Inflation - can send you broke!

Inflation has always been with us

The steady increase in the prices of most goods never ceases.  Governments in most of the advanced democracies have taken admirable steps to reduce inflation to a low level, but they all accept that there will always be some price growth.  The Reserve Bank of Australia targets 2-3% inflation, but does not try to achieve zero price growth.

The RBA and the world's other central banks have all recognized that while it's important to keep inflation low, it's more important to make sure that there's always at least some inflation as modern economies have come to depend on a bit of inflation to keep everything moving. 

In deflationary times (in which prices are generally decreasing) economies grind to a halt.  If you expect that cars, refrigerators, and building materials will be cheaper next year, you're more likely to delay purchases of all of these things.  As soon as a few people hold this belief, their behavior causes it to come true:  people stop buying; prices drop; people expect prices to drop farther, and deflation takes hold. 

 You need to inflation proof your income from your investments. The best way to do this is through investing in companies which will continue to grow their dividends over time. Cash is safe but over time due to inflation it will quickly disappear and your standard of living will fall.  

If you want to retire with $50,000 annual income (in today’s dollars) this nominal amount will have to increase a bit each year to keep up with the cost of the things you buy. 

Investing in cash

From 1990 until 2016 the average cash rate was 4.9%; we will use 5% for this example.

Some people think that all they have to do is accumulate $1,000,000 and put it on deposit to produce a $50,000 annual income.

If you did this, you would indeed get around $50,000 income the first year.  But after a few years, the purchasing power of that income would diminish dramatically.  With inflation running at just 3%, the purchasing power of $50,000 income will be reduced by 26% in just ten years.  Your $50,000 would be worth only about $37,000.  That would make a real difference to your lifestyle!  After 20 years, the value would be reduced by 45%, to about $27,500.

Look at it this way. On a $100,000 deposit paying 5% you would receive $5,000 annual income.  The Tax Office regards all $5,000 as taxable income.  If you’re on a tax rate of 32% (40% tax plus 2% Medicare levy), here’s what happens to the income from your $100,000 term deposit:

Annual interest income:                               +$5,000

Less:  tax at 32%                                            -$1,600

Less:  inflation cost                                        -$3,000

Real annual return to you:                                $400

This means that the real return to someone on the 30% tax rate is about 0.4% per annum.

This doesn’t mean you should never use term deposits.  If, for example, you have a bill to pay between three months and two years in the future, a term deposit can make sense, as it will guarantee that you have the cash required when it comes due.  

With only very rare exceptions, however, term deposits should never be one of your main investment vehicles.

Your dividends grow faster than inflation

Listed companies are always working to become more productive and more profitable.  This constantly increasing profitability allows companies to increase their dividends. 

The key point:  dividend income from a sensible, reasonably diversified portfolio grows faster than inflation.   This doesn’t mean that every company’s dividend increases every year.  Some years are good for banking and insurance company profits (and dividends), for example, while other years will be better for resources or technology companies.

Once your portfolio produces enough income to meet your living expenses, you can expect to feel a little bit better off year after year.

If you pick companies whose earnings and dividends grow strongly, you can be miles ahead of inflation.  Over the twenty six years from 1990 to 2016, for example, the Consumer Price Index (CPI) increased by about 85%.  This means that a collection of goods and services a typical person would buy for $100 in 1990 would have cost about $185 in 2016

Let’s look at the dividends from some major companies over the same period:

                                             Estimated

                                                                        1990                2016

Company                                        div/share    div/share        change

BHP Ltd                                                           36.5c               $1.09                   +194%

National Australia Bank Ltd                           51.0c               $1.98                   +288%

Rio Tinto Limited                                            58.0c               $2.96                   +410%

CSL Limited                                                    10.0c               $1.71                  +1600%

Westpac Banking Corp. Ltd                            52.5c               $1.88                   +258%

Woolworths Limited                                       12.0c               $1.16                   +866%

If you invested $100,000 into the above shares, your income would have started at $8244 p.a. and grew 326% to $35,162 p.a. Not only has your income maintained pace with inflation it has grown close to four times more than inflation.

Yes you are now better off than before. Starting to see why cash is not as safe as you think. On top of this the original $100,000 is now worth $556,000, that is right is has grown 456% in capital value over this time.

The owner of this portfolio has gone from being comfortable to being extremely well funded.  From experience, however, I can tell you which topic most clients in this situation would bring up most often will be about the company which failed!  The important point is this:  good portfolios, even great portfolios, always have a few stocks which will turn out to be dogs.  You deal with this by selecting stocks as carefully as you can and by learning to let the dogs go.

If you were to select a diversified portfolio of ten companies right now, all of which have a positive outlook, the likely outcome after ten years is this:

Winners:  one or two will have rocketed ahead, with both fast dividend growth and fast share price growth.  You’ll wish you had put all of your money in these. 

 Steady performers:  five to seven will deliver dividends which grow much faster than inflation.

 Dogs:  one or two will lag behind, with declining dividends and share prices.

 All you’re trying to do (and all you can expect from a good advisor) is to pick one or two extra winners or avoid one or two dogs.  This is all it takes to boost your results dramatically.

 Core Message

 Inflation makes life more expensive, if your income is not keeping you then you are getting poorer each day. A well-managed portfolio can ensure not only that you do not fall behind but that you also beat inflation.

Income over Price

The first mistake most investors make is obsessing over the share prices. The second mistake is thinking that the daily price movement of their shares reflects the underlying value of the share.

The growth in your share price will not be linier, as there are many factors which affect the daily share price. The sooner you stop focusing on price the sooner you will a successful investor.

