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! 

Superannuation is NOT an investment!

If we had a Twitter ‘follower’ for every time someone said "super is a bad investment" we'd be as popular as Ashton Kutcher. Seriously, it's frustrating to hear this line at the BBQ's, in the cab and over the Christmas turkey because super is not an investment and none of these social opportunities give us enough time to set the record straight.

Super is a structure, a vehicle within which you can invest, and there are many compelling reasons to do so.

So why are so many Australians disengaged from their super?  Perhaps it's a symptom of the super rules being so complex (this is a common reason), or perhaps it's a feeling of "no control"? I think we'd have to be honest here and throw apathy in the mix and the very unfortunate and too familiar attitude of "I can't have it now - so I’ll worry about it later".

Let's see if we can redirect your thinking.

Whilst super on its own won’t drive your investment returns, it definitely has the potential to improve them.  Your returns will be driven by the investments you choose, more specifically the asset classes you invest in like cash, property or shares.  Fees and taxes also matter and we will be talking more about these in future blog posts.

So superannuation is a structure, just like a Company or a trust is a structure, and each of these structures have their own rules and offer different tax outcomes.

Take Barry for example, his marginal tax rate is 38.5% (incl. medicare levy). He has $10,000 pre-tax income available for investment and he wants to invest defensively, targeting 6%pa.  He can choose to do this inside or outside of super.

If he pays tax first and invests outside of super in his own name, he has $6,150 to invest on day 1.  However if he salary sacrifices the $10,000 into superannuation, he has $8,500 to invest from day 1.  Remember, he is investing in the same assets – targeting 6%pa.  This means his super asset gets a head-start of more than 38% over his non-super asset and this advantage compounds over time.

Just last month, the current Assistant Treasurer and Minister for Financial Services and Superannuation Bill Shorten MP, addressed Financial Planning Professionals in Brisbane and discussed the impact of compulsory super savings in Australia.  He said

 “Superannuation savings in Australia are in excess of 1.3 trillion dollars, the size of our Gross Domestic Product.  If the American economy had made the same decisions that we made, they would have had 12-13 trillion dollars in savings! The most recent turmoil in North America, I suggest to you, would have been far less drastic, their economic recovery far quicker, the problems they’ve had far more shallow, if they had that pool of national savings.”

We Australians are so fortunate.

These are compelling arguments and when you couple this with our Government about to step-up the compulsory contribution level from 9%pa to 12%a, we must invite all Australians to re-connect with their super.  IT IS our future.

Image: Salvatore Vuono / FreeDigitalPhotos.net

I forgot my parachute!

"That is amazing" .... "I just can't believe this" ....

The tears in his eyes welled up but I could see he was trying hard to not let them start rolling down his face.  This was a 40-something man in my office and his real-life story goes like this:
I took an appointment that sounded like it was going to be fairly standard. A man calls the office concerned about his financial position and he wants to talk.  The appointment rolls around and we chatted for about 15 minutes during which he tells me that he and his wife and are under some financial pressure.  His wife may need to go back to work and the prospect was making him very unhappy.

I asked him why he was unhappy about his wife returning to work.  He tells me that three years ago she was diagnosed with non-Hodgkin's lymphoma, the treatment has been hell and it was amazing she survived and came through it at all.
He goes on to explain that he probably feels this way because he was so close to losing her and since then they have been living beyond their means - taking lots of holidays, saying yes to the kids more than they should and they are now feeling pressure to pay down the mortgage and start saving for their retirement.
As he continues telling me about his wife's traumatic treatment plan and recovery, I am flicking through their insurance documents.  He owns a trauma policy on his wife which covers, amonst other things, a range of cancers, heart attack and stroke.  Non-Hodgkin's lymphoma is a cancer of the lymphatic system.  There was $110,000 worth of cover, just sitting there, waiting to be claimed to help them manage the costs of treatment and recovery.

I said to him "you know you have this trauma policy - why haven't you claimed on it?"  After a brief pause, he quietly says "to be honest, I didn't even think about it".  I contact the insurer, process the claim and within four weeks I am handing them the cheque for $110,000.  And yes, I'm pleased to report that they have made the most of it - significantly paying down their mortgage and leaving enough to make some great family memories on their next "guilt-free" holiday.

This story has a happy ending but of course this isn't always the case.  Not everyone recovers and not everyone seeks the financial safety of insurance. Given the likelihood of being diagnosed with cancer (some statistics below), let alone any other major medical trauma, take this as a timely reminder to think about your own real-life story.

The Trusted Adviser. 

