who have fallen for the credit card and personal debt trap!), I am blessed with the ability to enjoy spending my money too much!

I found out recently that a guy who I went to uni with has just put a deposit on a unit in Sydney, using the $100,000 he saved while he was at uni.

That made me ask the question, how does someone save $100,000 while they are at uni? I remember uni days were living week to week on the few bucks I was earning working 15-20 hours in retail.

Then I remembered, while I was out partying at the local seedy uni pubs, skipping lectures for a few more beers at the on campus bar and spending my few dollars of savings on clothes and gadgets like iPods (actually in those days Minidiscs were the thing of the future... mp3 players were never going to take off), this guy was pulling a few extra shifts at work, studying hard and getting around in the same daggy clothes and a discman from 1996.

Is he happier than me, now that he has a relatively small deposit on an inner city overpriced shoebox? Who knows. I'd like to hope that smart investing over the coming years might put me in front in the long run, without having to hamper my lifestyle. Until then, I'm happy with my Minidisc player!

Saturday, February 24, 2007

Index or Active Managers - It's all in after tax returns

Numerous bloggers out there blog about this. The argument over which is better. Active fund management or Passive fund management (otherwise known as index following). Interestingly enough, the mainstream media seems to stay out of this one, probably for fear of backlash from Financial Planners and large Dealer Groups who are sponsoring their publications. For the uninitiated here is a brief rundown.

Active fund management involves a fund manager actively monitoring a portfolio with the aim to outperform an index.

Passive fund management involves a fund manager simply monitoring their portfolio to ensure it replicates an index with the aim to generate a return as close to the index as possible.

Now the active fund managers charge relatively high fees due to the time and expertise involved in their work but promise to provide higher long term returns. The passive fund managers charge lower fees as all they are trying to do is replicate the index, not outperform it.

This issue that many people have (bloggers included) is that for the relatively high cost of active management, does it actually provide a better long term return, or are you better off just investing in the index for a better net of fee long term return.

My opinion is divided. I see value in both strategies. If you pick the right Active Manager, you can definitely receive better long term average returns than the index, however, if you pick the wrong Active Manager you can end up performing worse than the index, and pay high fees for the pleasure of it! Start diversifying across fund managers to 'lower your risk' and you end up with some outperforming and some underperforming, leaving you with a net return of the index less management fees.

However, the issue isn't this complicated. You see, when comparing these returns, apples must be compared with apples. It's one thing to quote a certain return, however, if the investor is going to be liable to pay more tax on generating this return, then the 'net benefit' is not what is being quoted. It's like earning $100,000US in the United States, or earning $100,000US in Dubai. You're earning the same income, but you're going to be better off in Dubai where there is no income tax (and you get to ski on indoor snow and have servants at your beck and call).

This might be easiest to explain with an example.

Lets say your index fund has a return of 'X'. Of this return, 20% is returned to you in distributions, such as dividends and realised capital gains. You're actively managed funds generates a return of 'Y'. Of this return 50% is returned to you in distributions. Given that an active fund is constantly being analysed, stocks are being bought and sold based on feelings of whether it will go up or down, you would expect that more capital gains will be realised by the active fund.

I've gone to the liberty of researching average 5 year returns for a large Actively Managed Australian Share Fund and a large Index Australian Share Fund. To be fair, I've taken 6 active funds and taken an average return of the lot from VanEyk. The funds chosen are the flagship Australian Share Funds from AMP, Barclays, BT, Challenger and Colonial First State. The index fund I have chosen is run by Vanguard. I have not bothered averaging out returns for index funds as it would be expected that they would have similar returns.

Here's what I came out with.