The price means nothing, by itself

 The price of a share is driven by many factors including:

 1.      the dividend paid on the shares

2.      expectations about future dividends

3.      perceptions of the stability of the company’s earnings

4.      a premium or discount based on the mood of the market

5.      the market's assessment of the quality of a company's board and management

 Let’s consider each of these factors:

 Dividends

You invest for income and compare this against the risk you are taking. Whether or not this is reasonable depends mainly on how much you would receive for your money elsewhere. We use the cash rate to measure the risk free income; the share price value reflects the premium required by the investor to take the risk on that investment. When the risk high the dividend amount needs to be high and vice versa.

The share price will fluctuate depending on the dividend, if the dividend being paid is higher than the risk applied to the share, then investor will look to invest and push the price up until it gets back to fair value for the associated risk.

For example, banks will normally have a dividend yield of 5%, if the bank trading at $20 and paying a dividend of 10% then investors will pay more for the bank up until the price increase to a level, in this example $40, where the yield will be back to 5%.

 Expectations

If people expect future dividends to be higher, they’re willing to pay more for the shares which will deliver these dividends.  This clearly would push the price higher.  A gloomier outlook would pull the price lower.  At any given time there will be investors who expect the outlook to improve and those who expect it to deteriorate. The market price reflects the net view of all different investors.

Earnings Stability

This refers to the market’s perception of the reliability of a company’s earnings.  Such companies as Woolworths and Telstra are regarded as having high quality earnings, because people will keep on buying goods and services from these companies pretty much regardless of what happens in the economy at large. 

Equally well managed companies such as Qantas have less reliable earnings.  In a slow economy, business people may travel less, and everyone can defer or skip an overseas holiday.  In a pinch, people can get by without Qantas far more easily than they can get by without Woolies or Telstra. 

Market Mood

When markets are running hot, investors seem to like every share.  They’re often willing to pay too much.  In gloomy times, some people can’t envision a recovery, so they’re willing to sell their shares for far too little.  For this reason, shares are sometimes too expensive and sometimes too cheap.  In the long run, prices are pulled back in line with the dividends a company pays.

 Board and Management

The market places more trust in the management of some companies than others.  A company which produces steady, predictable results with few nasty surprises will be more highly regarded than an accident-prone company whose board members engage in public brawls.  Even a company with a long successful history will see its share price fall if the market loses faith in the board. 

A change in board member can bring uncertainty and cause markets to look for a lower price or alternatively be seen as a positive and push the price up depending on who have been changed.

You don’t have to trade

 I’ve mentioned this many times throughout this book, but it’s so important I’ll say it again.  Most investors do best by buying good shares and then leaving them alone.

 There are opportunities to make money from trading, but these are for people who are willing to treat their portfolios as a full-time job.  Most people have neither the time nor the information to do this effectively.

Budget 2016

This summary of the 2016 Budget will not be looking at all aspects of the Budget it will just be dealing with changes to Superannuation and Taxation.

Superannuation

Lifetime cap on non-concessional contributions:

1.       Effective immediately

2.       Limit is now $500,000 over your life time

3.       Pervious limit was $180,000 per annum or $560,000 in a three year period

If you have already contributed over the $500,000 in non-concessional contribution you will not be able to make any more non-concessional contributions to super. If you have not then you can make up to $500,000.

You will however need to find out how much you have made in non-concessional contributions up until now.

High Income earned threshold dropped to $250,000, previously $300,000:

1.       If you earn over $250,000 an extra 15% tax will be applied to your superannuation.

2.       Example if you earn $260,000 then $10,000 of your super contribution will be subject to an additional tax of 15 % or $1500.

3.       Effective 01/07/2017

$1.6 Million cap on tax free pension balance:

1.       Once you move into pension phase the maximum amount you can have as a pension is $1.6 million.

2.       Additional amount over this in your super account will be left in accumulation phase. Any income earned on this amount will be taxed at 15%.

3.       Lump sum withdrawals can still be made tax free.

4.       Pension can be topped up if it drops below $1.6 million.

5.       Effective 01/07/2017

Transition to Retirement Pensions (TTR):

1.       Income on funds held in a TTR will be subject to tax.

2.       Remove rules to prevent treating income stream payments as lump sum payments.

3.       Effective 01/07/2017.

Work Test:

1.       Work test will be removed for people between the age of 65 -74.

2.       Allows people in this age group to make contribution to super if not working.

3.       Effective 01/07/2017

Concessional Cap changes:

1.       Concessional caps will change to $25,000 per annum for everyone.

2.       Unused Concessional cap amounts can accumulate for a period of 5 years as long as super balance is less than $500,000.

3.       Pervious concession caps we $30,000 under 50 years old and $35,000 between age 50 and 74 years old.

4.       Effective 01/07/2017 – important to make most of concessional caps for the 2016 and 2017 financial year.

 10 Percent Rule is scrapped:

1.       Previously if self-employed you could only make concessional contribution to super if less the 10% of your income came from employment.

2.       As rule is gone self-employed people will be able to make up to concessional cap. Careful to check how much super you have received from your employer as not to preach the cap.

3.       Effective as at 01/07/2017.

Low income Superannuation Tax Offset (LISTO):

1.       This will pay low income up to $500 into their super fund to offset the tax rate in the super fund being higher than their personal tax rate.

2.       This will apply to people earning up to $37,000 pa.

3.       Effective 01/07/2017.

Low income spouse tax offset increased:

1.       The income threshold has been raised form $10,800 to $37,000 before you no longer qualify for this rebate.

2.       The offset provides $540 per annum.

3.       Offset rate is 18%.

4.       This is in relation to partner making contribution for the spouse.

5.       Effective 01/07/2017.

Anti – detriment provisions in respect of death benefits payments from superannuation:

1.       This payment is in regards to the beneficiary receiving a refund of the 15% contribution tax which the deceased has paid over their lifetime.

