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Financial Planning

Majority of retirees expected to fall short on retirement savings

 

Recent research has revealed that more than half of retirees are projected to fall short of their desired retirement income level by more than 10 per cent, says Russell Investments.

 

       

In a recently released white paper, Russell Investments said analysis of the financial goals and financial circumstances of more than 8,000 Australian superannuation members indicates that 64 per cent of the participants were projected to fall short of their desired income by more than 10 per cent.

“Our analysis also uncovers a second, poorly understood issue. The potential for overfunding — unintentionally saving more than needed,” it stated.

“Over one in 10 participants were projected to exceed their goal by more than 10 per cent, sacrificing spending now to achieve a future retirement income well above what they want.”

Based on the analysis, around 32 per cent were either on track or slightly above in terms of their projected retirement outcomes.

The research found that optimising contributions at the personal level can play a significant role in closing the retirement gap.

The research demonstrated that if individuals contributed 5 per cent of their salary in additional contributions when tracking behind, the analysis shows the proportion of members on track to their goal would increase by more than half.

The analysis also indicated that around one in five participants has little understanding of super and how their retirement savings were tracking.

“When asked whether respondents were aiming for a specific retirement goal, 21 per cent indicated they didn’t know or hadn’t thought about it,” the white paper said.

“This proportion of disengaged respondents was similar when asked whether their current super balance was ahead of, on track to, or behind where it needs to be to fund their retirement, with 16 per cent of respondents indicating they didn’t know or were unsure.”

The white paper also indicated that increasing growth allocations earlier in life, and more precisely reducing growth allocations when approaching retirement, can increase the projected retirement income for more than two out of every three people, while simultaneously reducing the impact of a significant market event later in life.

“In addition, by incorporating the individual’s desired income, asset allocation can be further optimised to reduce the chance of falling short. For example, if an investor is on track to their retirement income goal, but not above, a more defensive growth allocation can help ensure they don’t fall below their target income,” it said.

In line with the release of the research, Russell Investments has also launched a goals-based superannuation solution which uses proprietary algorithms to make it possible for every Australian to access a tailored investment strategy based on their unique circumstances and retirement income goals.

Russell Investments managing director, Australia, Jodie Hampshire said that while the Australian retirement system is considered among the best in the world, policymakers continue to debate how to improve the Australian system.

“Our analysis shows that optimising asset allocations and contributions at the personal level can form a substantial part of the solution,” Ms Hampshire said.

The GoalTracker solution factors in up to 10 individual data points, including a person’s age, super balance, salary plus capital market forecasts, to determine how each member is tracking towards their retirement income goal and to set up a customised asset allocation to ensure they have the best chance of reaching that goal.

 

 

Reporter
29 October 2020
smsfadviser.com

 

What millennials are thinking about investing and retirement

Vanguard surveyed more than 850 millennials in the U.S. currently aged 24 to 39, who make at least US$50,000 per year, as part of a broader study on how people across different generations feel about retirement, investing, and financial advice during market volatility.

           

In just over two months from now, the oldest millennials will be turning 40.

It's an interesting milestone in the sense that parts of what some still refer to as the “younger generation” are not so young anymore.

In fact, many older millennials may have already been working for more than 20 years, as opposed to those at the bottom end of this generational cohort who are still aged in their early twenties.

The widely accepted age definition for millennials (also known as Gen Ys) covers people born between 1981 and 1996, making the youngest 24 years-old. Next year, they'll be turning 25.

Because of this wide age variance, there is likely to be a large variation in accumulated investment wealth across the millennials spectrum.

Where this all comes together from an investment perspective is in recent research conducted by Vanguard in the United States.

Vanguard surveyed more than 850 millennials in the U.S. currently aged 24 to 39, who make at least US$50,000 per year, as part of a broader study on how people across different generations feel about retirement, investing, and financial advice during market volatility.

The survey was active during May – the period when financial markets were staging a strong recovery after their sharp falls in February and March.

Views on investing

The events during the first quarter would have been the first experience for many millennials of a major correction on equity markets.

When describing their feelings towards investing at the time of the survey in May, almost half of millennials said they were cautious (46 per cent), and used words such as fearful (28 per cent), and sceptical (27 per cent).

