All I want for Christmas...

With Christmas rapidly approaching, it has been interesting to observe the increased activity by financial institutions vying for superiority in the credit card space.

A recent report prepared by Roy Morgan Research on behalf of the Australian Retailers Association predicts that in Australia, retail spending for the month leading up to December 25^th will be somewhere in the vicinity of $41 Billion.  That’s a lot of reasons for the banks to ensure they are well positioned to get their slice of the Christmas pie.

The current flurry of advertising is designed to lure customers into transferring balances from credit cards held with another bank (or banks as the case often is).  The benefit is that you can reduce the interest rate currently being paid on outstanding balances down to somewhere between 0% and 2% p.a. for a period of up to twelve months.  The great part is that all the interest you’re going to ‘save’ for the next year can be diverted to purchasing those gifts you really want to give, including those you wish to give yourself.  After all, it is Christmas and you have been good!

Great news that the banks are so generous right?

Now consider that the level of core credit card debt, that is, the debt that ostensibly remains outstanding at the end of each month, currently stands at approximately $38 Billion in Australia alone.  If we use a typical rate of interest charged on outstanding balances of say 18%, this puts the annual interest bill at around $6.85 Billion.

To make matters worse (or better if you have a bank logo on your shirt), total credit card debt is supposedly up around the $50 Billion mark, if we include all the ‘interest free’ amounts that are yet to move into the period when the full interest rate is charged.

The process for a balance transfer involves an application for a new card with an institution other than the one with which you have the existing card (and outstanding balance).  Obviously, the banks are not going to allow you to take funds upon which they are earning 15% - 20% p.a. and convert it to a lower rate.  Sure, it’s Christmas, but how far do you really expect that to get you?

As part of the new application, you will be asked to provide your existing card details and if your application is approved, within around three business days, a deposit will be made in to your existing account in order to clear the balance.  This is where the fun starts…

There is no additional action taken after this point, meaning your old trusted friend is cleared and waiting in anticipation for the moment it will be brought back into action so you can ‘come in and save’ at your local retailer.  For most, it takes just a matter of days for this situation to deteriorate when the whole point of the exercise was to alleviate the burden of the credit card debt.

Of course, if you have an outstanding balance on your credit card, the balance transfer option can be financially beneficial.  However, prior to applying for the new card, it makes good sense to contact the bank with which you hold the existing account and ask them to suspend or close the account.  They will allow the amount outstanding to remain in place and will simply cease allowing further transactions to be added (except for the annual card fee and interest).  Then take a pair of scissors to the card so you’re not able to use it again.

The temptation of having a cleared and available balance on the credit card is enormous.  If you think you are disciplined enough not to suspend your existing account and cut up your card, remember that your outstanding balance, along with the other $38 Billion exists because discipline doesn’t come easy to most.

If you require assistance with your discipline, or want a helping hand to structure a payment plan that will get you through the repayment of your credit card debt in a manageable way, talk to your trusted adviser – financially, it could be the best learning experience you ever have.

What if I get the worst run of returns in the worst order?

When we invest in markets, we know to expect volatility.  We also know that diversification and a long term timeframe will help to manage this volatility and give us a reward for the risk we take.

A further sub-set of this general market risk that many investors do not know about or address is sequencing risk.

Put simply, a father of 60 and son of 30, choosing the same assets for their superannuation portfolio and both measuring their average return at 8%pa over a 20 year period, will likely have very different investment experiences, due to sequencing risk.

To start in understanding this issue, consider these points:

1. When you experience a 10% loss in one year, followed by a 10% increase the year after - you are not equal.  It takes a higher rate of return to recover from a downward turn.
2. Secondly, losing 10% on a $10,000 portfolio (when you're young and uninterested in retirement) has much less impact than losing 10% on a $1 million dollar portfolio, 2 years out from retirement.  This is known as the "portfolio size effect".
3. Finally, we have to acknowledge that you regularly add to your super portfolio over time and there will be regular income you want to withdraw from your account one you retire.  These inflows and more importantly, when they occur - have an impact.