2.       This payment went towards the beneficiary to reduce the tax payable on the amount received.

3.       Effective 01/07/2017.

Taxation

Personal Taxation relief:

1.       The stepped tax rate from 32.5% to 37% has increased $5000 from $80,000 to $85,000.

2.       Those earning $85,000 will save $225.

3.       Effective 01/07/2016.

Increase in Medicare Levy low income thresholds:

1.       Effective 01/07/2015 – will be available in the 2016 tax return

2.       This is the income you have to earn before paying Medicare Levy.

3.       Increased as follows:

a.       Individuals now $21,335

b.      Couples no children $36,001

c.       Pensions eligible of Seniors Card $33,738

d.      Pension Couples $46,966

e.      Add to each of above threshold $3238 for each child.

Indexation of the Medicare Levy Surcharge and Private Health Insurance rebate has been frozen until 30/06/2021.

GST on low value goods imported:

1.       Effective 01/07/2017.

2.       Any goods imported will be subject to GST.

3.       Provides a level playing field for retailers in Australia

Reduce Small company tax rate:

1.       Effective from 01/07/2016.

2.       Effects small business with turnover up to $10 million.

3.       Initially reduced to 27.5% down from 30%.

Increase in unincorporated small business tax discount:

1.       Currently tax discount is 5% this will increase to 16% over next ten years.

2.       Maximum discount will remain $1000 per individual.

3.       Effective 01/07/2016.

How wealthy people invest.

There is a big difference between being rich and being wealthy. Rich people make lots of money and spend lots of money. The illusion is that you have to be rich to be wealthy. Not true, the difference is that the wealthiest people I know all have one thing in common an instinct on how they spend their money.

A Wealthy person will look to buy top-quality shares and hold them forever. Rich person will look to spend their money on flashy houses, cars and trips as opposed to investing. The difference is that the rich person will need to continue to work to maintain their lifestyle while the wealthy’s lifestyle is maintained by the income from their investments. Work is an option.

A surprising number of people around you have share portfolios worth a million dollars or more, and almost all of them built these portfolios in the same way:  these investors (or their parents) simply started buying good shares ten, twenty, or thirty years ago and just held on to them.  To be this relaxed, you have to be perfectly certain about the quality of the assets you own.

Wealthy people instinctively buy the best things.  They buy houses in the best neighbourhoods, because they buy in good neighbourhoods, they’re happy to stay for a long time.  After ten or twenty years, no one, least of all the wealthy people themselves are at all surprised if these properties are sold for prices which deliver nice gains to the owners.

The wealthy select their shares in the way they select their houses.  They insist on being comfortable with their share assets, because they’re going to live with them for a long time.

Consider National Australia Bank (NAB) which has been listed since 1962, and by 1986 it was an established operation which looked likely to stay in business for a long time.  Even an experienced wealthy investor would have been impressed by NAB, and probably would have been happy to buy it.

Had you invested just, say, $20,000 in NAB  in 1986, (at a price equivalent to about $4.00 per share) your holding would today be worth about $135,000.  Even better, your $20,000 investment would now be producing dividend income of about $14,000 per year.  That's right: it would now be paying you a franked dividend every year equal to more than half the amount you paid for your shares in the first place.

Since 1986 NAB has paid just over $35 per share in dividends, on your initial investment of $20,000 you would have received $175,000 in dividends over 30 years.

Twenty or Thirty years sounds like a long time, but time does pass, and it does you more good if you own stocks which pay growing dividends.

Because wealthy  people have faith in their own judgement, they tend to overlook passing bits of bad news, and they tend not to fuss with their portfolios very often.  The opposite sort of investor makes changes with every bit of news or gossip.  I’m quite sure the confident, steady approach delivers far better returns.

You should recognise that time is passing whether you do anything about it or not.  The trick is to put your money where the passage of time does you some good.  You can choose today whether to be wealthier  in twenty or thirty years or just to be older and no better off.

The key to building a massive stream of dividend income is the passage of time.  Take steps now to start building a permanent and growing income.

Market Indices

You probably hear something on the news every day about the All Ordinaries Index or the S&P/ASX 200 Index.  These major indices measure the performance of the share market as a whole.

 The All Ords and the ASX 200 track closely together.  The ASX 200 comprises the largest 200 companies.  The All Ords captures 500 or so companies, but most of the value of those 500 companies resides in the largest 200, so these indices are largely interchangeable for the purposes of normal investors.

 The All Ords is based on the share prices of all 500-odd companies which meet the requirements for inclusion in the index.  Companies are weighted into the index according to their market capitalization (meaning the total nuber of company shares issued times the market price).

 Example:  if a company has a million shares on issue and the share price is $10, the market capitalization is $10 million.

The biggest companies, such as BHP, Telstra, and all of the four big banks, each have market capitalizations of $60-$130 billion.  The Financial sector make up 47% of the ASX 200 and the Mining sector makes up 13%. In total these sectors make up around 60% of the ASX 200, so they have the biggest effect on the index.

 The purpose of the All Ordinaries Index is to give you a single figure which reflects the experience of owning all the shares in the market (weighted for capitalization.)  If the All Ords goes up or down 2%, chances are a portfolio of major shares has probably moved by about the same amount.  The price of any individual share can move in a direction opposite to the index, of course.

 More useful, but less newsworthy, is the All Ordinaries Accumulation Index.  This index assumes you own all of the shares in the All Ords, but also accounts for the dividends you would receive from these shares.  It also assumes you re-invest your dividends when you receive them.  The Accumulation Index is more directly relevant to the actual experience of real investors than the All Ords itself.

There are also lots of sub-indices.  These include, for example, indices of listed property trusts, resources companies, energy companies, and smaller companies.  The main use of these indices is that of comparing the performance of your investments to those of the relevant markets.