This compared with before the COVID pandemic when millennials were understandably less cautious (32 per cent) and had a much higher leaning towards other words such as optimistic (29 per cent), and motivated (23 per cent).

That said, 74 per cent said they were interested in learning more about investing. That included 43 per cent who said they were somewhat interested, and 32 per cent who were very interested.

Vanguard's U.S. research ties in with the findings from the recently released 2020 ASX Australian Investor Study.

The ASX found that over the next few years the number of younger Australians actively investing will continue to rise. Intending investors have an average age of just 34, with 27 per cent aged under 25.

Among the “next generation investors”, as the ASX refers to them, 41 per cent list building a sustainable income stream as their top investment goal. Maximising capital growth was the next highest selection (25 per cent), followed by achieving a balance between capital growth and investment risk (16 per cent).

Views on retirement

On paper, the millennials generation is a long way from retirement.

But the reality is that a high percentage of millennials are actively thinking about retirement.

More than six in 10 U.S. millennials (61 per cent) said they plan to retire before age 65, and 22 per cent plan to retire before age 60.

According to the Australian Bureau of Statistics, the average retirement age in Australia is 55.4 years.

Nearly two-thirds (63 per cent) of those surveyed by Vanguard defined a successful retirement as being able to do what they want when they want.

That loosely fits in the Association of Superannuation Funds of Australia's “comfortable lifestyle” retirement standard, which factors in the ability to enjoy a good standard of living and make regular discretionary purchases.

ASFA's current budget calculations are that a single would need $43,687 a year to live a comfortable retirement lifestyle, and a couple $61,909 a year.

Almost 70 per cent of the U.S. millennials surveyed were confident they were putting away enough money to be financially secure in retirement.

However, once they reach retirement age, 39 per cent said they intended to pursue a new career at “retirement”, and 35 per cent planned to start a business.

The top reason for planning to continue to work was “to stay active and alert” (50 per cent), followed by “I enjoy what I do” (46 per cent), and “to have a sense of purpose” (43 per cent).

Conclusion

There's no doubt that when it comes to both investing and retirement, there's a lot of diversity across the millennials generation.

Older millennials, certainly in some cases, will be actively thinking about retirement already because they may even be considering retiring within the next 20 years.

Many will already own a home, have a family, and will have had the benefit of close to two decades of accumulated investment returns.

Younger millennials, on the other hand, may only be taking the first steps in their career, have limited assets, and have different investment objectives to their millennial elders.

Yet there are likely to be many commonalities, especially given the fact that almost three-quarters of the U.S. survey respondents, covering millennials of varied ages, said they were keen to learn more about investing.

In Australia, that relates back to around 70 per cent of next generation investors wanting to build sustainable income and maximise capital growth.

Yet, irrespective of generation, the fundamental principles around investing remain the same.

They revolve around setting appropriate investment goals that are measurable and attainable; having a well-diversified asset allocation strategy; controlling investment costs to maximise returns; and maintaining perspective with patience and discipline, regardless of short-term events.

 

 

Tony Kaye
Senior Personal Finance Writer
27 Oct, 2020
vanguardinvestments.com.au

 

Monitoring super performance critical in light of new measures

While the government has announced plans to increase governance over the performance of super funds, super members will still need to actively monitor the performance of their fund to avoid being stapled to an underperforming one, says a mid-tier firm.

         

As part of its Your Future, Your Super package, the government revealed plans in the federal budget to staple existing superannuation accounts to a member in order to avoid the creation of a new account when the person changes their employment.

BDO partner, audit and assurance, James Dixon said placing an obligation on super funds to align performance with members’ best interests and ensure their members’ retirement savings are maximised is good news.

“All superannuation investment vehicles — whether they are a self-managed superannuation fund, a retail fund or an industry fund — should be on a level playing field when it comes to transparency and governance. Ensuring the needs of members are front and centre should remain the end game,” Mr Dixon said.

However, Mr Dixon noted that as with many announcements of this nature in the past, the devil is in the detail.

“Developing an appropriate benchmark to measure fund performance against will be key to this proposal,” he said.

