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Hungry for income? Choose carefully.

When you are working or looking for a job, it’s only natural to think about the size of your paycheck. After all, you need to pay your bills, and it always helps to have a little extra.

         

 

The same need exists in retirement. But in both situations, focusing excessively on income can be a mistake. For example, taking the job that pays the most may lead you to choose work you don’t like or fail to consider your desired lifestyle.

In retirement, overemphasising income-producing investments can also lead to costly errors. Proof of these risks surfaced again a few weeks ago when — for the second time in a year — U.S. industrial giant General Electric slashed its quarterly dividend from 12 cents to 1 cent following news of a criminal accounting probe.

It’s often difficult to break the habit of fixating on income. We spend our working years trying to amass enough to retire. Our minds concentrate on a number — $1 million, for example — that will allow us to stop working. Psychologically, it becomes challenging to shift to spending that money, so many retirees try to live off portfolio income only.

History also encourages an income focus. When interest rates were high, many retirees could count on interest and dividends to pay their bills without dipping into principal. But as interest rates declined, so did income. In the last decade, the yield on a globally diversified portfolio split evenly between shares and bonds fell from nearly 5 per cent to 2.5 per cent, a 50 per cent decline in income, according to Vanguard research.

Investors may try to close this gap by overweighting income-producing or defensive assets, but let’s look at how these strategies can unwittingly increase risk:

Moving money from fixed income into shares that pay high dividends. This choice can increase portfolio volatility for a simple reason: Shares are riskier than bonds. When share prices fall, investment-grade bonds tend to rise in value, cushioning a portfolio. Also, shares that pay higher dividends tend to be value, as opposed to growth, shares and are concentrated in certain industries, such as financials. As a result, boosting allocations of dividend-paying stocks can reduce diversification and increase vulnerability to sector downturns — exactly the opposite of what the investor hopes to achieve.

Replacing investment-grade bonds with higher-yielding bonds. Higher-yielding bonds can be as volatile as shares, so this strategy also sacrifices downside protection for the potential of higher income. Bonds that pay above-average rates of interest are riskier credits. That’s why they are often called junk bonds. During periods of economic turmoil, default rates on lower-quality bonds increase, causing them to fall in value, often in tandem with shares.

Overweighting term deposits and cash while underweighting bonds. Shifting money toward safe bank accounts is tempting. But while term deposits and cash protect principal, they don’t offer capital appreciation in troubled times. When interest rates fall, bank deposits usually earn less money, but investment-grade bonds often increase in value, providing reassuring ballast when shares decline.

The pitfalls of these choices are many, which is why we advocate a total-return strategy, which involves creating a diversified portfolio in line with your financial goals. That way, you base withdrawal amounts on income and capital appreciation.

Compared to the income approach, total-return investing gives you flexibility. You can adjust spending and withdrawals based on overall portfolio growth instead of depending only on the income the investments yield. Total-return investors avoid the downsides of overemphasising income and enhance their ability to reach their goals.

Many investors can benefit from getting professional advice when making these decisions. If you’re looking to learn more about total-return investing, our paper, “From assets to income: A goals-based approach to retirement spending”, can help.

 

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
13 November 2018
vanguardinvestments.com.au

Franking credit policy to dent retirement savings by 15 per cent

Data analysis based on a 20-year time frame indicates that Labor’s franking credit proposal could reduce retirement savings by 15 per cent for SMSFs with an average balance.

       

 

In a submission to the standing committee on economics, SuperConcepts said that data analysis confirms that lower income retirees will be hit hardest by the removal of franking credit refunds.

Data analysis undertaken by SuperConcepts indicates that for a retiree with an account-based pension receiving the minimum pension amount of $45,000 per annum at age 65, the removal of franking credit funds will negatively impact their retirement savings by 15 per cent after 20 years.

This is based on a balance of $900,000, which is around the average balance for an SMSF member at that age.

The calculations assume a 40 per cent allocation to Australian shares, 3 per cent capital growth and a 4 per cent income return. The calculations also assume the SMSF has a single member who only has a retirement phase interest in the fund and is receiving the minimum annual pension entitlement from an account-based pension.