To highlight this issue, let's look at 25 years of hypothetical returns and re-arrange those annual returns to occur in 3 different orders.

If you were 40, saving for retirement over this 25 year period - your retirement savings bucket would vary considerably depending on the order in which you experienced the returns, as seen below:

  

Similarly if you were aged 65 and about to retire, your retirement bucket would last for vastly different timeframes depending on the order of returns you experienced.

Hence we are faced with a challenge.  We know that the majority of Australians do not have enough capital or money in their super bucket to park it in cash and live off the interest.  We know that having some exposure to growth assets will be necessary to ensure our funds last, but what if we get the worst run of returns in the worst order?

New rankings published by Mercer on October 15, 2012 suggest that Australian super funds have the highest share of their holdings invested in growth assets in the world.  So this suggests that we may feel the brunt of sequencing risk more than other countries.

Sequencing risk can be addressed in a strategic way that accounts for the possibility of negative returns in the last stage of accumulating your wealth (pre-retirement) or early stages of retirement.

Milevsky & Salisbury (2006) suggest that there is a retirement zone.  So if you're 40 now and plan to retire at 60 and we assume that you will live until you're 90, between the ages of 50 and 70 you could be taking a strategic approach to your asset allocation to tackle the impact of sequencing risk.  You may be relying on your super fund trustee to get this right for you, but we warn that a "default" asset allocation that you haven't chosen to suit your personal needs and objectives could be very risky.

The Association of Super Funds of Australia (ASFA) recently published this average asset allocation of "default" strategies which is between 56-70% invested in volatile, market-linked assets.

Outside of the family home, the next largest pool of assets is typically capital accumulated for your retirement.  Based on the impact sequencing risk can have, perhaps it's worthwhile having a trusted adviser show you ways to manage this.

The 4 Things Every Investor Should Know

We live in challenging times.  It has been a long time since rising markets have been so generous as to forgive the sins of a poorly constructed investment portfolio.  And it is in uncertain times such as this that it is worth remembering what we can rely on.  
With this in mind, we thought it timely to list the definitive top four investment principles that every investor should know:

1. How you allocate your investment capital across the different asset classes is by far the biggest determinant of portfolio performance.  Academic research shows that more than 90% of the long-term performance of an investment fund, is determined by its asset allocation.   Market-timing and individual stock selection are shown to have been unable to produce enough value to overcome the associated operating expenses and transaction costs of active management. Stock-pickers take note!
2. Stop thinking that you can second guess the market.  All the news, good and bad, is already reflected in the market price. Also, the probability of you being consistently smarter than the collective knowledge of all other market participants …. well, let’s just say that it is improbable.  Empirical research has found that even professional fund managers who do this for their day job have real trouble beating the market consistently.  And most don’t.
3. The best protection against volatility is diversification, both across the asset classes and within each asset class. Yes we have all heard this before – that is because it is an investment truism, so don’t break this golden rule.
4. Heads and tails … risk and return, two sides of the same coin.  When risk is high, investors gravitate toward safe assets and away from riskier assets.  The prices of riskier assets adjust downwards thereby offering a higher expected return for those assets.  This reminds us of a great quote from Warren Buffett  “Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance”.

Sorry if we are sounding like a broken record here but these are the fundamentals of a good investment strategy ..... applying them provides the highest probability of a successful investment experience.

financial advice

Image: FreeDigitalPhotos.net

One of life's lessons ...

Our 100% growth investors have had a bumpy ride, like most over the last few years, but it's very interesting to note how quickly the recovery can happen - you can't afford to miss it.

To 2nd April 2012, our 100% growth investors - diversified across domestic, developed international hedged markets and emerging markets experienced a - 6.17 % return for the 12 months.  But when you look at what has happened in just the last 92 days - they've had an 11.09% recovery.

To look at a longer period, if you invested $1,000 in the ASX 300 in June 1992 through to December 2011 - you would have achieved 8.8%pa average return - $5,232.  Not a bad average given that we've had the Gulf War, 911, the Afghan War and a GFC during that period.  However if you missed only the best 15 days in that 19 year period, because you retreated to cash when the world looked uncertain and markets got volatile, or perhaps you got concerned about what the European Debt crisis would mean for stock prices, then your average annual return would have dropped to 5.1%pa or only $2,641.