“It must balance the need for short-term reporting transparency against the need for funds to invest for their members’ benefit. The metrics used to determine the benchmark itself must also be carefully considered, with a wide range of market, fund and investor factors that should be taken into account.”

He also stressed that despite this increase in government, Australian workers will need to actively monitor the performance of their super fund to avoid being stapled to an underperforming fund.

“APRA may eventually take action against an underperforming fund, but many factors influence whether a member should switch funds before that time,” Mr Dixon said.

Mr Dixon said super members may want to have a discussion with their planner or wealth adviser about their personal risk profile and the composition of the fund’s investments and their diversification, liquidity and any other factors that determine retirement goals.

 

 

Miranda Brownlee
22 October 2020
smsfadviser.com

 

Comprehensive list of COVID-19 initiatives and packages.

 

The response by our Governments to the COVID-19 crisis has been a very good one.  Following is a comprehensive listing of links to important Federal and State initiatives and programs since the pandemic began.

 

         

Please click on the following links to access a wide range of Covid-19 related updates, initiatives, guidelines and resources from both Federal and State Governments.

Recent Updates:

 

Previous Updates:

  • Articles and Updates in other Latest News articles including:
    • Stage 3 – Covid-19 $1.1billion Domestic Violence, Medicare and Mental Health.
    • Stage 2 – Covid-19 – $66 billion stimulus package.
    • Stage 1 – Covid-19 Update – Small Business
    • Stage 1 – PM launches $17.6 billion virus stimulus plan

Capital preservation front of mind for SMSF returns

 

SMSF investors will increasingly be attracted to investments offering capital preservation post-COVID, with volatile markets and lower dividends compromising their ability to meet investment objectives, according to an asset manager.

 

         

SMSF investors will be placing a premium on preserving their capital in the next few years, with many investors no longer enjoying the tailwinds of strong equity markets that they did in the last decade.

Cor Capital managing director David Hood said the investment environment, both domestically and globally, is high risk, whether it’s assessed from a geopolitical, economic or health viewpoint.

“Although that’s the investment reality, it’s not reflected in the pricing of risk assets. But that day of reckoning must come – the markets can’t continue to defy economic reality forever,” he warned.

“SMSFs will not be immune to any market correction of risk assets. In fact, many will be particularly vulnerable for several reasons.”

The difficulty in obtaining advice, for example, due to its rising cost and the exodus of advisers from the industry and misplaced confidence in investment decisions are two of the factors placing SMSF returns at risk, he said.

“Further, in the past decade, and despite historically low interest rates in recent years, these SMSFs have been protected by their investment in fully franked ASX that have provided capital growth and healthy dividend income,” he explained.

“It’s our contention that investors should not expect a similar performance from equity markets in the coming decade, and that dividend income is also likely to be constrained, at least for the next few years.”

Mr Hood said the combination of weaker, and, just as importantly, more volatile markets for risk assets, and lower dividend returns, will be compounded by investors often failing to be able to articulate long-term investment strategies and stick to them.

With SMSFs looking for alternative ways of generating growth and income while preserving capital, there will be a growing appreciation of the need to find fund managers that can achieve these objectives without the need for high level of complexity or costs, he said.

“After the GFC, SMSFs increasingly shied away from fund managers that had failed to deliver during that crash and charged high fees for the privilege of doing so, with the bull market in equities in the past decade rewarding that strategy,” he stated.

“But in the wake of the COVID-induced recession, they may no longer have that luxury if analysts are correct in predicting much lower returns in the next decade, opening the door for fund managers with investment strategies that aim to protect their capital, maintain purchasing power and provide alternative sources of return not tied to high allocations to equities.”

 

Miranda Brownlee
21 October 2020
smsfadviser.com

 

Related party purchases must be clean

 

Trustees must ensure any purchase from a related party is not a proxy for a loan or financial assistance to avoid breaching their obligations.

 

         

SMSF trustees making purchases of business real property from a related party for inclusion in their fund need to ensure the transaction is not a proxy for a loan to a member to avoid breaching trustee obligations, a technical expert has warned.