The analysis shows that the member’s closing balance after 20 years would be $825,519 if refundable franking credit were removed compared to $953,480 if refundable franking credits were not removed.

SuperConcepts general manager of technical and education services Peter Burgess said this equates to a significant impact on the fund’s earning rate and the total income received per annum.

“In year one, the total income received including franking credits is $36,771 compared to $30,600 if refundable franking credits were removed. After five years, the income differential is $7,631 per annum, and after 10 years, the differential is $9,207 per annum,” said Mr Burgess.

Mr Burgess has also previously pointed out that while the measure is intended to target the wealthy, in reality it may actually allow them to accumulate more in super.

“Transferring some of their pension balance to the accumulation phase may allow them to use all of their franking credits. The effect will be more retained in super for longer, as they can draw down super from accumulation phase when they need it rather than being forced to take the minimum pension each year,” he said.

 

Miranda Brownlee
12 November 2018
smsfadviser.com

Compliance, tax advice in strongest demand from SMSFs

While investment advice is the most valued by SMSF clients, compliance and tax are still the areas that SMSF trustees required the most assistance with, according to recent research.

         

 

A report compiled by the SMSF Association and OpenInvest using data from an Investment Trends’ survey of SMSF investors indicates that most SMSFs tend to engage two different types of advisers each.

The results from the survey indicate that in the last 12 months, over 45 per cent of SMSFs had used an accountant for tax advice.

The second most common professional was financial planners with around a quarter of SMSFs in the survey having received advice from a planner in the past year.

The survey also showed that compliance is the area members require the most help with, closely followed by tax.

The report pointed out that members and trustees that do not understand their obligations could incur severe penalties and sanctions or significant financial detriment.

Investment advice was the most valued area of advice.

The four main areas which SMSFs said they require more advice were superannuation tax planning, investment selection, post-retirement planning and retirement strategies.

When asked what holds them back from seeking their unmet advice needs, SMSF clients said the cost, followed closely by the lack of trust.

SMSF Association chief executive John Maroney said it was surprising that one in five SMSFs have not used any financial advisers in the last 12 months, particularly when regulatory and market volatility is increasing.

“Investing in an SMSF means you’ve taken control of your retirement savings, it does not qualify you as an expert investor, and one of the most effective ways to achieve a secure and dignified retirement is with expert assistance,” said Mr Maroney.

The research report also revealed that some SMSFs were lacking in diversification with half of SMSFs holding 50 per cent or more of their assets in a single asset type.

The report said that confusion around what diversification means is still prevalent among SMSF trustees.

“SMSF trustees say they primarily invest in shares to achieve diversification in their SMSF, while just a quarter say they invest in at least four asset classes to achieve this,” it said.

“When you look at the allocation to shares, the majority of SMSFs believe they can achieve adequate diversification using only a range of shares, with two-thirds of SMSFs considering a portfolio invested in 20 individual shares to be a well-diversified portfolio.”

 

Miranda Brownlee
19 November 2018
smsfadviser.com

Our Advent calendar for 2018

On behalf of all our staff we wish our clients a Merry Christmas, Happy New Year and a great holiday period.

Come back each day for an inspirational quote or poem about Christmas, summer and life in general from some of the great writers and poets.

(Please click on the image to open the Advent Calendar and then click on a date)

         

 

 

 

 

 

 

The value of advice – Behavioural Coaching

Behavioural coaching is a major component in how a financial planner adds value to your portfolio.

 

     

     

 

 

Last month’s topic was “How a Financial Planner adds value to a Portfolio?”, a major component being Behavioural coaching. The month before the topic was “The Value a Planner Adds to a Portfolio”.

This month the focus is on “What is Behavioural Coaching?”.

There are many long-term investment charts that show how portfolio values increase over time but even with this proof many investors react to short term market volatility which can often undermine attainment of long-term objectives.

Managing this reactionary behaviour is the definition of behavioural coaching.

Behavioural coaching is how a financial planner manages investor 'emotion' and 'reaction’ to market ‘noise' to ensure long term goals are achieved. A good example of this was the GFC. Planners often talked of the stress of having to explain the correct path under such extreme circumstances. In the end, though, those who played the long game have recovered well.