The All Ords and all the other indices are interesting, but don’t make too much of them.  They’re all concerned only with prices, and if you get anything at all out of this book, you’ll learn to pay less attention to prices.

The chart above tracks the All Ordinaries Index (Blue) and the All Ordinaries Accumulation Index (Red) and shows what the experience of owning the whole market would have been like over the past decades.  Because the Accumulation Index captures the value of dividends paid as well as share price changes, its progress is smoother than that of the All Ords.  It's also far more like the experience of actually owning shares. 

This chart highlights the power of yield (income) the portfolio produces. Most investors focus only on the capital gains and forget about the income. As highlighted above the income contributes to the overall return, it also smooths out he performance of your portfolio.

Taking a long term view and focusing on income works wonders

Are you Diversified?

As previously discussed, investments can be broken down into the three main groups; Shares, Property and Cash.

"Diversification" means spreading your assets across these three different investments so that you don't lose too much if any one investment goes wrong. 

"Asset allocation" means how you divide your assets among the three main investment alternatives, to ensure that you have the right risk reward structure to suit you.

Diversification

Think of diversification this way, if you only hold 5 investments and one goes bad you suffer a 20% loss of capital. If you hold 20 investments and one goes bad you suffer a 5% loss of capital. Diversification is about limiting your losses when things go wrong. 

One of the most popular investments in Australia is a rental property, to diversify a property portfolio you would need to own several properties in different cities across the country.  If you are only exposed to one town a down turn in that town could wipe out your entire investment portfolio.  Rental property investors with a small amount of capital can best achieve diversification through the use of a property trust.

Share portfolio

Once you’ve decided what portion of your assets should be devoted to shares, you should make sure your share portfolio is diversified.

Diversification in a share portfolio is ensuring you are in a number of different shares in different sectors.  A good example is buying bank shares, if you only hold all of the big four banks being Commonwealth, National Australia, ANZ and Westpac you are not diversified.  Yes each bank has individual risk but there is also risk for the banking sector.

When the Global Financial Crisis hit, all banks fell in value. To reduce your risk your share portfolio should also hold investments in different sectors such as the Energy, Material, Consumer, Health, IT and Retail.

Your aim is to own companies in different industries in different markets, both in Australia and internationally.

Do not over diversify!

As a rule of thumb around 20 different shares is a good level of diversification, remember you are buying these shares because you expect to see capital growth and solid income. Over diversification can reduce you overall capital growth. Holding 40 different shares will not reduce your risk twice as much as holding 20 shares.  

Asset allocation

How should you divide your investments among shares, property, and cash deposits?

The appropriate asset allocation for you depends on your age, your health, your income, when you expect to retire, how many dependents you have, and many other factors.  A good financial planner’s main job is to find what asset allocation suits you best.

It is important that the big structural decisions are made before investments are selected. Work out if you should invest,  in your own name, that of your spouse, in your super fund, your family trust, your company. Getting the structure right, will save tax and fees, over the long run.

Shares and property are growth assets while cash is a defensive asset; you need to allocate you funds accordingly. Before you start picking the investment first determine how much is to be allocated into each investment type.

Start with cash, determine what your immediate cash needs will be over the next two years. It’s too risky to invest in shares for such a short a time, you could be forced to realise a loss if sell after a short period.

Remember though that your growth assets will also produce income so factor in this income stream.

Do not fall into the trap of holding cash “just in case”. Most sensible assets can be turned into cash on short notice.  If you sell shares or listed property trusts, for instance, your proceeds are paid to you three days later. 

Once you get the structure and the allocation right, you can move on to the task of selecting specific assets.  I think this part is the most fun, but I promise you that asset allocation matters at least as much as your specific investments, and in many cases it matters more.

So you are ready to start investing. But what are your investment choices?

So you are ready to start investing!

But what are your investment choices?

Analysist paralyses stops many investors from getting started. There are so many choices all claiming to get the best return. So where do you start?

If you are feeling confused or overwhelmed by the number of investment options just remember this: there are only three possible investments. By investments I mean an asset you can buy, which will produce income and capital growth but require no further effort from you.

All investment fall into three basic categories:

1.      Shares

2.      Property

3.      Cash deposits or “Fixed Interest”

All investment are either one of the above categories or a combination of them.

·         Shares – we have already discussed these in the previous chapter.

·         Property - can be residential, commercial or units in a property trust either listed or unlisted. However they all work the same way, the investor keep whatever is left over from the rental income after all expenses are paid.

·         Cash Deposits – these includes money you deposit with a bank, in effect you loan your money to the bank and they promise to pay it back at some point in time and pay you interest. This can be extended to Bond issued by the Government or individual companies. The name is different but the underlying process is the same.

There are no other investments, remember, investments require no further effort form you once they are purchased. All investment are either a re-packaged version of one of these three or a non-investment.

Non-Investments

I classify non-investments as something which does not do anything or requires further effort from you.

When we look at investments which do nothing, Gold is the big one, the price of gold will increase or decrease due to demand, you will not receive income from it. You need to trade gold to make money as such you are now carrying on a business. If you are lucky you will make money. Much the same can be said for Art, Racing Horses, Cars, other collectable items.

Other non-investment require your time and attention, the main one being a small business. Sure you can make plenty of money running a small business however it requires massive input by you; as such I do not consider it to be an investment. You need to start taking money out of the business first to invest before you start getting ahead.

Superannuation

Superannuation can be confusing for many people, Superannuation is not an investment.

Nor is it a different class assets, it is merely a low tax vehicle in which you can hold investments. Money in superannuation is invested in the three asset classes as discussed above (shares, property and cash). It is the low tax environment in super which makes it attractive.

We will discuss Superannuation in more detail later.  