Colonial First State head of technical services Craig Day said SMSF trustees could make certain purchases from a related party, but any transaction had to be carried out at market value and without any obligations attached.

“There is a need to watch out for financial assistance because a fund is prohibited from lending money or providing any form of financial assistance to a member or a relative of a member,” Day said during a session on the use of lumpy assets in an SMSF at the recent Tax Institute National Superannuation Online Conference.

“Financial assistance includes a wide range of circumstances and can include any security, obligation or lien over fund assets that provides financial assistance to a member where it relies upon assets of the fund.”

He said it did not matter if the assets of the SMSF were impacted or not, but rather as soon as a member, or a relative of a member, relies on the assets to get financial assistance it was a breach of section 65 of the Superannuation Industry (Supervision) Act.

Any form of financing arrangements would also create a breach as an SMSF member cannot provide any sort of assistance that would constitute or look like the provision of finance to a member or a relative of a member, he said.

“An example that has been given of this is where a member owns commercial property and sells it into their SMSF, and uses the capital released to invest into their business and then later arranges to buy the business real property back off the fund in the way that would constitute the repayment of a loan,” he said.

“Most people would never do this because of the transaction costs involved, but if someone is desperate for investment, but can’t get a bank loan, then you do see these types of arrangements, and it is financial assistance and it breaches section 65.”

 

 

Jason Spits
October 26, 2020
smsfmagazine.com.au

 

How your coming tax cut could pay off

 

Over the coming weeks, around 12 million working Australians will start receiving extra cash in their pay packets as a result of changes to personal income tax brackets announced by the federal government.

 

         
Over the coming weeks, around 12 million working Australians will start receiving extra cash in their pay packets.
 
It's an artificial pay rise that's largely come about from changes to personal income tax brackets that were announced by the federal government in the 6 October budget.
 
By lifting tax bracket thresholds, more Australians will now be paying less overall tax.
 
As shown in the table below, most individuals will receive a tax cut of between $1,060 and $2,745 per year, depending on their taxable income. The individual tax savings equate to between about $20 and almost $53 per week more in after-tax cash income.
 
And because the start of the new tax scale has been backdated to 1 July this year, workers also will receive a one-off lump sum amount for the higher income tax rates paid since the beginning of this financial year after they lodge their 2020-21 annual tax return.
 
Working couples, of course, will receive a double benefit in terms of more combined weekly income and two backdated lump sum payments.
 

Tax relief by taxable income, 2020-21 compared with 2017-18 2017-18 2020-21

2017-18 2020-21
Taxable income $ Tax liability $ Tax liability $ Change in tax $ Change in tax %
40,000 4,947 3,887 -1,060 -21.4
60,000 12,147 9,987 -2,160 -17.8
80,000 19,147 16,987 -2,160 -11.3
100,000 26,632 24,187 -2,445 -9.2
120,000 34,432 31,687 -2,745 -8.0
140,000 42,232 39,667 -2,565 -6.1
160,000 50,032 47,467 -2,565 -5.1
180,000 57,832 55,267 -2,565 -4.4
200,000 67,232 64,667 -2,565 -3.8

Source: Commonwealth Government. Actual outcomes for individuals and households may differ.

 
In announcing its tax changes, the government noted the measures will support Australia's economic recovery by giving individuals and families more immediate money to spend on what they need.
 
Yet, depending on personal circumstances, it also may be worthwhile considering whether some or all of the new tax windfall can be used as part of a longer-term wealth building strategy.
 

A tax cut compounding strategy

 
Scientist Albert Einstein famously described compound interest as “the eighth wonder of the world”.
 
Why? Einstein rightly calculated that any savings balance will grow significantly over time when interest payments are added. As an initial balance increases, so does the size of the interest payments made because they are applied to the higher savings balance amount.
 
As such, even a small weekly deposit amount will steadily add up over time when combined with compounding investment returns on the growing savings balance.
 
As noted above, a person on a taxable income of $40,000 per year will now be receiving an extra $1,060 a year in take-home pay as a result of the government's announced tax changes. This works out to $20.40 per week. Someone on a taxable income of $120,000 will receive an extra $52.79 per week.
 
The table below incorporates the announced tax savings and shows how regular deposits can add up over time with the benefit of compounding returns.
 
