Record low interest rates are making it harder for your money to keep pace with the rate of inflation. While it may be a struggle to grow your wealth in such an environment, low interest rates do mean that it is cheaper to borrow.
So why not take advantage of this opportunity by borrowing money to invest in growth assets such as shares or property? Gearing (borrowing) can be a great way to fast-track wealth creation although it must be remembered that it is a double-edged sword. While using borrowed money magnifies profits, it also magnifies losses. However, by borrowing sensibly and cautiously, and investing in quality assets, the benefits can outweigh the risks.
As well as boosting your returns, there are also tax advantages because you can offset interest paid on your loan against your income.
What are your options?
There are a number of ways you can borrow to invest including home equity loans, margin lending, warrants and internally geared managed funds. Each has its pros and cons so it is wise to get professional advice.
Home equity loans
As the name implies, home equity loans let you borrow against the equity you have built up in your home by using a redraw facility or an additional line of credit.
This method of borrowing is relatively cheap to service as you are only paying mortgage rates of interest. The downside is that you put up your home as collateral.
The second method is via a margin loan where you typically borrow somewhere between 30 to 50 per cent of the value of an asset. The lender will stipulate the maximum you can borrow, called the loan to value ratio (LVR).
If markets fall, your LVR will rise and if it rises above a certain level you have to pay extra money to rebalance your borrowing. This is called a margin call and may be requested at short notice, forcing you to sell some of the investment quickly (and at a bad time) to meet the call.
Warrants add leverage
Warrants, which are traded on the Australian Securities Exchange, give you exposure to an underlying asset for a portion of the price without the need for margin calls.
As a result, a warrant gives you leverage which means small changes in the value of the underlying asset result in larger changes in the value of the warrant. This magnifies gains and losses.
There are many types of warrants, each offering a different level of risk and leverage. Warrants can be on individual shares or on exchange traded funds which offer greater diversification.
The maximum you can lose is the amount you paid for the warrant. As the borrowing is non-recourse, you can walk away and only be liable for the loan.
Gearing made simple
The simplest alternative is to let a professional handle the borrowing for you with an internally-geared managed fund. The advantage here is that you don’t need to take out a loan yourself, risk your home as collateral or face a margin call.
Such funds are for investors seeking capital growth rather than income and should be viewed as a long-term investment as the funds are generally more volatile than the sharemarket in the short term.
You can also gear up your selfmanaged super fund with a limited recourse loan. The rules are complex so it is vital that you receive the right advice to make sure you comply with superannuation laws.
By adopting a borrowing strategy that aligns with your risk profile, you can turn today’s low interest rates into tomorrow’s gains.
Owning your own home has long been the Australian dream but after years of strong house price growth it’s becoming less of a reality for many. This has major implications for retirement planning.
The major factor behind the shifting approach to home ownership is the prohibitive price of property, particularly in Sydney and Melbourne. As a result, today’s younger generations may be close to 40 before they take their first step on the property ladder.
It’s sometimes argued that renting can be just as wise as owning. Advocates say you can invest the money you save through not paying rates, meeting the costs of maintenance or interest on loans. But this strategy can prove a problem in retirement.
Owning your own home is often viewed as the fourth pillar of our retirement support system, with the other three being superannuation, savings and the aged pension.
Increase in mortgage debt
In the past, it was assumed that most people will own their own home outright and be mortgage free by the time they retire. Accordingly, the burden of paying rent or loan repayments is generally not taken into consideration in assessing the cost of living in retirement.
But in recent years there has been an increase in the numbers of retirees holding mortgage debt. In fact, 9.7 per cent of people aged over 65 had mortgage debt in 2013-14 compared with just 3.9 per cent in 1995-96.i
More significantly, the number of people aged 55-64 with an outstanding mortgage debt had jumped 29 per cent from the level in 1995-96 to 44.5 per cent in 2013-14.i It’s safe to assume that many people in this age group will still be in debt once they reach retirement.
Some of this increase in mortgage debt can be put down to the rising cost of housing. An additional factor is the increasing divorce rate which means people can find themselves in the uncomfortable position of starting anew in the housing market later in life.