	Lifetime Risk
Cancer Type	45 year old Male	45 year old Female
All Cancers	1 in 3	1 in 4
Breast Cancer	-	1 in 11
Prostate Cancer	1 in 11	-
Colorectal Cancer	1 in 17	1 in 26
Melanoma	1 in 25	1 in 35
Lung Cancer	1 in 22	1 in 45
Non-Hodgkins Lymphoma	1 in 66	1 in 88
Cancer of the Uterus	-	1 in 75
Cancer of the Kidney	1 in 76	1 in 143

Statistical data provided by IRESS: Risk Researcher 2011

Image: Michelle Meiklejohn / FreeDigitalPhotos.net

Trick or Treat?

Did you have children knocking on your door for Halloween on October 31st?   It seems to have become quite popular in our neighbourhood over the last few years and again this year we had a few groups of kids knocking on our door, bags at the ready.  I never say "Trick" because I don't fancy washing eggs off the front windows of my house.  So we had our stock of treats in preparation for the hungry hordes and by treats I mean chocolate and lollies, not a piece of fruit, fresh or dried thankyou very much.  I understand the whole "healthy snack" principle but if I am a kid, I'm not getting all dressed up and running around looking for fruit!

Anyway, in the spirit of Halloween, The Trusted Adviser will make a habit each year around October 31st of asking a "Trick or Treat" question about investing.  

This year, we are going to talk about a certain type of "property educator" that promotes investing in property, often, but not always, through "wealth-creation seminars".  I will kick off by quoting directly from one of these "investment mentors":

"Our earnings come through property developers.  This means we can offer our advice and support free to clients.  We are not here to "sell you a property" - we are here to help you build a property portfolio and achieve financial independence."
OK, so how much do they receive from property developers for finding you "the best investment property": 4% - 6% of the property sale price.  That doesn't sound like "advice and support free to clients" does it. You don't have to be Einstein to work out that this is all about selling a property and it is being dressed up as financial advice ....... and it certainly isn't free!  

These property investment gurus sell these development properties for a commission and their sales angle is emphasize the tax benefits.  Principally, they show the "magic" of claiming depreciation allowances to reduce your personal income tax bill.

My advice to you if ever you find yourself getting the hard sell from one of these "property educators" - remember these three things:

1. More than half of the purchase price of these development properties can be attributed to the building and yet we know that the building depreciates.  When buying investment property, you want to be putting most of your money into the land component because it is the land on which the house is built that goes up in value over time.
2. The building depreciation allowance that is being used to promote these properties is deducted from the purchase cost (i.e. cost base) when it comes time to sell, resulting in a higher capital gains tax assessment.
3. When the tax benefits of an investment are being heavily promoted, think twice about the quality of the investment.

So next time you are invited to a seminar selling development property and you are offered advice for "free", I would suggest that you give it a miss or at least take some eggs with you!  

financial advice
Image:  A Jack o' Lantern made for the Holywell Manor Halloween celebrations in 2003.  Photograph by Toby Ord on 31 October 2003.

Word of the year?

If I asked you to name the top word for each of the last five years, what would you say?  I’m guessing that you are thinking along the lines of Global Financial Crisis (GFC), or perhaps the gravity-defying rise and rise of Apple (contrary to Newton's law), or even the Social media phenomenon.  If this is where your mind was taking you, then you would be right – at least according to the American Dialect Society (ADS).

For the record, the ADS chose the following over the last four years:

2007:  Sub-prime

2008:  Bailout

2009:  Tweet

2010:  APP  (and surely an honourable mention must go to “Vuvuzela”)

My guess for a front-runner in 2011:  Austerity

In essence, “austerity” means lower spending and at the moment, its utterance is so closely connected with the word “Greece” that the two could almost be hyphenated.  But the Greeks don’t have this urge to over-spend all to themselves do they.  And I’m not just talking about other governments.  It has become part of the human condition.  And at the very heart of the problem – spending on credit!  Which brings me to my point.

Cash is King and managing your cash-flow is paramount to financial success.

If you want to make smart choices with your money, then you need a cash-flow plan just as all successful businesses do.  You need to know what's coming in, what's going out and have a plan for the surplus. If you don't have a surplus, more work needs to be done on the first step to ensure you don't live beyond your means.

People that need credit cards, do so because of poor money management - they've had something unexpected come up and don't have emergency funds, or they are constantly spending more than they have available and keep thinking they'll clear it next month!

Or the marketing con of frequent flyer points has won them over – paying a surcharge of 1-3% (or even 10% in the case of taxi fares) for the privilege of using credit. There is your free flight each year, if you weren't using credit.  And then there are the higher annual credit card fees if attached to a frequent flyer program.  We know, because we see it all the time.  People managing cash-flow on credit cards spend more than they planned to each month and end up paying more than it would have cost for the trips that they are earning for "free".  It’s a false sense of benefit!

The convenience argument is now gone, as debit cards provide the same convenience and you are spending your own money.

The emotional impact is known – you will always think a little longer if you are paying in cash, versus whacking it on the credit card.

Avoid your own taste of “austerity” by making a smart financial decision – develop a cash-flow plan that works without credit.financial advice