The numbers are based on a hypothetical starting balance of $5,000 and are calculated using an annual return of 8 per cent.
 
This largely matches the 7.9 per cent actual annualised total return from the top 300 companies listed on the Australian share market over the last 10 years.
 
To simulate the effect of compound interest, the total return assumes than an investor had reinvested all of the company dividends that were paid since 2010 back into the Australian share market.
 
This would have been possible using either an Australian share market managed fund or exchange traded fund (ETF) offering a dividend reinvestment program (DRP) option. In this way, whenever dividend distributions are paid, they are converted into additional fund units.
 

Using the tax savings to achieve compound growth

Extra cash per year Extra cash per week (rounded) Total deposits Total interest earned Total savings
$1,060 $20 $10,400 $11,554 $26,954
$2,160 $42 $21,840 $17,554 $44,394
$2,445 $47 $24,440 $18,918 $48,358
$2,565 $49 $25,480 $19,464 $49,944
$2,745 $53 $27,560 $20,555 $53,115

Source: Vanguard.

 
The annualised 8 per cent return number used in the calculations is for illustration purposes only. Past investment performance should never be seen as an indicator of future performance.
 
However, the long-term positive effect of compound growth would still apply on lower annualised returns.
 

A superannuation angle

 
Investing the new tax savings directly is one option, but individuals also may want to consider channelling their higher after-tax income into their superannuation account.
 
It's now possible to make after-tax payments into a superannuation fund, up to the annual allowable $25,000 concessional limit, and then claim a 15 per cent tax refund deduction in the next year's tax return.
 
That's because superannuation payments are generally paid from one's salary using pre-tax income, and are concessionally taxed at 15 per cent.
 
In a practical sense, what that means is that individuals can use the new tax cuts to claim an additional 15 per cent deduction by directing their after-tax income into superannuation.
 
Done over an extended period of time, such a strategy will have the same benefits of compounding returns as someone investing outside of superannuation, but have the extra benefit of being able to claim a tax deduction – which also could be reinvested.
 
Conclusion
How the new tax cuts are spent, or invested, is absolutely an individual choice – and probably a joint decision for most couples.
 
Used as part of a disciplined, low cost and diversified long-term investment strategy, however, the benefits of making regular deposits and leveraging compounding returns are clear.
 
Before making any investment decision, it may be worthwhile to consult with a licensed financial adviser.
 
 
 
Tony Kaye
Senior Personal Finance Writer
04 Nov, 2020
vanguardinvestments.com.au
 

Most SMSFs are still poorly diversified

 

Data only just released by the Australian Tax Office, detailing the asset allocations for all SMSFs in the quarter to the end of June, shows there was still a large investment weighting at that time towards cash and term deposits.

 

         
From its COVID-inspired low point in late March, the Australian share market – as measured by the performance of the S&P/ASX 300 Index – has surged more than 40 per cent.
 
It's an impressive rebound in such a short period of time, delivering strong returns to equity investors, especially to those who have broad exposure to the Australian share market through low-cost index-tracking exchange traded funds (ETF) and managed funds.
 
But it seems many of Australia's roughly 600,000 self-managed super funds (SMSFs), covering more than 1.1 million members, have failed to capitalise on the share market's robust growth.
 
Data only just released by the Australian Tax Office, detailing the asset allocations for all SMSFs in the quarter to the end of June, shows there was still a large investment weighting at that time towards cash and term deposits.
 
In fact, cash still remains the second-biggest holding for SMSFs behind ASX-listed shares.
 
At 30 June 2020 SMSF trustees were holding around $191.5 billion in Australian shares and $156.3 billion in cash, representing 26.1 per cent and 21.3 per cent respectively of the $705.4 billion in total SMSF assets.
 
Total SMSF cash holdings were largely unchanged on the March quarter number of $156.6 billion.
 
While the value of holdings in Australian shares at the end of June was actually up considerably on the $165.3 billion total value at the end of the March quarter, that's largely explained by the 16.5 per cent rise on the local share market between 1 April and 30 June.
 
By contrast, the average returns from term deposit accounts were below 1 per cent in the June quarter, and remain so.
 