This form of control is hard to achieve when acting alone, it often requires teamwork and professional help.

Behavioural coaching centres on four issues:

  1. A financial plan is the anchor to all actions.
  2. Set clear expectations at the beginning.
  3. Managing the emotions that accompany periods of market volatility.
  4. Work together to ensure an effective planner / client relationship rather than simply reacting to markets.

Behavioural coaching may also involve assisting in areas such as budgeting to save money now to help attain goals later.

A planner, though, will struggle to help you achieve your goals if they aren't continually kept up to date with any changes in your life.

There are four components that you and your planner need to work on together. These are:

Goals

Without goals there can be no planning. However, goals must be realistic and for many investors this is itself difficult because of their starting age. The earlier a person has a financial plan then in most cases the better the outcomes.

Discipline

Market noise and emotion means decision making is difficult. It may even mean cuts now to help win in the end. Discipline is very hard to do on your own so help in this area is a major contributor to attaining long term goals.

Balance

This simply means not to put all your eggs in the one basket. Spreading the risk may mean the full extent of up swings aren't gained but it means that the full extent of down swings aren’t either. Balance means 'slow and steady' and we all know how that works out.

Cost

A planner needs to be able to show that they manage the costs in your portfolio, so they can be as low as possible. History shows that on average, lower costs means better performance.

This is the third in a series of articles is based on a 16-year study by Vanguard Investments Pty Ltd.

 

Peter Graham
BEc, MBA
PlannerWeb / AcctWeb

 

 

Ranking of the world’s best: Taking it personally

You may have read about the latest ranking of Australia as one of the best countries for retirees in terms of lifestyle and retirement-income systems. 

         

 

And you may have wondered what such rankings personally mean for you – apart from perhaps making you feel fortunate about where you live.

After all, you are unlikely to move to, say, the Netherlands because it’s retirement-income system ranks as the world’s best.

However, the rankings may prompt you to take measures to improve your chances of a successful retirement lifestyle.

Retirement incomes

First, let’s look at the Melbourne Mercer global pension index 2018, published by Mercer and the Australian Centre for Financial Services. This ranks Australia’s retirement-income system fourth out of the 34 countries assessed, based on adequacy, sustainability and integrity. Australia was given a B while the Netherlands and Denmark received A grades.

A B-rated retirement-income system is described as having a “sound structure with many good features” but, in the words of many school reports, says: There’s room for improvement.

Irrespective of each country’s social, political, historical and economic influences, this report stresses that many of their challenges in dealing with an ageing population are similar. These include encouraging people to work until older ages, setting the level of retirement funding and reducing the” leakage” of retirement savings before retirement.

Although the suggestions of the Global Pension Index are directed mainly at government and the pension/retirement sectors, individuals may pick up useful personal pointers from most of its suggestions. In short, consider taking a personal perspective on this global retirement-income challenge.

Personal pointers may include:

Think about whether to work until an older age than planned. A longer working life may provide a chance to save more for a shorter, and, therefore, less-costly retirement. And as the report says, working until an older age will limit the impact on retirement savings of increasing longevity. In reality, your ability to work past traditional retirement ages will much depend your personal circumstances including health and employment opportunities.

Save more in super within Australia’s annual contribution caps. This can include making higher salary-sacrificed contributions if employed. If self-employed, consider making voluntary super contributions, which are not compulsory for the self-employed.

Aim to repay your debts before retirement. Otherwise, you face repaying that debt with your retirement savings. One of the reasons why Australia has achieved a lower score this year (down from B-plus to B) for its retirement-income system is that the latest Global Pension Index includes pre-retirement household debt in its calculations for the first time.

Take your super as pension rather than a lump sum upon retirement. This will keep your savings in the concessionally-tax or tax-free super system for longer and, most importantly, make your retirement lifestyle as comfortable as possible for as long as possible. The Global Pension Index suggests that a way to improve Australia’s retirement-income system is to compel super members to take part of their super as a pension.  

