Beating the rate of return

This is a great article by Martin Hawes which explains why the key driver for accumulating retirement funds is the level of savings.

The savings rate nearly always beats the investment rate. This basic rule of personal finance effectively says that you are likely to end up with greater wealth if you can save more rather than find a higher rate of investment return.

It means someone who budgets and puts more aside will usually beat the investor who hunts out a higher return.

This idea is one of my basic financial planning principles and, in most circumstances, I encourage people to save as much as they reasonably can, although, obviously enough, I do not ignore good returns either!

This high savings rate is one of the reasons KiwiSaver is working so well. Many people are starting to see quite significant balances in their accounts. Kiwisaver accounts have been getting very good returns in the past five years or so, but this is not the main reason for growing funds.

The real reason for the high balances is the amount that is being contributed. You put in 3 per cent of salary, your employer also puts in 3 per cent and on top of that the Government chimes in with the Member Tax Credit ($520 p.a.)

Add it up and for many people that is a lot of savings – and the good investment returns that we have had in recent years put the icing on a nice, big cake.

Given that the biggest factor for the ultimate size of your KiwiSaver is the amount of your contributions, a question arises: should you add more? Why not put in 4 per cent or even 8 per cent or more? In fact, if you received a lump sum (e.g. an inheritance) why not put that in?

Well, if you added more you would certainly end up with a much greater amount. Although any amounts over 3 per cent of your salary probably will not attract any further employer subsidy, you can, if you want, add more.

The big problem with adding more than the amount to attract maximum subsidies (usually 3 per cent of salary) is that you would be unable to withdraw the additional contributions if that became necessary.

KiwiSaver accounts can only be cashed up for the purchase of your first home or on retirement. There are a few other extraordinary circumstances that allow you to get at your KiwiSaver funds (e.g. bad health or financial hardship), but these are not things that you want to plan for.

This lack of KiwiSaver liquidity means standard advice from most financial advisers is that you only contribute sufficient to receive maximum employer subsidies. Then, for any further money that you have spare, open another investment account. This new investment account that you open would be liquid – i.e. if the need arose you could draw on your funds at any time

However, there are some circumstances which could mean that do not follow standard advice and you add more than the usual amount:

• You are using your KiwiSaver account to save for your first home.
• You are within a few years of retirement age – i.e. funds are able to be drawn quite soon.
• You want to access some particular kind of investment account which is not available outside of the KiwiSaver scheme.
• You lack discipline and do not trust yourself to keep your hands off another more liquid investment account.
• You judge that you are most unlikely to need your KiwiSaver funds before retirement age.

To get ahead financially you do need to save as much as you can. KiwiSaver might be a suitable savings vehicle for a relatively small amount of your additional savings especially if you find the array of other, alternative funds confusing to the point of inertia.

Remember also that the fees on KiwiSaver are often lower than other comparable funds. Generally, using KiwiSaver as an all-purpose savings vehicle is not the right thing to do, but I would rather see a client save through KiwiSaver than not save at all.

Sunday Star Times 24 April 2016 Martin Hawes

What your portfolio is really missing

While this article is written for Australians it raises a number of relevant points for New Zealanders including the point; investors should be paying more attention to infrastructure offerings given the low rates of return available in the equity market and defensive nature of the infrastructure.

Australians are a diverse bunch. We enjoy a variety of food, sport and cultural activities. But when it comes to investing, our tastes are a little bland.

With the exception of some token hybrid shares or a handful of capital notes, the average Australian investor is holding just three asset classes: local shares, property and cash.

Chris Morcom of Hewison Private Wealth knows this only too well. As a private client adviser he is frequently presented with the portfolios of clients that are a little, shall we say, lopsided.

"Most investors tend to start with assets they know and understand, such as term deposits and then residential property, then they move onto Australian shares," he says.

This can cause investors significant heartburn when markets take a leg down.

Few realise, for instance, that property is in fact a growth asset and when times are bad the capital values of property can correlate with other growth assets, such as shares. That means prices can fall, and sometimes fall swiftly.

The way to solve this problem is to diversify into other asset classes.

Craig Keary is the Australian and New Zealand director at fund manager AMP Capital. Like other traditional fund managers, AMP Capital runs a number of strategies including equities, fixed income and so-called alternatives.

Keary says, however, that it is the company's infrastructure offerings that investors should be paying more attention to, given the low rates of return available in the equity market and the defensive nature of the infrastructure sector.