Small SMSFs have even more cash

 
The stubbornly high percentage of SMSF assets in low-yielding cash is even more evident in the ATO's data breakdown of asset distributions by fund size.
 
Its latest data has only recently been extracted, but relates to the 2018-19 financial year.
 
It shows that, on average, super funds with $1 million to $2 million had around 30 per cent of their total assets in Australian listed shares, and 23 per cent in cash and term deposits.
 
The next-largest holdings in this subset were unlisted trusts (10 per cent) and non-residential real property (8 per cent).
 
SMSFs with $500,000 to $1 million were holding around 25 per cent in listed shares and 24 per cent in cash.
 
Interestingly, the numbers started turning the other way in smaller SMSFs. Those with between $200,000 and $500,000 in assets were holding around 23 per cent in listed Australian shares and an even larger 29 per cent in cash.
 
The smaller the amount of assets, the higher amount of cash.
 
For SMSFs between $100,000 and $200,000, the average holdings were 23 per cent in Australian-listed shares and 42 per cent in cash. And, for funds holding between $50,000 and $100,000 in super assets, the numbers were 23 per cent in Australian-listed shares and 45 per cent in cash.
 

Lack of diversification

 
Another observation from the ATO's data is that many SMSFs are generally not well diversified into other major asset classes, including international equities and fixed interest.
 
Unlisted trusts, which by and large represent unitised unlisted property securities, are third-highest in terms of total SMSF assets, accounting for around $86 billion of capital (11.7 per cent).
 
Commercial properties account for more than $73 billion in SMSF assets.
 
Overseas shares, which accounted for $7.7 billion of total SMSF assets at the end of June, rank outside of the top 10.
 
The table below shows the top 10 holdings represent almost 100 per cent of the assets held by SMSFs.
 

Top 10 SMSF Asset Allocations at 30 June 2020

Asset class Amount ($m) % of total SMSF assets
Listed shares 191,464 26.1
Cash and term deposits 156,278 21.3
Unlisted trusts 85,752 11.7
Non-residential real property 73,493 10.0
Limited recourse borrowing arrangements 50,234 6.8
Listed trusts 43,330 5.9
Residential real property 39,100 5.3
Other managed investments 37,700 5.1
Other assets 19,352 2.6
Debt securities 11,525 1.6
Total 708,228 96.4

Source: Australian Tax Office

 

The ATO's crackdown on SMSF strategies

 
The overweighting by SMSF trustees into Australian shares, cash and illiquid assets such as property has been on the ATO's radar for some time.
 
In late February the SMSF regulator released new guidance for trustees around what should be detailed in their fund's written investment strategy.
 
The ATO specifically wants to know from trustees how the asset allocations they make from their super fund assets supports their investment approach towards achieving their retirement goals.
 
For funds with too much asset concentration risk, trustees must justify their lack of diversification and how they believe this will achieve their overall goals.
 

Taking a broader view

 
While share markets have rebounded since March, ongoing uncertainty over COVID, the US election and other situations will ensure equity markets remain volatile over the short-to-medium term.
 
At the same time record low interest rates will ensure ongoing poor yields from cash holdings, meaning those with large cash balances needing to generate income may need to consider other types of investment assets.
 
Diversification to offset risks across different asset classes is one of the key elements of every investment strategy.
 
The latest ATO asset allocation data once again illustrates that many SMSF trustees should be taking a broader investment approach.
 
It may be prudent for some SMSFs trustees, especially those with large cash balances earning near-zero per cent returns, to consider consulting a licensed financial adviser to discuss their investment strategy.
 
 
 

Tony Kaye
20 Oct, 2020
vanguardinvestments.com.au

 

Lenders are getting tougher on older borrowers

 

Australian banks this month started the largest ever customer contact program in the industry's history.

 

       

The mammoth program involves banks contacting more than 900,000 borrowers who have needed to defer making payments on their loans as a result of the COVID-19 pandemic.

Among them are hundreds of thousands of home loan borrowers around the nation with owner-occupied and investment property mortgages.

The first stage of this contact program coincides with the initial wave of six-month loan payment deferrals coming to an end, and will involve the assessment of around 80,000 mortgages by the end of September.