Unfortunately fear drives many investors to miss the returns that are available to them.  They're convinced that they know something that the market doesn't.  It's just not true - the market is efficient at taking all new information and factoring it into prices very quickly.  We are more globalised than ever and whilst pricing mistakes can happen, it's not as often as you think.

It doesn't help investors that most economists don't get it right either.  In the SMH/Age Economists survey on Jan 6 2008, 28 leading economists forecast that the $AUD would go up to $0.90 US cents (from 88c), the cash rate would go up to 7.5% (from 6.75%) and that the ASX 200 would go up 8% to 6800.  What actually happened was that the AUD dropped to 70 US cents, the cash rate dropped to 4.35% and the ASX 200 was down 41% to 3722.

Then in Dec 2010, the same SMH/Age Survey (21 economists) forecast the AUD down 10% - it went up 5%, forecast the cash rate to go up to 5.25% from 4.75% and it went down to 4.25% and that the ASX 200 would go up 8% to 5169 and it went down by 14.5% to 4056.

The video clip below, The Investment Answer, provides some useful insight.

The lesson is to realise that market timing will cost you more than it will save you.  Successful investing does not require a crystal ball - it requires discipline.

Breaking up: What's the difference?

Recently, we learned of a case regarding a client concerned about the fees being levied against their superannuation fund for the level of service being delivered by their existing financial adviser.

There was an obvious lack of clarity around fees and when the client asked some clear questions, there was a distinct lack of clear answers. Not surprisingly, this left the client questioning the integrity of the relationship, which had existed for around 10 years.

Of particular interest is the client's recognition that during times when performance is positive, as was the case in the early years of the existing relationship, the fees are often ignored.

In response, the client made an appointment with the long term adviser of another member of his family.  After a detailed inspection of the facts, the adviser was able to confirm that the total fees being charged against the portfolio were amongst the highest they had seen over the past 15 years.

The adviser then calculated the ongoing costs of an alternative administration system with an asset-class portfolio, and set a fixed retainer style annual fee in line with the service required by the client.  When compared to the existing costs, the results were staggering.

This got us at The Trusted Adviser thinking.  What could the difference in fees be for a client in a similar situation, over the course of 20 years?

Using all the facts and figures from our earlier example and a simple calculation methodology, we put the difference over a 20 year period at around $83,000*.

Bear in mind that the reduction in fees in our example includes the client having engaged a fee for service, professional Financial Adviser who uses asset class investing.  Not a bad outcome in our view.

Naturally, there are an endless number of assumptions that can be made about what the results could be.  However, a simple fact is:  the higher the fees you are paying, the more return your assets are required to generate for you to break even.  It really is a negative sum game.

This issue has led us to place some attention on a current marketing campaign of the National Australia Bank, commonly known as "Break up with your bank".  We think this is an excellent campaign and the concept can be considered in so many other areas of life.

In relation to financial advice, it is so important that you are engaged with your adviser.  That is how you are able to gain the most value out of the relationship.  In our experience, clients who continually seek professional advice are taking action, as opposed to not taking action, which makes all the difference over a lifetime.

If you feel something isn't quite right, be sure to ask questions until you are satisfied with the answers provided.  If this doesn't work, as the NAB suggest (at least on the topic of banking), maybe it's time to consider a break up.

* Starting capital: $300,000.  Term: 20 years.  Return: 5% p.a. average.  No additional contributions.  Fee differential $2,600 p.a. 

Can You Manage Yourself?

Happy February everyone!  I don't think "Happy New Year" sounds right anymore now that we are in February ... and where did January go already?

Anyway, year 2012 is in full swing and 2011 is over!  We might have seen Aussie Cadel win the Tour de France in 2011 but it was a forgettable year for investors.  This fact was reinforced with me just last week when my neighbour (one up and one across) called me to ask if he could catch up to discuss setting up a Self-Managed Super Fund.  In case you were wondering, he called because it was 8pm, otherwise it would have been a chat on the front lawn.  His primary reason for wanting to set up a Self-Managed Super Fund ..... Control.