Cost of housing
If you choose the rental path, you could struggle in retirement as rent can take up an increasing amount of your available income.
In the past, well over half of renting retirees were in public housing, but that figure has dropped to less than 40 per cent due to reduced availability of public housing.(i) This has implications for retirement incomes.
Today, tenants aged 65 or over renting from private landlords spend 35 per cent of their income on housing costs.(i) Anything more than 30 per cent is regarded as being in ‘housing stress’.
Looking at housing figures overall, including those who rent as well as own, 22 per cent of all retirees spent more than 25 per cent of their income on housing in 2013-14, this number has been steadily rising over time.(i)
Advantages of home ownership
One of the advantages of owning your own home outright in retirement is that you can always draw on the capital if necessary either by way of a reverse mortgage or taking out a loan using your home as collateral.
Another plus is that you have an asset to pass on to the next generation. Although for many baby boomers, passing on wealth is no longer a key focus. In fact, many prefer to use some of their savings to help their children get a foothold in the housing market.
A COTA50+ survey found that around 40 per cent of self-funded retirees have helped their children or grandchildren fund a deposit for a home.(ii)
For those who have the funds, this can be a good strategy. However, you do need to be mindful of leaving yourself short in retirement by passing on too much of your money too early. And if you are already retired and receiving an aged pension, then you will be limited to gifting your children no more than $30,000 over a rolling five-year period.
Housing affordability is becoming an issue for Australians at both ends of the age spectrum. That’s why it’s a good idea to have a talk with us to discuss your retirement housing and income needs.
i ‘No place like home’, prepared by Saul Eslake for AIST, March 2017, http://www.aist.asn.au/media/20734/AIST_Housing%20affordability%20and%20retirement%20incomes_FINAL%2021032017.pdf
It’s been a decade since the market crash known as the Global Financial Crisis rocked the investment world. At the time investors could only watch in disbelief as 50 per cent was wiped off the value of their shares. Arguably, the actions those investors took are still reverberating today. Which begs the question: what are the key lessons of the GFC and did we pay attention?
Predictably, there were warning signs before the eventual market crash. Just as predictably, no-one could predict the exact timing or the magnitude of the crash.
Ground zero of the GFC was in middle America. A lengthy period of low interest rates and poor home lending practices left homeowners vulnerable when rates began to rise and house prices fell below the amount they owed the banks. When whole neighbourhoods walked away from their homes and their debts, the liability shifted to the banks.
Compounding the housing bust was the proliferation of new financial products that packaged up sub-prime loans along with higher quality debt and sold them on to global investors. These derivative products with names like collateralised debt obligations (CDOs) were sold as cutting edge but few investors understood the risks.
When in 2007 investors tried to dump their CDOs the investment banks that issued them were unable to finance redemptions. The crisis led to a credit crunch and the eventual collapse of major investment firms like Bear Stearns and Lehmann Bros.
The shock impacted markets around the globe. The Australian sharemarket followed Wall Street, falling around 50 per cent from its peak in November 2007 until it hit rock bottom in March 2009.
What lessons did we learn?
Ten years is a long time on global markets. The US sharemarket is experiencing its second-longest bull run in history – eight years and still going strong. Australian shares have also had eight good years, although prices are still below the 2007 peak. All of which makes this a good time to ask if investors still remember the lessons of the GFC. Judging by a recent investor survey by Deloitte Access Economics for the ASX, it could be time for a refresher. (i)
Overall, 21 per cent of investors said they had little tolerance for risk but still expect annual returns of 10 per cent plus. Worryingly, less than half have diversified portfolios. But the real surprise was that older investors who lived through the GFC were less risk averse than younger investors who have no direct experience of a market crash.
Be aware of market cycles
Perhaps older investors have learned what goes down comes back up, albeit with some twists and turns along the way. Time in the market also makes investors aware that one year’s best performing asset class can be next year’s worst. The best way to avoid timing the market is to have a diversified portfolio and ride out the short-term volatility.