A further 180,000 customers with deferred mortgages will be contacted before the end of October, and the program will continue as the banks work through their customer lists to determine whether further payment deferrals are required.

In short, lenders are seeking to mitigate their potential loan defaults.

Tighter loan serviceability guidelines

But there's a lot more going on behind the lending scenes than immediately meets the eye.

Some of this is directly related to COVID-19, but there also have been developments that follow recent regulatory updates in responsible lending guidelines.

Following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, at the end of last year the Australian Securities and Investments Commission updated its guidelines for how it expects lenders to deal with borrowing applications.

Those updates are still filtering through the lending system.

In its detailed guidelines, ASIC outlines that lenders should specifically be noting whether there are “foreseeable reductions” to the amount or frequency of a loan applicant's income.

What the regulator means is that it wants lenders to pay particular attention to older borrower applicants who are at an age where the loan they are seeking would mature beyond their retirement age.

ASIC recommends that lenders should be proactively asking these applicants how they intend to pay off their loan.

“For example, if a consumer is approaching retirement, and will still be making repayments on the credit product after their expected retirement age, you will need to determine whether this event is likely to change their income, and information about the amount that is expected to be available,” ASIC states.

“And, if the income is of a kind that has a known end date which will occur during the term of the loan…you should have regard to the effect that change to income is likely to have on the consumer's overall financial situation.”

These are general lending guidelines, however what's changed in recent months is that some lenders have strengthened their loan serviceability criteria – especially in relation to home loans.

They've done this by instructing their internal loan managers and external mortgage brokers to ask borrowers approaching retirement age to document their actual loan exit strategy, including the age they intend to stop working.

One large bank has recently issued instructions that if a loan applicant is aged over 55 or intends to retire in the next 10 years, their application will need to include:

  1. “At least one co-applicant under the age of 55 or within 10 years of their intended retirement with “sufficient income to service the home loan at drawdown.
  2. “Evidence of financial assets worth at least 100 per cent of the loan limit; or
  3. “Evidence of a plan to downsize an owner-occupied home (with at least $200,000 in available equity at drawdown) once the applicant retires.”

Loan exit strategies to consider

ASIC's responsible lending guidelines state that borrowers should preferably be able to meet their payment obligations from income rather than from the sale of assets.

But the regulator recognises that may not always be possible post retirement, and that asset sales may be required to extinguish a loan.

One important point to note is that most lenders are unlikely to consider the future sale of your principal place of residence as an acceptable loan exit strategy.

However, the intended future sale of an investment property, or being able to gain access to equity in a property through an equity release facility such as a reverse mortgage, are likely to be considered as viable exit plans.

Other assets that lenders will take into account when assessing pre-retirement loan applications are superannuation (if it is sufficient to pay off the loan balance), and investments outside of super such as shares.

On the income level, lenders will consider any plans to continue earning income on a casual of part-time basis, rental income derived from investment property, and dividend income from shares.

The key for those close to retirement who may be contemplating borrowing money for a property or other investment purposes is to be prepared to answer some hard questions during the application process.

Having a well-defined loan exit strategy has become a much more important part of the lending process for older Australians.

 

 

Tony Kaye
Personal Finance Writer
15 September 2020
vanguardinvestments.com.au

 

How to construct an effective portfolio

 

Portfolio construction is always a popular topic among investors, but as markets become more volatile, the practice of carefully piecing together a jigsaw of investments that weathers both good times and bad is particularly relevant.

 

         

Effective portfolio construction is essential to successful investing, but many investors struggle to understand the underlying concepts, much less put them into practice.

Fortunately, constructing an investment portfolio that suits your needs and delivers your goals is simpler than it sounds.

The first step to effective portfolio construction is simply knowing what you want to achieve.

Every portfolio has a purpose. It might be to fund your retirement or to provide an inheritance for the children. It might be to pay for education or housing.

Understanding your purpose and setting a goal for your portfolio lets you plan for how much you need to invest and how long you have for your savings to grow.

Good portfolio goals are measurable, attainable and based on reasonable assumptions. That means they do not require impracticable savings targets, lucky breaks or unlikely investment outcomes.