Why you should own shares? Dividends!

History shows us that shares are the fastest way to grow your wealth and increase your investment income.

For the last hundred and more years, shares have outperformed all other asset classes. This is because business continues to make profits through all of the drama history throws at us.  There is always some good reason why not to invest, but those who take a long term view will benefit for the returns of investing in shares.

At time markets will be trading above fair value at unreasonable prices while at other time trading well below their fair value. Over time these boom and bust events will pass, leaving the sensible investor with a healthy profit.  

But what are you buying when you buy shares?

In affect you are buying income; businesses are run to make a profit, business sell shares to raise money, much like borrowing from a bank. As such the owner of the shares is entitled to share in the profits and capital growth of the business.  

Why is income important?

A healthy business is making a healthy profit. This profit is shared with shareholders via dividends. As profits increase so too will the dividends, increase in dividends means an increase in the share price. But be warned if you focus too much on share price you will usually get it wrong.

Let’s look at an example:

If you had purchased Woolworths back in 1993 for $3.19, by the end of 2015 financial year you would have been paid $47.05 in dividends. This is more than 14 times what you paid for the shares. The dividends started at $0.40 per share and have grown to $4.63 per share as the company has grown its profits over the years. This is a healthy yearly return on your initial investment of $3.19.

At the same time the share price has increased from $3.19 to $22.93 a return over 600% on your initial capital invested or 25% per year.  As income of the company grows so too will the share price. Notethat the growth in the share price is not as smooth as the growth of the dividend.

This is because, shares are not always valued at fair value, the latest boom or bust news will affect the share price in the short term.  The key take away is that the share price is always secondary to the income stream the shares produce. Shares will at time be overvalued or undervalued as long as the income grows the price will return to fair value.

The main point is this; a rising dividend drags the price along with it. If you focus relentlessly on the income the company’s shares can produce for you, your result will be right in the end.

The Reluctant Investor

I can spend all day long explaining the benefits of share investing but this will not get me anywhere if I am speaking to a reluctant investor.

People are generally reluctant to invest in the share market due to horror stories they have heard, reluctant investors will clutch at every bit of news which might support their reluctance to invest: corporate misbehaviors, reports of the shocking misdeeds investment advisers have visited upon their trusting clients, scary events around the globe which threaten to bring the world economy to its knees. 

Sometimes such investors come from families in which money has been lost to bad investments (whether these had anything to do with the share market or not) or they've just heard stories.

A reluctant investor dislikes the entire idea of share investing.  This investor finds share investing all too scary, and often prefers to have everything in rental property because you can drive by and see it or to just keep money in the bank.

If you're in a long term relationship, it's important that you and your spouse both understand why and how you're investing.  Otherwise you run the risk of making big mistakes when one spouse's irrational exuberance or unreasonable fear causes you to make silly choices. 

The key is education, you need to understand how the markets work, and you need to know your North Star, the end goal you are trying to achieve. You need to know what you will and will not invest in, your rules for investing which will not be broken.  Finally you need be willing to put aside your unfounded fears and learn how to get the most out of the share market. 

By Jason Fittler

Property – Units

By Jason Fittler

As an investor, I watch all markets including the property market. 

The property market is a key indicator as to how the underlying economy is going, but like the share market you need to watch for the warning signs.

Right now low-interest rates have sent unit developers into overdrive with Brisbane now experiencing a large growth in the number of units under construction. The second quarter of this year has seen a record 13,000 units under construction with a further 15,000 units in the pipeline. This has sent some property experts calling it a peak. 

The key is that the low-interest rate makes these projects measure up on paper. However, who will be buying them and what happens if interest rates start to increase? 

Recent CPI figures indicate that further interest rate cuts are now looking less likely. 

Will all of this construction of units in Brisbane cause an oversupply? If so what will happen to prices, if interest rates increase will some of these developers fall over pushing down property prices in fire sales?

Urbis Economics and Market Research Director Mal Aikman said construction activity for inner-city apartments had reached record levels. Apartment sales also reached their highest ever level of 2277 in the June quarter. 

"Inner-Brisbane is entering its highest ever level of new residential construction," he said.

"Construction activity can still lag by 18 to 24 months so with a sales peak in June we still have 18 to 24 months of very heavy construction activity to come."

A rush of new apartments onto the market - even if the bulk of them have been pre-sold before construction - still raises the issue of who is going to live in them.

The message is caution; low-interest rates will not be low forever. 

Property is a long-term investment with high purchase costs and high sales costs. Property prices will be driven by low unemployment figures like those seen in around 2005 – 2012. 

Returns to large capital growth in property is in my view 10 years or more away so ensure that you have the cash flow to support this type of investment. 

Grow Your Wealth SMA Update

By Jason Fittler

The Grow Your Wealth SMA has outperformed the market for the month of December; it has also produced a less volatile return.

During December, the Grow Your Wealth Assertive SMA produced a 0.52% return being 0.41% above its benchmark.

Since the inception of the fund in August 2015, the Grow Your Wealth Assertive SMA has outperformed the market by 8.82%.

The Grow Your Wealth SMA is currently providing a gross yield of 4.7% partly franked. This fund suits investors looking for solid income and long-term growth.

If you would like to find out more about the Grow Your Wealth SMA and how this investment can benefit you, please contact Grow Your Wealth on 07 47714577 or www.growyourwealth.com.au.

Grow Your Wealth SMA Update

By Jason Fittler

The Grow Your Wealth SMA has outperformed the market for the month of October.

It has also produced a less volatile return. 

During October, the Grow Your Wealth SMA produced a 4.98% return being 0.6% above the market. 

Since the inception of the fund in August 2015, the Grow Your Wealth SMA has outperformed the market by 7.2%. 