These lessons were borne out recently when Vanguard looked at the outcome for three investors with a diversified investment portfolio of 50 per cent shares and 50 per cent bonds when the GFC hit.(ii) When the market bottomed in March 2009 one sold the lot and switched to cash. One sold all their shares and put the money into bonds. And one stayed put in a balanced portfolio.
Fast forward to 2016 and the investor who fled to cash was sitting on a cumulative return of 27 per cent. The investor who put everything in bonds had a return of 71 per cent. But the investor who sat tight with a mix of shares and bonds enjoyed the best return of 93 per cent.
While each boom and bust cycle is slightly different, investors who understand the trade-off between risk and return, hold a diversified portfolio and stay the course are best placed to ride out market cycles for long-term success.
i ASX Australian Investor Study 2017 by Deloitte Access Economics
ii ‘Lessons from the GFC 10 years on’ by Robin Bowerman, 4 October 2017
Australians are living longer than ever before and accumulating more wealth in the process. Chances are you not only hope to enjoy your nest egg while you are alive but also to make sure that what remains when you die is distributed according to your wishes. To do that you need an estate plan with an up-to-date will.
An estate plan involves making appropriate financial and legal arrangements to pass on everything you own when you die. This might include the family home, superannuation, life insurance, investments, a business and personal items.
Dying without a valid will means dying intestate and this can create unintended financial and emotional stress for your family. A will may be invalid if it is poorly drafted or the legal rules have not been followed.
When this happens, debts are paid from the assets in your estate and the remainder is distributed according to a pre-determined formula. As a result, some people may receive more or less than you intended and your estate could be eaten away by unnecessary taxes and legal costs.
It is estimated that as many as 60 per cent of people die intestate and, of the 40 per cent who do have a will, many aren’t sure where it is located, or whether it is validi.
Just like a financial plan, a will needs to be reviewed and updated when your circumstances change, such as with the birth of a child or a divorce. It needs to be signed and witnessed in the correct way and kept in a safe place.
It is a good idea to leave a copy of your will with your solicitor or the executor of your estate so the family are not forced to search the house for it when you die.
A helping hand
The best way to make sure all your affairs are in order is to establish an estate plan with the help of a solicitor. A will is a good starting point, but it should not end there.
Now that we are living longer it is increasingly necessary to have measures in place in case we become mentally or physically unable to cope.
Giving a trusted relative or friend an enduring power of attorney gives them legal authority to look after your financial affairs.
A medical enduring power of attorney authorises a person to make healthcare decisions for you if you no longer have the capacity to do so. An enduring power of guardianship authorises someone to make personal and lifestyle decisions for you if you become mentally incompetent.
Superannuation and Insurance
You also need to take estate planning into account when you invest because issues such as tax and ownership structure can have far-reaching effects beyond the grave. For example, many people are not aware that superannuation and life insurance (whether held inside super or outside) are not covered by a will.
Your financial adviser can work collaboratively with your solicitor to ensure that all your assets are distributed to the people you nominate in the most tax efficient manner.
In the case of superannuation, it may be possible to make a binding death benefit nomination. This allows you to leave your superannuation to the people you have nominated, including your estate. Where it is paid to your estate it will then be distributed according to your will.
The best way of ensuring your all your assets are preserved and end up in the hands of the people you love most is to seek help from a trusted professional. Not only is this the legally and financially wise thing to do, it is a final act of kindness to your family at what can be a very stressful time.
They are marketed as being the optimum lifestyle choice for recent retirees, often in ideal locations with all the facilities for a stress-free lifestyle. But with complex fee structures and inconsistent regulation, retirement village living should be approached with caution.
Before becoming emotionally attached to the idea of living next to a golf course or an ocean, or the prospect of no more home maintenance, consider how long you are going to be able to enjoy all the lifestyle options and whether you can afford it.
Affordability is impacted by the way operators build into a contract the cost of living in a village, by way of recurrent charges, and the cost when it comes time to sell.
The retirement village sector is complicated further by each State and Territory having its own legislation.
For these reasons reading and understanding any retirement village contract – which may be as long as 100 pages or more – is a must. And so is professional advice.