As Dr David Knox, a senior partner of Mercer in Australia, comments in the report, retirement income systems around the world are under pressure from ageing populations; low growth and low interest from investments reducing long-term compounding interest; and lack of “easy access” to pension plans (superannuation in Australia) in the gig economy; high government debt in some countries; and high household debt.

In this environment, individuals have more of an incentive to take matters into their own hands to maximise their retirement savings.

Best countries for retirees

The 2018 Best Countries report once again ranks Australia as the world’s second-best country for a comfortable retirement – behind New Zealand and ahead of Switzerland, Spain and Portugal in the top five. This is an annual survey and analysis by US News & World Report, BAV Consulting and the Wharton School at the University of Pennsylvania.

Survey respondents aged over 45 ranked the best countries for retirement on seven attributes: affordability, favourable tax environment, friendliness, “a place I would live”, pleasant climate, respect of property rights and a well-developed public health system. (The survey did not seek views about the adequacy of a country’s retirement-income systems.)

For the main report, more than 21,000 survey participants from around the world were asked to grade 80 countries on a range of factors from quality of life to economic potential. It aims to gauge global perceptions of the countries.

Australia came seventh overall with Switzerland again taking first place. Specific areas where Australia ranks in the top five are: quality of life (Australia fifth), best countries to invest in (Australia sixth – up from 22nd last year) and best countries for a comfortable retirement (Australia second).

Now think about what these findings may mean for you personally.

 

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
04 November 2018
vanguardinvestments.com.au

Information needed to be the BBQ expert.

Comprehensive statistics on how Australia is performing.

 

 

An up-to-date snapshot of Australia's vital statistics.

Please click on the following link to see all this interesting information. The areas covered are:

  • Overview
  • Markets
  • GDP
  • Labour
  • Prices
  • Money
  • Trade
  • Government
  • Business
  • Consumer
  • Housing
  • Taxes
  • Climate

 

Access all this data here.

 

tradingeconomics.com

The global financial crisis: Behind us but far from over

Ten years ago this month, Lehman Brothers, the fourth-largest US investment bank, filed for bankruptcy protection.

         

 

It was a seminal event in what has come to be known as the global financial crisis (GFC). Even a decade on, the massive damage it inflicted across the world continues to shape both the global economy and investor behaviour.

Just how bad was it?

The epicenter of the crisis was a wave of US subprime mortgage failures that hit the housing and financial sectors and then spilled over into the broader economy and far beyond the United States. It created a synchronised global recession. For a number of countries, including Greece, Italy, and Spain, recovery from this recession to pre-crisis GDP levels has taken even longer than it had from the Great Depression. Other countries still aren't there yet.

Although numbers alone can't capture the full impact of what happened, below are some indicators for the United States that at least give a sense of the scale of the crisis.

Sources: Vanguard, Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, and “The 2007–2009 Financial Crisis: An Erosion of Ethics: A Case Study” in Journal of Business Ethics, December 2017, Volume 146, Issue 4, pp. 805–830.

Some healing from the GFC and some enduring scars

“Obviously, we're in a much better place right now than we were a decade ago,” said Roger Aliaga-Díaz, Vanguard chief economist for the Americas. “The global economy has been expanding—the US is in its ninth year of expansion, which is the second-longest on record, and most developed economies are at or near full employment. And inflation remains modest despite unprecedented monetary stimulus.

“But on the other hand,” he noted, “the GFC set in motion or accelerated some deep shifts in the global economy that leave us still short of 'pre-crisis normal,' according to some key metrics. I'd point specifically to wages, global growth, international trade, and interest rates as prime examples of that.”

  • Slower global growth, less international trade. The financial meltdown put a brake on the debt-fueled consumption boom in the developed world and, with it, the main growth driver for export-oriented emerging markets. The US, for example, began buying less abroad, causing its trade deficit to drop from close to 6% of GDP in 2006 to about 2.5% post-crisis, while China's trade surplus shrank from 10% of GDP to around 2%. (They are still at roughly those levels today.) The abrupt drop-off in international trade accelerated the drive of some emerging markets like China to rebalance their economies from export-oriented manufacturing production toward domestic-oriented services. Other emerging markets, especially commodity exporters, have struggled to reorient their economies. As a result, emerging markets are not the engines of global growth they once were. Growth in China has slowed from an annual average of about 10% for the two decades prior to the GFC to about 6.5% since then. Overall emerging-market growth has fallen from about 7% to about 4% over the same time frame.
     