"Investors are getting wise to the benefits," says Keary, highlighting the steady nature of income that flows from multibillion-dollar assets such as toll roads, airports and railways.

In the past, the problem has been getting access to such gems, which are typically owned outright by industry superannuation and global pension funds, or conglomerates such as Warren Buffett's Berkshire-Hathaway.

But as rates dipped lower, fund managers such as AMP have spotted an opportunity to launch retail products offering access to the wider market, opening up a whole new world for investors.

"The need for infrastructure is never-ending," Keary says.

"For investors, it offers predictable, regular and sustainable income as well as portfolio diversification as is lowly correlated to other asset classes such as bonds. Infrastructure is a good defensive play when markets are volatile."

Which brings us to another asset class that Australian investors have largely dodged: fixed income or bonds.

Where shares are equity – an actual portion of the company which may or may not pay dividends and are prone to wild swings in valuation – bonds are debt.

Bonds are also more stable. The price you pay for a bond at issue is the face value and the interest payment the company makes to you is called the coupon.

The face value of the bond rarely changes very much and the coupon should never change unless the company (or country) that issued it goes broke.

A nice, boring, stable asset class that should be in the portfolio of every investor.

Or should it?

Dr Doug Turek is the managing director of advice firm Professional Wealth and has a keen interest in asset allocation and investor psychology.

He says that the typical Australian investor is under-exposed to bonds but says right now, that's actually a good thing. 

"Bond prices have never been so high. For instance, the benchmark 10-year Commonwealth Government Bond is yielding 2.2 per cent and so is trading on a price-to-earnings ratio of 45 times. You might justify paying that for Google but not a nil growth bond," Turek says.

Expectations of low rates for longer have weighed on the coupons for bonds and the only way for investors to get a higher yield is to drift up the risk curve, which means swapping the safety of a bond backed by a government to one backed by a company the specialises in lending to commercial kitchens. 

Turek says most investors will get much better value by hunting down a high-yielding bank account offering around the 3 per cent mark or by heading offshore.

"If you must buy bonds consider buying global bonds, which enjoy an about 2 per cent lift in yield from currency hedging or buy local inflation bonds, which nowadays give you free protection from surprise inflation."

But if you're shopping overseas for bonds, then why not shares? Over the past few years there has been a growing acceptance among local investors that having a massive bias to Australian banks and mining stocks makes very little sense.

Nick Ryder, an investment strategist with JB Were, says that over the past five years, annual total returns from international shares have averaged at around 16 per cent, against 6 per cent from Australian shares.

"By value, Australia represents only about 2 per cent of global equity markets, yet the ATO [Australian Tax Office] statistics show that self-managed superannuation funds hold 31 per cent of assets in Australian listed shares," he said.

Andrew Moir, managing director of private wealth at Evans & Partners, says that if you assume that the majority of an SMSF's managed fund exposure is to overseas shares then the overall allocation could be as high as 10 per cent.

"It's hard to generalise, but for growth investors looking at wealth accumulation over the long term this should be two to three times higher," Moir says.

He points to the asset allocation of the Future Fund, a benchmark for investors with long term horizons as an example. The Future Fund had a 22.5 per cent portfolio allocation to international equities as of March 31, 2016.

Of course that's before we even get into such investments as private equity and alternative assets such as hedge funds. All of which the Future Fund has meaningful exposure to.

But those in the early stages of diversifying, it might pay to knock over the big ticket items first.

Australian Financial Review, Smart Investor 8 June 2016

 

Brexit

I have had reports articles from a number of fund managers recently and the overall feeling is that this is a political event and not a financial event like the global financial crisis. One manager feels there is a 75% probability that this is not negative over the long term. Over the short term however markets will likely be volatile.

Below is Harbour Asset Management’s view on investment implications:

The largest reaction to the Brexit vote has been in the foreign exchange markets, where the British Pound (GBP) has fallen to its lowest level since 1985.  This reflects that Brexit is first and foremost a British political crisis, and a sharp depreciation in the GBP is the best way to help the UK economy through the economic adjustment. 

For broader global capital markets, increased uncertainty means global trade and economic growth forecasts will need to be trimmed. Similar to the post ‘Grexit’ market uncertainty the cost of capital for some asset classes will increase, particularly some more marginal credit issuers. And market liquidity may dry up for some asset classes, meaning price volatility may increase. As there is very little scope to provide policy support via monetary policy, pressure will build for other forms of stimulus. This will be a challenge for those countries that are already in a difficult fiscal position.   