Fund Income (%) Growth (%) Total (%)
Barclays 12.85 3.49 16.34
BT 3.53 12.15 15.68
CFS 10.2 5.97 16.17
Challenger 9.37 8.01 17.38
AMP 9.77 5.05 14.82
Average 9.144 6.934 16.078

Index Fund

Growth: 10.73%
Income: 4.49%
Total: 15.22%

Well, between these 5 funds, we have outperformance of the index fund of 0.86% pa. Barclays, BT, CFS and Challenger have all outperformed the index, but AMP has underperformed. Good for you Mr Fund Managers!! However, 57% of the return has been distributed as income, compared to 30% on the index fund. I'm going to assume that the 4.49% income on the index fund is all dividends (in reality there will be some capital gain) and the 9.14% income on the active fund is made up of 4.49% dividends and 4.65% capital gains. For simplicity I will say that ALL of the capital gains are on assets held for more than 12 months, therefore are entitled to the 50% discount (in reality, not all will be held for that long).

Therefore, after tax return, assuming a marginal tax rate of 31.5% (which applies to most people with taxable income between $25,000 and $75,000) gives a return as follows:

Active Funds - 13.93%
Index Fund - 13.81%

The 0.86% per annum out performance has all of a sudden eroded to 0.12% per annum. This doesn't leave a lot of room for underperformance!

As Tim Shaw once said, "but wait, there's still more!".

The fund managers, after much criticism of late regarding these after tax returns have hit back. They have said, hang on a minute, you're only looking at returns whilst you are invested in the fund. By providing you with part of your capital back every year, we are helping you by spreading the capital gain out over the life of the investment, so you don't get hit with it all when you exit the investment at the end.

This argument is fine, apart from a few issues.

1. How much of the gain is being distributed with 12 months, where there is no 50% discount for capital gains? If the fund manager is buying and selling within a 12 month window, the investor is missing out on this 12 month exemption.

2. Many long term investors plan the sale of their taxable assets in years when their income is lower. They don't need you, Mr Fund manager to help them decide when is the best time for them to pay tax.

3. Gains are being duplicated. Whilst a stock may be held for the 12 months mentioned in point 1, there still must be some duplication of gains where they are realised over and over again. Eg, sell stock on a high, share price drops, rebuy, sell on high, etc. Multiple gains are being realised here.

The index vs active management debate is something I will address more often. I believe that there is a place for both. I actually have money invested in active funds and am happy with the returns I have received, although come tax time this year I'm sure I will do my usual round of complaining.

Something interesting I found whilst researching for this entry, from the funds I have compared here, the one year returns for the active funds and index fund are:


Active Index
Income (%) 18.92 6.65
Growth (%) 3.28 15.45
Total (%) 22.2 22.1

Using the assumptions used above, this is an after tax return of the active options of 18.17% and the index options of 20.01%.

Time to start finding some tax deductions I think!!!

Thursday, February 22, 2007

Seller's Remorse

Buyer's remorse, as defined by Wikipedia, is an emotional condition whereby a person feels remorse or regret after the purchase of an item. Something I quite often get after forking out for that new gadget and realising soon after that I didn't really need it.

Seller's remorse on the other hand, usually occurs when someone sells their home. The place where they have lived for a large part of their life is no longer theirs. Have they done the right thing? Who knows!

Today I had seller's remorse of another kind. In August last year I took a punt on a Uranium explorer. I didn't put a lot of money in, enough that if it went well I would be happy, but enough that if it things went belly up, I wouldn't be slitting my wrists. Well, in about 6 months, I have more than quadrupled my original investment. I didn't in my wildest dreams expect this.

I feel the Australian market as a whole has become quite overheated in recent times. The S&P ASX 200 has just cracked through 6000 points, with the All Ordinaries closely behind it. It was only late September that the market was under 5000 points. This sort of growth can't be sustainable. During this time these Uranium explorers, who are still earning no money, and are unlikely to start mining for at least another 5 years have been running hot. All purely based on speculation that Uranium is actually the Commodity of the future. Is Uranium the commodity of the future? Who knows... I'm sure the people of Chernoble would think not.