The Grow Your Wealth SMA is currently providing a gross yield of 4.7% partly franked. 

This fund suits investors looking for solid income and long-term growth. 

If you would like to find out more about the Grow Your Wealth SMA and how this investment can benefit you, please contact Grow Your Wealth on 07 47714577 or www.growyourwealth.com.au.

Economic Indicators

By Jason Fittler,

This week the Reserve Bank kept interest rates on hold, the expectation at present is that America will look to increase their interest rates in the near future; this is positive for their economy.

With our official interest rate at 2%, you have to wonder if Monterey Policy has any further benefit to our economy.

The banks have already moved and increased interest rates two weeks ago on the back of increasing liquidity requirements which are now in place. These increase liquidity requirements also limit the amount of funds banks now have available to lend. Effectively through government legislation, we have already started to see the Australian cash rate increase. Personally, I expect that the next rate change by the Reserve Bank will be an upward move.

If we look at the latest Economic date available, I note the following:

1.    GDP is down slightly year on year but up from 2007 lows.

2.    Retail sales have been consistently growing each quarter all be it only 0.3% per quarter.

3.    Private business has started to hold more inventories.

4.    Total dwelling units commenced is down.

5.    Income from sale of goods and services by manufacturers are also down.

6.    Wages have continued to increase however at a slower rate.

7.    Unemployment has continued to increase over the past 12 months.

8.    Company gross operation profits have been decreasing each quarter over the past 18 months.

This data indicates to me that our economy is nearing a bottom, and although it may not get worse, there is no guarantee that it will rebound quickly. In fact, I expect that any recovery will be quite slow given that household debt and percentage of income used to pay the debt are at all-time highs it will take a time to unwind these positions.

With interest rates at these historically low levels Monetary Policy, I feel will have little effect on our economy. As such, I expect rates will remain low for some time while other economic indicators are looked at.

I expect that we will see the government focus on jobs that by its nature will require an input of capital by governments and by the private sector.

We are starting to hear more about increases in taxes by the Government; this should in turn translate to infrastructure spending, decreased unemployment and increase in the official cash rate. 

I expect business will be cautious not to invest too much capital during this period. Governments increasing spending will be positive for our listed companies as it will create opportunities and increase profits providing long-term growth.

House Prices

By Jason Fittler

Recently I have had a lot of clients asking me about house prices. I have found that the below graphs best sum up the situation. Although I draw no strong conclusion as to whether house prices will drop sharply the evidence points to at best house prices staying flat for some time.

The three graphs in regards to Sydney house prices show the following:

1. House prices have increased faster than wages. Houses are less affordable now than they were 10 years ago.

2. Interest rates were lower than they were 10 years ago.

3. Mortgage payments are a higher percentage of take home pay then they were 10 years ago. 
These graphs highlight the relationship that mortgage rates and house hold income has on housing prices. For house prices to increase you need house hold income to increase and for mortgage rates to fall. 
Given our current record low interest rates I do not expect to see any further rate cuts, however if there are cuts I doubt that this will have a big impact on housing prices given the lower the interest rates are the less impact further rate cuts have.
With unemployment running so high at present, inflation low and the economy not expect to see any growth for some time I do not expect to see take home income increase much in the coming years.
At best I expect house prices to stay the same at worst we will see a correction especially if unemployment moves up.

Economic Cycle

By Jason Fittler,

Investing is all about looking forward and trying to best estimate what will happen in the coming years. First we need to know where in the economic cycle we are now. It is my view that we are at the bottom of the growth cycle or near enough to it, as such I expect over the next 10-years all sectors will experience growth in the following order: 

Companies – I expect around 2017, the government will have started infrastructure spending and approval for major projects from the private sector. We have seen this with the recent approval of coal mines. The push will be to reduce unemployment to get the economy going. We have seen the Free Trade Agreement, and I expect next will be a relaxing condition of employment to encourage employers to put on more staff. The flow on will be increased revenue to companies. That in turn means increased forecasts from analysis and increasing share prices. We also see dividends increase during this period. I expect that there will be a lot of Initial Public Offerings during this time.

Property – the property sector comes after the share market in growth. First it is commercial property as business looks for more space and new businesses start up. Rents will improve, and occupancy rates will increase. Next is residential property as people feel safer in their jobs and employers have more profits they will look to upgrade houses, cars, etc. Around this time, we will also see an interest rate increase as the Reserve Bank looks to slow things down a little.

Cash – interest rates will increase as the Reserve Bank tries to slow the economy and also due to the extra demand for credit putting a strain on reserves. Bonds rates will move first as companies have to offer high rates to attract cash away from other sectors such as shares and property. 

Time Frame – I cannot estimate with any accuracy when this will happen as a lot of this has to do with government and when they make the necessary decisions to start the ball rolling. This will of course depend on the Polls and what will get them re-elected. It is however my positions that we are getting to a point when governments will need to act so I expect that in the next few years. 

It is time for investors to start focusing on growth. Income is still important but portfolios need to be weighted to growth or as the economy starts to recover they risk missing out on substantial gains. This will mean buying companies paying lower yields but have more potential to grow.

Do not forget to also continue to increase exposure to overseas markets, as some of these lag both Australia and the US. The best way to gain this type of exposure in a cost effective way would be to invest in the Grow Your Wealth’s SMA.

We have 2 SMA's, one for Balanced Investors and one for Aggressive Investors; they both provide exposure to high yield companies, Australian shares, International Shares and property.

Grow Your Wealth SMA Update

By Jason Fittler

In September, Grow Your Wealth launched it Balanced and Aggressive SMA. This investment suits smaller investors looking to growth their portfolio quickly. It provides a spread of investments that generally is only available to large investors.