In the lead up to the EU referendum we needed to ask some key questions. Has the market priced in the potential range of outcomes? Has it over/under stated the risk? Our analysis suggested that while capital markets had allowed for some degree of Brexit, with bond yields falling to recent low levels and equity markets softening, a full Brexit and potential EU contagion event had not been priced in. While we remained relatively fully invested through the Brexit period we kept liquidity available to take advantage of investor overreaction.

Markets may have over-reacted in the near term, and some asset classes may be oversold. But there is a significant amount of uncertainty to work through, and a recovery may be hesitant.

We have and will make selective investments after careful analysis. 

Markets face a number of known events currently, for example, changes to US federal monetary policy and US federal elections, which may have a range of impacts on asset class returns.  Arguably markets always face known events, but the current crop of events seem to be influencing investor confidence more than usual.  Referendums, elections, geopolitics and central bank policies all increase investor uncertainty. They often contribute to investors ‘doing nothing’ but they can lead to investors making short term investment decisions that are inconsistent with long term objectives.   As Citibank highlighted in a recent report ‘it is challenging to consider a period when doubt did not loom and clarity was evident – think Grexit fears, financial crises in the US, periphery Europe and Asia over the years, the Cold War, Japan’s lost decades, etc’. Uncertainty and limited visibility have been a factor in all of these events. New technology which allows information to be shared everywhere, all the time, with everybody may not be reducing uncertainty.

Harbour Navigator 27 June 2016

Some insurance options explained

Some of my insurance clients are looking at options as their insurance premiums start to get expensive.

Just to start with there are two premium options when you take out Life Trauma or Income Protection. They are stepped also known as rate for age or level. CPI (Inflation) adjustments aside stepped will increase each year based on age while level premiums remain the same, although start off more expensive than stepped. Typically level premiums are the way to go if you are in your 20's and 30's and can afford them.

There are a couple of options though to maintain stepped premiums when they become increasingly expensive.

1. Invoke a premium freeze option which mean the premium stays the same however the cover will reduce on an annual basis. This is a good option when you still require cover but where your budget is fixed.
2. Reduce your cover periodically. You can reduce Life, Trauma and Income Protection cover at any time via a simple request to your insurer. Note the owner of the policy needs to do this. When premiums are becoming out of hand a request to reduce the level of cover can be a simple solution.

Health Insurance

I am sure health insurance doesn’t need too much explanation to you , however I felt it would be useful to provide a bit of detail on it.

Why it is important

1. My condition could get worse while on the public waiting list
2. Who will pay my bills
3. Stress on relationship
4. Who will look after my children
5. How will I pay for extra bills that come my way
6. My partner may need to work an extra job
7. Will I lose my job

What does the Public System provide?

Acute Services
An acute patient is one who requires immediate assessment or treatment.

• All emergency treatment such as heart attacks and appendicitis are provided with care immediately and covered.

Non Acute Services
An elective patient requires treatment that is regarded as less urgent under the public health system, and whose surgery can be scheduled for a future date.

• Depends on location, severity, staffing levels, funding, capacity.

What does Private Health Insurance provide?

Non Acute Services

• Choice of when the treatment takes place:
• E.g. May want to hold off surgery until after school holidays.
• Choice of where and who is conducting the surgery:
• E.g. Treatment does not need to be conducted in the place of residence could be in a city closer to family members to have on hand to support.
• Access to the latest technology and procedures:
• E.g. Brachytherarpy for treating prostate cancer, not available through the public system.
• Expert assistance:
• E.g. Dedicated case manager to handle your case from start to finish.

Don’t join the queue, jump it

Arecent survey found an estimated 280,000 New Zealanders currently need elective surgery, with 170,000 of these not even making the public waiting list.

Waiting could mean:

• Your condition could deteriorate
• Loss of income, if you can’t work
• Prolonged periods of pain and discomfort

Take the fast lane to recovery ….

With private health insurance you can access quality health care, fast. You don’t need to compromise your quality of life while you wait for treatment. Private Health insurance can help you skip the long waiting lists for elective surgery in the public sector.

ACC and Private Health Insurance

The Accident Compensation Corporation (ACC) provides comprehensive no-fault personal injury cover for all New Zealand residents and visitors to New Zealand

What relationship does ACC have to health insurance?