So, today, as the All S&P 200 broke through 6000 points and people starting asking the question of will we see 7000 points by year end, I did what I wasn't expecting to do so soon, I hit the sell button on my Uranium shares. I wanted to hold for 12 months to get my 50% capital gains deduction, but it looks like I'll be providing Peter Costello with a few more bucks for the next Federal Budget. As some say, "It ain't so bad having to pay tax".

Immediately after I sold it hit me. This share that I had enjoyed a wild ride on for 6 months was no longer in my possession. Those days of watching the difference in open and closing prices of over 10% are gone. What had I done??? This stock might still have a long way to run! Not only that, but I've got to hand over part of my winnings to the Government! There's no reversing a decision like this.

However, now I sit back, with the cold hard cash in my hands (well, in my bank account in 3 days anyway) and feel relieved that common sense had overcome greed. Like many of those burnt in the dot-com boom & bust that soon followed, at least I know I didn't hold too long.

Time will tell if this was the right decision. I know for sure that I will be doing something more sensible with this money, like investing in an established stock or managed fund. I will report on the progress and if I actually have made the right decision!

Pre July 2007 Superannuation Tips

As I've previously talked about, there are some huge changes to superannuation about to come into force. The majority of these changes are due to be implemented on 1 July, 2007, whilst others came into effect on budget night, 9 May, 2006. For many of these changes there will be a transitional period with a 5 year window that the changes will take place in.

There are a number of strategies that can be implemented prior to July. Some are obvious, others not so obvious. I will talk about a couple of these changes here.

1. Undeducted Contribution Limits

This has been one of the most publicised change to super from the May Budget. In the past you could make unlimited undeducted contributions (other wise known as after tax contributions) to superannuation as long as you were under age 65 or under 75 and still working. However, this all changed on budget night. From 9 May, you are able to contribute just $150,000 per annum to superannuation as an undeducted contribution. Alternatively, you can contribute $450,000 one year but not be able to contribute for the next two years, allowing you to average out your contribution over three years.

However, soon after these changes were announced, the Federal Government realised that in limiting undeducted contributions, they had destroyed many Australians' retirement plans. You see, previously people would possibly hold money in other assets such as share portfolios and investment properties, sell these just prior to retirement and contribute the proceeds to superannuation to commence a tax effective income stream. Peter Costello's new rules, limited these contributions. Therefore, the Government has decided to allow $1,000,000 worth of contributions per person between 9 May, 2006 and 30 June, 2007.

Therefore, if you have a heap of money sitting outside of superannuation and want to get it in, this is your last chance. Remember though, you will still be allowed to contribute $450,000 from next year. If you have a partner, that means between you, you can get $900,000 into superannuation. So all is not lost.

2. Start your pension after 1 July

If you're between age 55 and 60 read on, if not this does not apply to you. If you've had money in super since before 1983 read on, if not this does not apply to you. Now, I've got rid of all but 0.001% of the population! However, this is an important rule that can easily be forgotten and potentially save thousands in tax.

Currently, if you have had superannuation since before July 1983 (you were most likely a public servant to have super back then), your taxable component of your superannuation will be broken into two components. Your pre-July 1983 and post-June 1983 components. When paid from an allocated pension, these components are treated the same, however, when making lump sum withdrawals or when death benefits are paid to the estate, the components are treated differently.

From 1 July, these components will no longer exist. To simplify super, The Government has decided that all super benefits will be split into two components, "Taxable components" and "Tax Exempt Components". This definitely makes things simpler. However, they must then put all the existing components into one of these two. So, at 30 June, your "pre" components will be 'crystallised' and these components will become part of your tax-exempt part of your super. Undeducted components will also form part of the tax-exempt component.

If your allocated pension is commenced prior to 1 July, the tax free income you receive from it (called the tax deductible amount), will be based on an amount prior to your Pre-July 1983 components being tax free. However, if you start your pension after 1 July, your tax deductible amount will include your crystallised pre 1983 component. Providing you will more of your pension tax free.

If you've already got a pension running, you can simply commute this pension back to super and start a new one, however, the Tax Office is yet to make a ruling on whether this will be classed as "Tax Avoidance" or not, so treat this strategy carefully.