We are pleased to report that both portfolios have performed well in the first quarter of 2016 details as follows:

Balanced SMA

As you can see, the Balanced Portfolio (Blue Line) has outperformed the ASX 200 Accumulation Index (yellow line) for the first quarter. The Portfolio has returned a -3.35% against the -10.5% of the ASX 200.

Aggressive SMA

As details above the Aggressive Portfolio (Blue Line) has outperformed the ASX 200 Accumulation Index (Yellow Line) for the first quarter. The Portfolio has a return -4.9% against the -10.5% of the ASX 200.

Please call on 07 47714577 or email [email protected] if you wish to discuss these products further. 

Grow Your Wealth (SMA)

By Jason Fittler,

In September, Grow Your Wealth will be launching two SMA’s products. 

These products will allow investors to have a professionally managed portfolio but at a lower price.

The models allow smaller investors to obtain more control over their investments through divarication and lower cost structure.

A separately managed account (SMA) is a customised share portfolio where the assets are owned by individual investors.

An investment is allocated across one or more available investment models, which will determine the portfolio allocation between shares.

These investment models have been provided by investment specialists and vary in focus in much the same way that managed funds vary in their risk and return objectives.

A separately managed account is professionally managed like an individual portfolio with many key advantages:

  • The securities in the account are visible and portable just as they would be if they had been purchased directly
  • The underlying securities are owned, not units in a fund. As a result, the investor can manage the tax position.
  • Consolidated reporting is provided online with complete and concise reports available at any time. All the paperwork and administration is taken care of by the SMA provider, reducing the administrative burden on investors.
  • Low minimum investment requirements and low brokerage costs allow SMA investors can more effectively diversify their portfolio.

An SMA will offer a number of model portfolios for investors to select from.

A separately managed account portfolio is constructed using one or a number of investment models managed by professional investment managers.

The key difference between an investment and a managed fund is that the SMA holder retains beneficial ownership of the securities. The underlying securities are visible to the investor, and the investor retains the tax advantages of owning direct shares.

Until recently, separately managed accounts (SMA) have been for high net worth individuals with access to minimum investments of $500,000 or more. Changes in technology have made SMA’s more affordable for the average investor.

Initially, Grow Your Wealth will offer an SMA to suit Balanced investors and Assertive investors for those who are looking for more growth.

In time, Grow Your Wealth will also be offering a Value Investor model for those clients looking for long-term growth and higher yielding investments.

SMA’s suit smaller investors due to the lower fee structure and transactions costs as they allow you to achieve the desired level of diversification in your portfolio on the money invested.

Professional investment managers run them but still allow you more control over where your money in invested.

Please contact us if you would like to discuss if these products are right for you or if you would like some more information. Call (07) 4771 4577.

Your Superannuation

By Jason Fittler

There have been over the past months many comments in regards to superannuation and changes that may come into effect.

At present, there are no changes in regards to superannuation before parliament.

There are however comments made which indicate that it is only a matter of time before this large pool of money is looked at as a source of revenue for the government.

Let’s look at a few of the issues that may come up. 

1. Using superannuation as at tax effective vehicle for tax planning:

Superannuation, as it is at present, provides a perfect vehicle to invest money that you would like to pass on to your children. The main reason for this is super is the most tax effective vehicle available at present. The money is taxed at 15% going in and at 15% on income earned during the accumulation, and once in pension mode all income is tax-free.

The best you can do outside of superannuation is to limit your tax to 30%. Given the massive tax savings you can see why people would exploit this option.

The changes made to superannuation in 2007 were for covering your expenses in retirement and not to be passed on. I expect we will see some rules around this are tightened in the future. I expect we will see limits on how much you can put into superannuation or at least on how much will receive the reduced rate of tax.

2. Large tax breaks for the rich when using super:

Superannuation is tax at a flat rate of 15%, which means if your income is less than $45,000, per annum it makes no sense to salary sacrifice into super. The reason being you will be taxed at a higher rate.

Your tax rate on $45,000 per annum is approx. 15%. As your income gets higher, you save more tax by salary sacrificing into superannuation.

For example if you earn $120,000pa your tax rate is around 30%, so salary sacrificing $10,000 into super will save you $1,500 in tax. As your income increases so does the tax savings.

This issue here is that super contributions are much more attractive to the higher income earners as they have the extra disposable income they can put into super and it saves them tax.

This door is partly closed for people earning over $300,000pa as they do pay the extra tax.

I expect however this higher limit will be reduced to catch more people by increasing the age at which you will be able to access your superannuation.

The Government has already increased the age at which you can access the age pension, do not confuse this with the age you can access your super.

At present this has stayed the same for those born after 1964 it is age 60 between 1960 and 1964 it varies between 56-59 and if before 1960, it is age 55.

I do not expect these dates to change as this only encourages people to save inside super if you want to stop work before age 70 that is when the Age Pension will kick in for me. 

Superannuation has always been for the purpose to take pressure off the Age Pension system not to provide estate planning.

As such, I expect that there will be changes in the next couple of years.

The best way to control the outcome is through a Self-Managed Super Fund.

Sydney Morning Herald Article - Australians Unprepared for Risk

The below article was in the Sydney Morning Herald this week.

It is a bit long but does sum up out current economic situation well.

http://www.smh.com.au/business/australians-unprepared-for-risk-after-25-years-without-recession-20150624-ghw27r.html

Australia is set to enter its 25th year without recession next week. For the economy, one of the longest periods of growth on record in the developed world has actually stored up trouble. The country is increasingly relying on past momentum, as the costs of political inertia mount and a generation untouched by economic shock breeds complacency. Having shunned major policy change since the turn of the century, Australia's economy may need to weaken further before the nation will accept reforms from any government.