When super fund returns are negative, the urge for control is understandable and perfectly rational.  There are of course, a few things to know about Self-Managed Super Funds before jumping in the deep end. This article by Bina Brown in The Sydney Morning Herald does a good job of explaining what you should consider so I won't say it all again here.

What I do want to say about SMSFs is that the administration costs of having one can vary greatly.  Often these costs are billed on an hourly rate and that means that the final bill can come as a surprise.  We prefer a fixed fee service agreement and if you already have an SMSF or are thinking about one, take this as a suggestion: Speak with your accountant about setting a fee so that you know what you can expect to pay.  As a guide, if you have less than ten investments in your fund and you transact infrequently, you should expect to pay no more than $2000 for the accounting and audit costs combined.  How does this compare to the costs of a personal super fund I hear you ask.  This would be equivalent to having around $350,000 - $400,000 in a personal super fund which means there are no real cost savings to have an SMSF for less than $400,000 but of course, there is that control factor.  If you are disgruntled with your super fund return and you think an SMSF is the answer (just like my neighbour), just make sure you know what you are getting yourself into.... and consider how much your time is worth as well.

P.S.  The Sydney Morning Herald article states "since 2007 that DIY funds could borrow to buy residential property. More recently, the ATO clarified that DIY funds could "value add" and increase the worth of a property through renovation..".   As detailed in our News Update post in December, borrowed funds cannot be used for property improvements in an SMSF but can be used for repairs and maintenance.  An SMSF can however use its own funds (not borrowed funds) for improvements.

Image: Salvatore Vuono / FreeDigitalPhotos.net

News Update

As another year draws to a close, we thought it might be useful to sign off for 2011 with a summary of some key announcements that we can all look forward to in 2012, or not, as the case may be.
The Legislative Amendment Bill to increase Superannuation Guarantee (SG) contributions passed the lower house on 23rd November.  This bill also abolished the upper age limit (currently age 70) applying to SG obligations on employers.  The increases to the SG rate are as follows:

• 1 July 2013 to 30 June 2014  9.25%
• 1 July 2014 to 30 June 2015  9.50%
• Then an increase of 0.50% each financial year
• From 1 July 2019  12.0%
  

The current 25% pension drawdown relief for minimum payments from account-based, allocated and market-linked (term allocated) pensions will continue for the 2012/13 financial year.

The superannuation concessional contribution limit of $50,000 for people aged 50 and over will be halved to $25,000 for 2012/13 under current legislation, though the Government is considering legislative change to retain the current (2011/12) $50,000 limit.  Under 50's will continue with the current $25,000 limit for concessional contributions and this won't be indexed until 2014/15 when it is expected to rise to $30,000.

The maximum government co-contribution will be halved to $500 from 1 July 2012.  People with incomes up to $31,920 will be eligible for the maximum with the amount phasing down for incomes up to $46,920.

The tax concessions available on employment termination payments (ETP), as well as the ability to direct all or part of the payment to a superannuation fund under transitional arrangements, will cease on 30 June 2012.   From 1 July 2012, all ETP's will be taxed at the standard rate with no ability to direct these amounts to superannuation.

The Australian Tax Office (ATO) has recently released a draft ruling (SMSFR 2011/D1) defining key concepts that relate to self managed super funds borrowing to invest. This draft ruling clarifies the meaning of a 'single acquirable asset' and confirms that borrowing can be used for repairs and maintenance on the acquired asset but cannot be used to pay for improvements.

Revised impairment tables have been introduced from 1 January 2012 for the assessment of new claims for the Disability Support Pension (DSP) and for current DSP recipients undergoing a medical review.  As a result of this change, it will be potentially more difficult to gain or retain a DSP from 1 January 2012.financial advice
So that's it from us for 2011 and we'll see you back here early next year.  From everyone here at The Trusted Adviser, we wish you the most wonderful Christmas and prosperous 2012!