These are just a couple of the strategies available prior to the budget changes taking effect on 1 July, 2007. There are other strategies which I will attempt to address in coming weeks. Remember though, none of this is legislated yet, although with the Coalition controlling both Houses of Parliament, it is likely that most of the proposed changes will be legislated.

Monday, February 19, 2007

The truth about "simpler super"

We all remember the night. May 9, 2006. A mid term budget. Nobody expected much. The usual, token tax cuts and rebates to families. We all expected the big announcements to come this year in a lead up to an election.

We saw Peter Costello with that usual smug look on his face to announce "the biggest change to superannuation that Australia has seen". And the ability for "average Australians to not need to pay for expensive financial planners to access their retirement benefits".

This was a huge change to superannuation. The biggest? Possibly not. I still believe the Superannuation Guarantee Scheme (SGC) implemented by the Hawke/Keating Government in 1992 was the biggest change to super we will ever see. However, there were some fundamental changes announced.

Some of these are:
  • Tax free retirement benefits for those aged over 60.
  • Abolition of Rasonable Benefits Limits.
  • Funds are able to remain in the growth phase of super indefinitely.
  • The assets test for social security benefits will be expanded to allow more people access to Social Security Entitlements.
This is just the tip of the iceberg. The major benefit that has been well and truly flogged by The Federal Government is the fact that retirement benefits will be tax free for those aged over 60. What they forgot to mention was that if you arrange your retirement benefits correctly, retirement benefits have always been primarily tax free for all but those who can afford to still pay tax! But that's a completely different issue.

I recently went to a course that discussed the budget changes. The general consensus to come from the course was, how did Costello sell this to us as 'simpler superannuation'? The changes are incredibly complex, especially the transitional rules which apply for about the next 5 years. Don't listen to the garbage that Costello sold us that there is now no need to see a financial planner! See an adviser and make sure you are maximising your retirement benefits.

I plan to use the following weeks to discuss some of these issues. Please contact me if there is anything in particular you would like to know more info about.

For more information, have a look at the Simpler Superannuation web site.

Sunday, February 18, 2007

Get off the diet soft drinks!

I know this is a personal finance blog. However, there's no point getting rich and then dying and leaving all the money you have worked hard to accumulate to someone else! So, from time to time I will approach health and lifestyle issues.

I was told the other day to be careful with diet soft drinks, because they can lead to neurological disease. There is a history of it in my family, my grandfather had Parkinson's disease. Today, whilst procrastinating on an assignment on "Technical Analysis", I decided to do some research.

The artificial sweetener in question is called "Aspartame". Next time you have a diet soft drink, look at the ingredients. Aspartame is listed as Sweetener - 951. Basically its in Coke Zero, Diet Coke, Pepsi Max, etc.

There's heaps of info out there on the net, and its got me thinking. Apparently the world's most famous Parkinson's Disease sufferer, Michael J Fox, lived on Diet Coke (he was even the spokesman for Diet Coke for a while), my grandfather used to have those "splenda" artificial sweeteners in his coffee and a friend who has recently been diagnosed with MS, has lived on Diet Coke in the time that I've known her.

Could be coincidental, but very scary. Whilst I don't live on soft drink, i have never really liked normal coke, preferring the taste of the diet options, and often in the afternoon when i need a caffeine hit and don't feel like a coffee end up with one of these diet drinks. Not any more though. Considering it does run in the family, I'm going to be extra careful.

Whilst the sugar in normal soft drinks is definitely not good for you, at least a workout at the gym can burn that off, not so with these artificial sweeteners.

You're body, you're choices. Take it or leave it.

You can't unlock your superannuation!

A colleague of mine came across this one this week and David Koch mentioned it in his Sunday paper column today, so it's obviously a wide scale problem.