Understanding the contract
There are three main contract and finance models used by the country’s estimated 2000 retirement villages: outright ownership which gives the unit owner a title over the unit; the loan licence model, where the bulk of the ingoing contribution is set up as a loan to a village operator in return for a licence to occupy the unit, and a traditional lease.i
In each case there is an ingoing contribution, often similar to the cost of buying the unit (if this was possible). A departure or exit fee will be based on the length of time someone lives in the unit.
Operators also charge weekly, fortnightly or monthly fees, called recurrent charges, which cover the day-to-day operating costs of the village and which may or may not include rates, water, electricity, maintenance of common areas and staffing costs.
Depending on the legal structure, residents may or may not share in any capital gain in the value of the unit when they leave the property. A resident can also be asked to contribute towards the refurbishment of their unit before it’s sold.
Calculating departure fees
Departure or exit fees are unique to the retirement village sector and require particular scrutiny by a professional who understands the sector.i
The calculation is commonly a percentage paid per year of residency, and is usually capped somewhere between 30 and 38 per cent. The cap is generally reached after 10 years. The departure fee may be calculated on the ingoing cost that the resident paid, or the amount the unit is sold for when the resident leaves. The calculation method can vary between providers and within a village.
The Retirement Living Council says the departure fee helps to compensate the village owner for the cost of building the village and allows the resident to part-pay for this at the end of their residency rather than the start.
It can also be designed to give prospective residents a choice of whether they pay a full market price for the unit when they move in or defer some of the payment until they leave.
Make sure you
- Understand the contract and have it reviewed by a professional
- Know something about the operator and their experience
- Know how village budgets are presented
- Know how the operator reacts to residents who query how money is being spent
- Are happy with how the residents’ committee works
Looking for lifestyle benefits
Financial considerations aside, there is real value to be had from retirement village living. Many residents enjoy the benefits of being part of a community, living independently but with some additional support, activities and social interaction. The financial benefits are dependent on the finance model and the market.
While the primary reason for entering a retirement village is often lifestyle choice, it’s important to understand where the value lies in making that choice. If you would like to discuss your retirement planning, give us a call.
One of the golden rules of investing is diversification, but that can be difficult to achieve when you are just starting out or have limited funds to tap into a world of opportunities. Which is why investors have been flocking to exchange-traded funds (ETFs) and listed investment companies (LICs).
ETFs and LICs are like managed funds in that your money is pooled with other investors to create a large portfolio of assets which is professionally managed. Not only do they provide diversification, but they can be bought and sold on the Australian Securities Exchange (ASX) as easily as shares and have lower fees than traditional managed funds.
In the six years to July, the market value of LICs has more than doubled from $16 billion to almost $34 billion. In the past year alone there have been 11 new listings, taking the total to 101.(i) ETFs have also grown strongly. There are now 212 exchange traded products (ETPs) on the ASX, including ETFs. From a standing start 15 years ago, ETFs have a market value today of about $31 billion.(ii)
Yet despite their popularity, there is confusion about the technical differences between these products.
What are LICs and ETFs?
LICs are the great grandfathers of the listed managed investment scene, with a history going back almost 100 years. Trailblazers such as the Australian Foundation Investment Company (AFIC) and Argo Investments have provided investors with steady returns for decades, mostly from a portfolio of Australian shares selected by the fund manager.
While Australian shares still account for 83 per cent of total LIC assets, these days 16 per cent are in global equites through well-known fund managers such as Platinum. Newer LICs also offer exposure to micro-caps, infrastructure, private equity and absolute return funds.
By contrast, ETFs invest in a basket of shares or other investments that generally track the performance of a market index. You can buy an ETF to give you exposure to an entire market, region or market sector such as global health or technology stocks. They also offer investments in a wider range of asset classes, from local and international shares to bonds, commodities, currency, listed property and cash.
Structure and tax
As the name suggests, LICs use a company structure while ETFs are unit trusts.
Like other companies, LICs are governed by the Corporations Act. They pay company tax on their income and realised capital gains which they can hold onto or pay out as dividends plus any franking credits. Investors are then liable for tax at their marginal rate.