• Top Up
• Injury during treatment

What is the difference between what ACC covers and my private health insurance?

ACC offers cover for accident and/or injury whereas your private health insurance offers cover for a medical condition that is not usually as a result of an accident or injury.

Annual claim value by age band and sex (Nib data)

All products, average annual claims paid per person, net GST.

To deal with escalating health insurance premiums particularly the future of health insurance will be focused around the following areas:

• Focus on Health and Well Being
• Dietary requirements
• Wellness portals
• Non-Pharmac drugs
• Online self help
• Costs escalating / premium management

Revolving mortgages and leverage

I know a number of you will have revolving mortgages or offset mortgages. Of course the advantage of an offset mortgage is that you only pay interest on the difference between your borrowings and your savings.

A big trap though with a revolving credit mortgage is to use it as an ATM machine. In my view borrowing to spend on holidays, cars and boats or non appreciating assets is not a smart financial decision. These type of things should be paid for out of savings and if those savings don’t exist then these items should be deferred until savings can pay for them.  Of course increasing your debt to invest in appreciating assets such as investment property or shares is ok as long as the debt can be comfortably serviced. 

Note though that borrowing to invest in shares is risky given the greater volatility that the share market has versus property. Of course one real benefit of borrowing to invest is that the interest is tax deductible. If you are not looking to use your mortgage for additional investment purposes i.e. property or shares my advice would be to take a standard mortgage that cannot be increased, that you pay down over time on a regular basis. Note that in a rising market a mortgage will give you leverage. The assumption here is that the capital gain in your property is greater than the cost of borrowing which of course has been the case in Auckland over the last few years. A house that has no borrowing on it will only increase at the rate of capital gain. 

This leads me to comment that in a low interest and rising market environment there is some downside in paying your mortgage off quickly. Doing so will negate the leverage effect of a mortgage. Of course there are peace of mind reasons for paying a mortgage off early. Note too that in a falling market environment having leverage (a mortgage) worsens the return.

AMP Kiwisaver Essentials Insurance Cover

For those of you who have AMP Kiwisaver, AMP has just launched the Essentials Insurance package. This is a low cost opportunity to take a modest level of life and disability cover.

The details are as follows:

• No lengthy forms
• Two easy medical questions
• No medical exams
• 100% online

I would recommend you take up this offer if you:

• Need cover and currently have none
• Have cover however feel cover is not sufficient
• Have medical issues and up to now have been unable to obtain cover

I am happy to discuss though your individual insurance situation with you so feel free to contact me.

Hey, Big Spenders

How does someone who earns $500,000 a year land themselves in a situation where they are living month to month, with no assets and credit card debt?

That’s the scenario Peter*, a Sydney barrister, found himself in a couple of years ago. When you a regular, high income, “it’s not as hard as you think to fall into the habit of spending everything you earn”, he says.

Eating two to four times a week at hatted restaurants ($30,000-plus over a year) catching taxis around town and keeping a lease car for mini-breaks ($25,000-plus) having meals prepared and delivered ($25,000-plus) hiring a personal trainer for mornings ($22,000) and outsourcing drycleaning home cleaning and gardening ($20,000-plus) add up quickly. (See example at end of article)

Peter is not alone in spending up. A recent MLC survey found most people don’t think having $1 million makes you rich any more, many consider eating out and private schooling essential costs and one in five households with incomes of more than $200,000 report living pay cheque to pay cheque.

It’s not uncommon for individuals who earn a lot to think they are not wealthy, financial planner Justin Hooper of Sentinel Wealth, says. “They say, ‘I know I earn a lot, I know I am in the top half per cent, but I don’t feel wealthy and I am not accumulating assets’. The other interesting thing they say is, ‘I don’t think I have a lavish lifestyle’.”

Indeed, there is a big disparity between high incomes and wealth, say financial planners, who find people who overspend and fail to accrue wealth are often successful business people who are simply time-poor and not cognisant of how much they are spending. They are masters or mistresses of their careers, but not of their wealth. “Spending significant amounts of money is quite prevalent among professionals, particularly in the legal profession,” Hooper says.

Others might assume the money goes on luxury holidays and mansions, but that’s not always correct. Often it’s fine dining, rental accommodation and hired help that are the culprits.