There are firms out there offering to provide you with access to your superannuation. Now, there are a few ways you can gain access to your super, they are as follows:
  • Reach age 55 (up to 60 for those of us who are younger) and permanently retire from the workforce.
  • Reach age 65 and still be working.
  • Become Totally and Permanently Disabled.
  • Use Financial Hardship grounds.
The first two points are fairly straight forward. The third involves the trustee of the super fund deciding that because of a disability you will never return to work, and therefore in effect become 'medically retired'. The third involves applying to the regulators that you require access to some of your super because of an 'extreme' case. By saying that you have got yourself into too much debt does not justify financial hardship, but requiring $10,000 for emergency medical treatment probably would (generally financial hardship grounds grants access to a maximum of $10,000 to $20,000).

Now, it can be seen, that if you are under 55, your super is pretty much locked away. After all, super is there to fund your retirement, not buy you a new boat! However, these shonky operators are offering to roll all of your super into a Self Managed Super Fund, and provide you with access to the funds. Generally, a Self Managed Fund involves setting up a bank account, and as the Trustee of the fund, you are granted access to the account to invest from. The funds in the account are not to be used for your personal lifestyle expenses or "investing" at The Crown Casino! They are to invest in the fund, and regular audits and reporting helps to ensure they are invested appropriately.

I'm not sure how these 'dodgy brothers financial planners' are disclosing themselves, but they are not providing a duty of care to their client to explain that these funds are to be used for investment purposes only. By withdrawing preserved benefits, you are breaking the law and could possibly end up, along with your dodgy adviser, in gaol!

The case I have been made aware of has been reported to APRA. If you are aware of similar schemes, please report them, as at the end of the day, it will only be the unsuspecting consumer who loses out here!

Saturday, February 17, 2007

Property Is the Best Share Investment

The age old argument, property or shares. "You can't lose money from bricks and mortar" or "You can't sell a room of your property". Most retail investors fit into one of the two categories. I'm not going to take sides here, but I have done well out of shares (and managed funds) and have never invested in property.

Anyway, this topic isn't trying to weigh in to the debate. I want to discuss the huge advantage that property investment has over share investment. It's all to do with the ways you can borrow to invest, with the major advantage being tied to the banks' lending criteria.

Why Borrow to Invest?

Borrowing to invest involves using money that's not yours (ie, the bank's), to invest in property, shares or other investments. In Australia, interest payments are generally tax deductible and capital gains, if the asset is held for more than 12 months have a 50% discount applied to them. Therefore, by borrowing to invest, you can gain access to capital gains on money that's not really your's, whilst getting a tax deduction for your interest payments. Sounds pretty good hey? Of course, the disadvantage is that by investing with money that's not yours, if the value of the investment falls your potential losses are much higher!

Types of loans?

I'll start with property. This is a simple one. I'm going to focus on residential property, as this is what the typical 'mum and dad' will be investing in. If you want to purchase a property you go to the bank and take out a mortgage. Now there are numerous types of mortages, ones with offsets or lines of credits attached, but at the end of the day a mortgage is a mortgage. You put down a deposit. In the old days the banks required a 20% deposit for a mortgage, but competition has reduced that. From some dodgy brothers loan providers you can borrow 100% of the value of the property. Once you get below deposits of 20%, you're usually up for mortgage lenders insurance though, which protects the lender if you default on your loan.

Shares aren't as straight forward as property. There are many ways to borrow to invest in shares. These involve margin loans, protected portfolio loans, internally geared managed funds and using home equity to borrow to invest. The most common form of borrowing is the margin loan and is what I will focus on here. A margin loan shares some similarities as a home mortgage, in that you put down cash or shares as security or a 'deposit', you can then borrow to purchase shares. Generally with a margin loan, you must put down 30% deposit and can then borrow the remaining 70%. For example, lets say you have $30,000 in cash. You can use these funds to invest in BHP shares and then borrow another $70,000 and invest this. Making your entire exposure $100,000. The other point of interest with a margin loan is that if the value of your portfolio falls by a certain amount, you get hit with a margin call. A margin call requires additional funds to be deposited or shares to be sold to bring the portfolio back up the the allowed lending ratio.