Take the example of an investor who needs to save $1 million in today's dollars to comfortably retire and has 40 years of working life left to do it.

If that investor makes a $10,000 deposit today and saves the same inflation-adjusted amount every year for the 40 years, the real required rate of return from the portfolio only needs to be an achievable 4 per cent per year.

The portfolio construction process begins with this kind of plan.

From there, the next decision is to select the assets that will deliver the required 4 per cent return without exposing the investor to needless risk.

There are three main asset classes for investors to consider: equities, fixed income and cash.

There is also a wide range of sub-groups like real estate, infrastructure and commodities, but most diversified investors will have exposure to them through the equities asset class.

Asset classes are best understood by the way they typically perform in terms of risk and return.

Equities, or shares in stock market-listed companies, are characterised by demonstrating the highest historical return of the three, but with an associated higher risk of loss.

Fixed income investments like government and corporate bonds tend to provide lower returns but come with lower risk of losing money.

Finally, cash provides both low return and very low risk and protects you from the risk of being forced to sell other assets, but its value is continually eaten away by inflation.

So how do investors balance the three?

The aim is to find a way to deliver enough return to achieve the goal while minimising the risk of permanently losing capital on the way.

This concept of risk is worth exploring. Many investors conflate risk with volatility but for a regular investor with a defined goal, a better definition of risk is the chance of losing money at the very point you need it.

A period of negative returns in the market – as we are likely to see in the coming years – may not be a risk for someone willing to wait until the market recovers, thereby avoiding selling during the downturn.

But if another investor needs the money and has to sell at lower prices, that becomes a permanent loss of capital – the definition of risk.

This risk of permanent loss is why younger people can comfortably take more risk in their investments – and thus aim for a higher return – than someone nearer retirement.

A 35-year-old has at least 30 years of earning income ahead of them, allowing market downturns to run their course. Their income covers their living expenses, so they don't need to withdraw investments at depressed prices, and they even get more assets for every dollar they invest during the downturn. This means they can lean towards equities which offer higher returns at higher risk.

Someone in their 50s has 15 years left of income to recover losses and might choose to take slightly less risk in their investments by reducing their equity holdings.

A retired person has no easy way to add to their investments so if they are forced to withdraw at depressed prices, they suffer permanent loss. In retirement, an even more conservative portfolio might be suitable.

For all investors, constructing a diversified portfolio spread across the three asset classes is the best way to reduce the risk of permanently losing money.

Asset allocation is a surprisingly powerful tool.

Repeated studies show that the vast majority of variability in portfolio returns is explained by asset allocation rather than stock selection or market timing.

So, by simply selecting an asset class mix that suits your risk and return needs – and then buying a widely diversified bundle of investments matching that mix – most of the work of portfolio construction is done with no need to worry about individual investments at all.

Contrast this kind of steady, planned, top-down approach with the bottom-up, investment-collecting approach many investors take.

By buying individual stocks and funds without giving thought to the overall portfolio construction, investors are introducing unnecessary risk to their investments and crimping potential returns.

Portfolios built this way often show concentration in an industry or sector and are prone to being buffeted by volatility and attempts at market timing.

A well-constructed portfolio should also diversify by holding assets across a variety of countries, sectors and industries. Investors may even want to consider a mix of investment styles by holding active managers alongside index funds.

By holding hundreds or thousands of individual securities, the chances of any one of them affecting total returns is minimised.

The next factor to consider is fees. One of the best predictors of the future performance of an investment is the fee it charges. Some find it surprising, but the cheaper the fee, the better the performance. This is because the less you pay in costs, the more of an investment's return you get to keep.

Minimising costs is a crucial part of portfolio construction.

And finally, once the portfolio is in place, the critical trick is to stay the course.

Too many investors have been provoked by market swings to buy and sell at the wrong time, driven by fear or impulse.

A disciplined, long-term approach – rebalancing from time to time to stay within a chosen asset allocation and adjusting the risk profile as you age – gives you the best chance of achieving your goal.

 

Robin Bowerman
Head of Corporate Affairs at Vanguard
vanguardinvestments.com.au

 

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