The problem starts early in professionals’ careers, a young legal professional says. It’s the lack of preparedness for substantial jumps in salary. You go from being a frugal university student to earning more than $100,000 and suddenly it’s like you’ve won the lottery she says. And so the cycle continues, until a circuit breaker enters. 

For Peter that circuit breaker was being on the cusp of 40. About to have his first child and getting worried phone calls from family. He did his first stocktake and realised some lifestyle changes would have to be made. For others, the circuit breaker might be realising you don’t want to rely on your parents – or children - when you have your own income and so it’s time to build your wealth, Hooper says.

Not using your top earning years to build wealth is an enormous waste of a very valuable resource – a high salary. Fortunately, it’s not too difficult to correct these wealth-sabotaging habits.

Advisers use a variety of strategies to help their clients build wealth, from using spending trackers and secret accounts to disabling internet redraws. Some of the tricks planner Suzanne Haddan, of BFG Financial Services, uses include encouraging her clients to siphon a proportion of their salary straight from payroll into a locked account, or, better still, their superannuation through salary sacrificing. “If they can’t see it, they can’t spend it and they don’t feel like they’re missing out on it, “she says.

For credit cards, she says the limit should be one, with an automatic repayment set up. She also tries to ban advances offered to clients for quickly paying down their loans by removing internet redraw options. “Budget can be a dirty word in the minds of some high-income earners, say Haddan and Hooper and clients sometimes feel they should be rewarded or compensated for their long hours by being able to buy what they want.

Hooper instead prefers to start by tracking spending and then linking it to various outcomes. Some clients realise they are not actually spending more than they should to achieve their goals while others find themselves on “disastrous paths”, he says. “I try to show them what the future looks like through projections if they continue to spend that way, then we set targets linked to goals and objectives.” 

Another strategy for building wealth is understanding how to use debt, financial planner Olivia Maragna of Aspire Retire Financial Services, says. “Maximise your good debt (where you can claim the interest expense as a tax deduction) and concentrate on reducing the interest on your bad debt. The strategic use of an offset account can reduce your interest on your bad debt but maintain the principal debt amount, which can potentially be used later on to claim tax benefits from, should you wish to,” she says.

Haddan agrees top earners are psychologically more likely to want to pay down debt quickly than put money into a savings account and says this can be used to their advantage with investment loans.

Financial planner Ben Smythe, of Smythe Financial Management, puts his clients on Xero Cashbook, which he says helps them manage their cash flow and wealth planning more like a business. Xero, which is best known for its small business and accounting functions is linked to bank accounts and credit cards to keep a record of spending. It then categorises receipts and lets the user know how close they are to their spending or saving target. You start by setting up categories, like mortgage, school fees, food, entertainment, and then your transactions start flowing in live and fall into their respective groups. Patterns are then formed to show you where you are overspending and how that will affect your goals.

“It gives them a very transparent picture of what cash flow is available for building wealth,” Smythe says. Once clients are set up on Xero, he puts them on a plan and links it to emotional outcomes, like a family holiday. One of Smythe’s clients Sharon*, the owner of a small business, says the program saves her the three hours that she previously spent on a Saturday morning reconciling her transactions. The main benefit for her is not the financial savings but the time it saves. You also don’t have to have that conversation with your partner about whether those shoes were really $200, because it’s in the budget,” she says.

However, a significant barrier for some prospective users is the fact you have to surrender private bank account details to the cloud. Xero acknowledges these concerns and says though the cloud isn’t totally safe from hackers, there are things users can do to reduce the threat, like multi-factor authentication and installing anti-malware devices. Smythe says he’s never seen or heard anything that would make him worry his clients’ security was being breached.  “It’s always a risk with a lot of things, but there’s nothing that makes me uncomfortable (with Xero).”

Xero costs about $50 a month, which for some people might be a fraction of what they would save but for others already wary of spending it might not be worthwhile. It’s available as a free trial through its website. For those who don’t want to pay that there are other free applications emerging for personal wealth management, including PocketBook, MoneySmart’s TrackMySpend and MoneyPad.

Finder.com.au says its searches for bugeting apps more than doubled between December and January, which signifies the growing awareness for these tools.
 
Apps to budget by:

• PocketBook
• GoodBudget
• Wally
• TrackMySpend
• MoneyPad 

An example of over spending:

Couple with two children at high school, single income of $400,000

Article: AFR Weekend 12-13 March 2016