"No one under the age of 43 has any experience of a recession as an adult," said Saul Eslake, former chief Australia economist at Bank of America Merrill Lynch. "That's bred a degree of complacency among managers of firms, among employees, and among voters and politicians." The economies in more than a third of Australia are contracting, according to a PricewaterhouseCoopers LLP analysis. Even as firms plan to cut investment by the most on record, Prime Minister Tony Abbott is putting off contentious tax and labour overhauls that could make the economy more efficient and companies more productive.

Yet the urgency for change is intensifying: Treasury says Australia should brace for the weakest income gains in half a century in the coming 10 years, unless it can achieve record productivity growth. "If we keep going the way we're going, we could have people in 30 years' time looking back for the first time in Australian history at a third of a century without growth in living standards," Ross Garnaut, a University of Melbourne economics professor who counselled Prime Minister Bob Hawke in the 1980s, told a conference on June 22. "We need a change in political culture. We need a lot of reform." The portents are not good.

Abbott has ditched the spending cuts that made his first budget so unpopular, delivering what he had promised would be a "dull" second budget last month. After surviving a leadership challenge in February, Abbott said fiscal problems he dubbed an emergency before his election were now manageable. He has also sent contentious policies to review committees that are unlikely to report before elections due late next year, including changes in tax, labour relations, pension savings and co-ordination with the states.

"You'd be brave to forecast the government will take a serious reform agenda to the next election, and the opposition will want a small-target strategy to help it appear electable," said Haydon Manning, a politics professor at Flinders University in Adelaide. "Unfortunately it seems we won't have real reform until a recession forces voters to listen to politicians who have the courage to take on long-term problems."

Australian firms, too, had little pressure to increase efficiency in an economy undergoing simultaneous commodity, property and share price booms since 2000. The country sailed through the 2008 global financial crisis. To boost productivity, the government can force firms to increase efficiency through intensified competition and removal of subsidies, Eslake says. It can also make it easier for businesses to implement changes through areas like labour-market reform, invest in education to equip the workforce and build infrastructure. For now, the government is relying on a benchmark interest rate at a record-low 2 per cent to support growth.

"The fact that we did get out of the GFC without being scathed probably was a liability in the sense of there being no impetus to reform," said David Burchell, a professor of humanities at the University of Western Sydney. "In comparison with previous decades, there's also a lack of government leadership on promoting change."

In fairness to Abbott, the peak of reform in Australia in the 1980s was facilitated by the then opposition leader John Howard backing the Hawke government's economic agenda in a rare show of bipartisanship. Since 1996, opposition parties supporting government-backed economic reform has been the exception rather than the rule. Moreover, Abbott's government has secured free-trade agreements with China, Japan and South Korea, three of Australia's top four trading partners, since its election.

Still, the last significant policy move that stuck was the introduction of a 10 per cent goods and services tax in 2000, pushed through by Howard in the teeth of Labor opposition. It replaced sales taxes and some state levies to make doing business easier, broadened the government's revenue base and allowed for personal income tax cuts. Political inertia had a limited impact on an economy underpinned by a mining investment boom amid a surge in demand from industrialising China.

"The record of taking on vested interests in the past 15 years is somewhere between disappointing and abysmal," said Eslake, who sees a 20 per cent chance of recession in 2016 or 2017. "The outlook is not a very optimistic one."

Investing for Beginners

By Jason Fittler

You have made the decision that you need your money to work harder than you do!

It is time to start investing and ride the gravy train everyone else seems on.

So where do you start?

1. Do you attend a seminar on how to get rich?

2. Should you speak to that friend who is always telling you how well they are doing?

3. Is there someone you know who is highly successful and has plenty of money, surely they can give you some good advice?

4. How about speaking to a financial adviser of a major bank, surely they will get it right?

Who do you trust? How do you know if you are getting the right advice?

Most people simply just take a leap of faith. Many are burnt and lose money first time out never to return.

The problem being is that investments are just like anything else you might buy. They are products you are being sold, which means most of the time you are speaking to a salesperson.

Do you remember the investment that you lost money on? Did it stop you investing again? For many I suspect it was a hot tip from a friend or trusted source. This turned out to be the worst advice you have ever received.

However, instead of blaming the source of the advice most people tend to blame the investment. This is common in the share market, as most first-time investors do not get the right advice at the start.

I blame this on the fact that it is easy to access the share market; you can invest small amounts, and everyone thinks they are an expert.

Few investment advisers truly understand how complex the share market is and how to navigate it.

What is also true is, used correctly; you can create wealth with reduced risk and without having to borrow large amounts of money. It is called compounding returns.

So listen up and I will share with you the key to creating wealth and I will give it free!

1. Regular savings – the first and most important is you need to save and start now if you have not already. Savings is about putting away money now so that in the future you can draw down on this money to live, so you no longer have to work. Sound good?

2. Do not invest money that you need now – investment returns are higher if you invest over the long-term. This is due to the volatility (ups and downs) in the market. You have to have a longer investment time frame to give you the best chance of riding out the lows and taking profits in the highs.

3. Diversification of risk – you cannot just buy one investment and hope for the best. You need to spread your risk across a number of investments. To do this, you need to work with your investment adviser.

4. Controlled gearing – borrowing to invest increases risk on a number of fronts. Any losses are magnified plus the fees, and interest you are paying to the bank will impact the overall return.

5. Control your tax payable – no one likes paying tax, so you need to have the right structure and advice to keep tax under control.

6. Make sure fees equal advice – most people are not aware but around 2/3 of the investment fees you pay go to the platform provider, not to your adviser. If you are in an industry super fund, then 100% of your fees go to the product provider. You get no advice.

7. Understand what you are investing in – make your investment adviser explains the investment clearly to you. Check with a third source to ensure your adviser knows what they are talking about.

8. Never panic – it is only money, you can make it back.

We are always here to help.