  • Persistently low interest rates. Global demand for “safe assets,” such as high-quality government bonds, had been increasing well before the GFC. One reason was the burgeoning retirement savings of aging populations transitioning toward more conservative portfolios. A second reason was a buildup of reserves by emerging-market central banks in response to their traumatic currency crises of the 1980s and 1990s, and more recently by their attempts to offset the effect of quantitative-easing policies of the last decade on their currencies.  The GFC caused a collapse in the availability of those assets, effectively shrinking the pool of what constituted “safe.” Before the crisis, many investors felt that financial assets, such as synthetically engineered AAA-rated securities, securitised mortgages, and related derivatives in the US, as well as euro-backed peripheral government bonds in Europe, were all valid alternatives to Treasuries. After the US housing and European debt crises, investors learned that that was not the case. 

    The deteriorating global supply/demand imbalance resulted in a massive shortage of high-quality, risk-free assets around the world. This had the effect of pushing the prices of the few safe assets left—mainly US Treasuries, British gilts, and German bunds—to extreme highs. Since bond prices and yields move in opposite directions, bond yields and interest rates have reached historical lows. 

    This global shortage of safe assets is likely to persist and long-term interest rates could well remain at current levels for some time.
     

  • Stagnating wages. In a typical economic recovery, companies have to raise wages in order to attract and retain increasingly scarce workers. However, there hasn't been as strong a demand for more workers in this recovery because global growth has been slower. 

    Demographic trends across developed markets are an important part of the explanation. In the US, the main reason for the fall in the unemployment rate has been the retirement of baby boomers, a trend that the recession probably accelerated and that is likely to continue for decades. The US labour force participation rate has shrunk by almost 4%, or more than 9 million workers, since the GFC. And because the retiring boomers have been replaced by younger and cheaper workers, the usual post-recession surge in wages, after adjusting for inflation, hasn't materialised.

And yet the financial markets have been surprisingly robust

“The contrast between the economy and the markets couldn't be starker,” observed Vanguard Chief Investment Officer Greg Davis. “While most economic variables showed subpar performance, stocks have delivered solid returns.”

The US market has delivered an outstanding annualised average return of 19% since March 2009 (the crisis-era low) following a meltdown of –47% in the six months prior to that. Those returns put the average annual return for the full ten-year period at 11%, or slightly better than the comparable return of 9% for two decades prior to the crisis.

The performance of bonds was also decent given the low-interest-rate environment—the average annual return for US bonds was 3.5% for the decade. Given the demand for safe assets, neither the extended period of economic expansion nor the unprecedented quantitative easing across much of the developed world has lifted rates very high.

*Data for Hong Kong bond returns were not available.

Note: The periods cover the global financial crisis (September 2008 through February 2009) and the post-crisis period (March 2009 through August 2018).

Sources: Vanguard calculations of stock returns, using data for MSCI Total Return Indices, and Vanguard calculations of bond returns, using Bloomberg Barclays indices.

Lessons for investors

There's no better illustration of the importance of staying the course through good markets and bad than the US equity market's impressive turnaround since the GFC. Investors with a broadly diversified portfolio of 50% stocks and 50% bonds who didn't hit the panic button saw an average annual return of 7% from the pre-crisis market peak in 2007 through June of this year.

Notes: Stocks are represented by the Standard & Poor's 500 Index. Bonds are represented by the Bloomberg Barclays US Aggregate Bond Index. The 50% stock/50% bond portfolio was rebalanced monthly. Data are provided by FactSet and cover the period from 9 October 2007, through 29 June 2018. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard calculations using data provided by FactSet, as at 29 June 2018.

As would be expected, more risk-tolerant investors with larger portions of their portfolios in stocks would have done better. It's worth noting, however, that a 100% stock portfolio would have been under water for the first four years after the market peaked in 2007.