Why property?

I can hear you all screaming at me now. Why buy property when it means dealing with dodgy tentants and dodgier real estate agents. Where's the liquidity? Shares provide better long term capital growth. I know, I know. It's not me who's spruiking property, its the lenders.

You see, the potential gains on something where you only have to put 10% deposit down are much greater than that where you have to put 30% deposit down.

An example will explain it better.

Lets say you've been in your professional career a few years and have $30,000 saved, currently sitting in cash. You want to invest this for the long term and seek some solid capital growth. You can deal with short term fluctuations and are not going to lose sleep at night if the value of your investment drops. Right, we've now established you're a suitable candidate for gearing (borrowing to invest).

You see the lender at your local bank. They tell you that with your $30,000, you can borrow $270,000 to invest in an investment property. Therefore having total capital of $300,000. This means you basically put down 10% and the bank lends you the other 90%.

You then see your friendly financial adviser. They tell you that with your $30,000, you can borrow only $70,000 and invest the total in shares. Therefore, you put down 30% and borrow the other 70%.

Lets say your investment property and shares average a return of 8% per annum over a 10 year period and all income is reinvested (you can't reinvest rent income I know, but we're talking hypotheticals). We will also ignore tax and interest. At the end of 10 years, your property has generated you wealth of $647,678 - $270,000 = $377,678 or a return on your original capital of 1259%! You're geared share investment has generated wealth of $215,893 - $70,000 = $145,893, a return on original capital of 486%, nowhere near that of your property.

It can be seen that the lending 'rules' on property investment make it a very attractive investment! A cheaper interest rate than a margin loan makes it look even better.

"Thats it, I'm getting rid of my shares and buying as much property as possible!"

Hang on a minute, lets be realistic here! Share investment has a lot of advantages over property investment. Firstly, my numbers are distorted, as by borrowing more, you are liable to pay more interest on your loan. I have ignored this for my example as tax deductibility of interest payments makes it a difficult calculation to make. Secondly (and this is a big one), in reality how are you going to reinvest your rental income from your investment property? Whereas its extremely simple to reinvest your dividends on your shares. Most top 200 companies have dividend reinvestment options and all managed funds certainly do. This helps to increase the compounding effect of share investment and ensures you don't just spend the money when you get it.

Shares provide a liquidity that doesn't exist in property, are easier to diversify in and require less active decision making than property. I know which one I'd rather invest in!!

Time for the lenders to get real

The major lenders still have this old time mentality that shares are risky investments and property is a risk free investment. They lend at higher ratios and charge lower interest rates than margin loans provide. My argument (and hopefully yours by now) is that shares are the less risky investment! You can easily diversify, there's liquidity and you're leaving the major decisions up to professional CEO's.

My challenge is for a lender out there to provide a facility, like a property mortgage, that allows well diversified portfolios to be geared into at high ratios, without the need for margin call for short term volatility, at an interest rate that is represented by the low long term risk of a well diversified share portfolio.

Until this day, the property investor will always have at least one argument against the share investor.

This is it

As you can see, I am employed within the Financial Planning industry. I'll choose to keep my true identity and who I work for to myself. You see, what I plan to say on this blog is my opinions only, and should not be treated as advice. But unfortunately, this day and age you can never be too careful, and someone may follow my instructions to go to the Casino and put their life savings on Black and then come back and sue my white ar$e!!!

Anyway, every day I annoy my coworkers with my weird ideas, strategies, conspiracy theories and ramblings. This blog is an attempt to unleash them on the outside world. Whilst a lot of what I talk about is targeted towards the Australian market, investing is one of those things that is universal. The legislation or product names change from region to region, but the economic fundamentals remain the same.

This Blog will not be a gloat about my financial position and how much money I have made this year as many of the finance blogs seem to be. It is about you and helping you meet your lifestyle goals.

I hope you enjoy. If there are any topics you would like me to cover, please feel free to contact me.

The Bull