Maybe the GFC's most enduring effect on investor behaviour is greater fear of loss. Millennials who started investing with Vanguard after the GFC were twice as likely to hold zero-stock portfolios as those who started investing before it occurred. For them, market risk seems to be more salient than potential return.

“Bond returns are likely to remain modest and US equities also face some headwinds due to high valuation levels,” said Mr. Davis, “which translate into subdued return expectations for the next decade. For all the contrast between the performance of the economy and market returns over the past ten years, we may be heading into a period of lower portfolio returns over the next ten years. A global balanced portfolio may return between 3% and 5% after accounting for inflation, compared with a historical return of around 7%.”

One of Vanguard's main goals in providing forecasts about capital markets is to arm investors with realistic expectations about portfolio returns so they can calibrate an appropriate level of savings in order to ensure they reach their investment goals.

Timeless advice

The global economy is in a very different place a decade after the GFC and some investors remain risk-shy (especially those who didn't participate in the great stock bull market that ran from 1982 through 2000). But Mr. Davis said Vanguard's investment approach hasn't changed: “Think about how much risk you can take on and still sleep at night, diversify your portfolio across the globe among stock and bonds, and make sure to rebalance from time to time—those steps should still offer you the best chance for investment success.”

 

Roger Aliaga-Diaz
Chief Economist for the Americas
vanguardinvestments.com.au

 

‘Hefty penalties’ with TRIS payment failures, SMSFs warned

With clients who fail to pay the minimum pension payments for TRISs potentially up for illegal early release and significant penalties, SMSF practitioners have been urged to pay close attention in this area.

           

 

With failure to pay minimum pension payments for TRISs potentially resulting in illegal early release and significant penalties, SMSF practitioners have been urged to pay close attention to their clients’ pension payments.

Speaking in a webinar, DBA Lawyers director Daniel Butler said SMSF clients who have a transition to retirement income streams (TRISs) and have not yet retired can land themselves in serious trouble where they fail to meet the minimum pension payments.

Where a client fails to make the minimum pension payments, the pension ceases for that income year and the withdrawn amounts become a lump sum, he explained.

Typically, most TRISs contain preserved money only, and it is only possible for a member to take preserved money as a lump sum once the member has retired, he said.

“If it is preserved money then effectively you have an early release on your hands,” warned Mr Butler.

Therefore, unless the member has an unrestricted non-preserved amount, the fund has contravened a very important operating standard and the ATO could decide to “apply the full force of the law”, he cautioned.

“[Consequently], the client could get slammed with fully assessable income, even though the money from the TRIS was tax-free,” he said.

“Not only that, but they could potentially get an admin penalty of $4,200, so that’s a hefty penalty. If the client doesn’t have a corporate trustee, then that penalty amount could be doubled or tripled depending on the number of members in the fund.”

Mr Butler said it is vital therefore that SMSF practitioners stress to their clients the serious consequences that can arise from failing to make the minimum pension payments for their TRIS, especially where the client hasn’t retired. 

 

Miranda Brownlee
26 October 2018
smsfadviser.com

ATO claws back $850m in unpaid SG in FY 17-18

Compliance activities undertaken by the ATO in the 2017-18 financial year saw the ATO raise around $850 million in unpaid super entitlements.

         

 

ATO deputy commissioner, superannuation, James O’Halloran said that during the 2017-18 financial year, the ATO received around 31,000 employee notifications and contacted approximately 24,000 employers.

“We also completed 19,000 employee-generated cases. Additionally, we initiated a further 13,000 SG audits and reviews based on our risk modelling. Total liabilities raised by this casework were approximately $850 million,” said Mr O’Halloran.

From the beginning of this financial year, Mr O’Halloran said the ATO has begun undertaking additional SG casework using the funding provided from the government for the SG Task Force.

“We’ve completed 537 cases and raised $22.8 million in liabilities, including $3 million in penalties,” he said.

“We’re on track to close over 2,600 cases, raising about $130 million in 2018–19.”

 

Miranda Brownlee
25 October 2018
smsfadviser.com

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