ETFs pass on all tax obligations to investors. Despite these differences, the after-tax position for investors is similar to LICs.
Another key difference is that LICs are closed-ended investments, which means they have a fixed number of shares on issue. This structure means they tend to trade at a premium or discount to the value of their net tangible assets (NTA) because the market determines the share price, not the value of the company’s underlying assets.
ETFs are open-ended which means units in the fund can be created or redeemed according to investor demand without the share price being affected. As a result, ETFs trade close to their NTA.
The growing interest in LICs and ETFs can be traced back to the growth in self-managed super funds (SMSFs). SMSF investors are keen to keep investment costs down and constantly on the lookout for simple, effective ways to create a diversified portfolio tailored to their personal needs.
LICs were also given a shot in the arm following a change in the Corporations Act in 2010 that allowed them to pay regular franked dividends.
It’s important to understand how different investment vehicles work and whether they are appropriate for your personal circumstances and appetite for risk. If you would like to discuss your investment strategy, give us a call.
i ASX Investment Products Monthly Update August 2017
ii BetaShares Australian ETF Review August 2017
Driving towards a mega mansion and watching the house light up as the gates open. Clapping hands to dim the lights and turn up the music. Blinds opening automatically to reveal a stunning vista from the exclusive perspective of a minimalist holiday home / evil lair. If these scenes sound familiar, it’s because they’ve been TV and film tropes for years, used to illustrate a certain kind of conspicuous consumerism. But home automation has come a long way from its inception in the 70’s and is no longer the domain of the super rich.
Contemporary smart home systems allow users to automate a huge variety of manual functions. Think of something you’d normally have to be home for – or something you hate getting off the couch to do – and a smart home system can probably do it. All those jokes about having a robot to grab a beer for you in the middle of a match? Not that far off reality any more.
You might have heard the phrase ‘internet of things’ (IoT). This describes the way the internet now connects a variety of devices, not just computers. According to some theorists, contemporary smart home tech has come to the market in three waves:
(1) wireless devices with a proxy server,
(2) AI that controls devices, and
(3) actual robots as we’d recognise them from those shows and movies.i
There is a wide range of functionality available. More sophisticated platforms on the market allow you to pre-set a variety of conditions for any activity; blinds, lights and heater for a cosy movie night, or music and flashing lights to get the kids up in the morning. If you’ve ever seen an ad for the Google Home or Amazon Echo/Alexa, you’ve seen an example of second gen devices.
On the up side…
Speaking of those two devices in particular, the good news is that the technology is getting cheaper and cheaper. Where once a home automation system – even first generation – would have cost tens of thousands of dollars to install, home control AI now starts at under a couple of hundred bucks. What’s more, the fact that the systems are modular means they can be built up over time. There’s no massive initial investment, and you don’t necessarily have to buy all the components from the same manufacturer. In other words, it’s an increasingly scalable lifestyle investment.
The other benefit is that if used well, home automation systems can reduce your energy costs. Smart thermostats can detect when you’ve left the building and adjust heating/cooling on the fly and lighting controls use sensors to turn lights on only when rooms are occupied. Smart power strips shut power hungry electronics (like DVD players, video game consoles and coffee machines) down when they are not in use.
Too smart for their own good?
Smart homes are more affordable, scalable and effective than ever before. So what do you need to consider? Well, one of the concerns that’s been raised with the advent of AI systems is privacy. Some units are ‘always on’, constantly listening for your next command. That means they hear everything. Wi-Fi-connected units may also have the potential to be hacked.
The good news is that there’s a lot you can do to prevent someone messing with your new smart home. Ensure you compare security specs just as closely as you inspect the cooler features when you’re shopping around. Look for component suppliers who continuously work with security testing companies (a.k.a. ethical hackers) to seek out and eliminate security flaws.
One thing is for sure, home automation is a trend that is not going away any time soon. Incorporating some level of automation into your home can potentially add significantly to your lifestyle, and may even reduce your bills and improve the value of your property. While it’s important to ensure your household’s privacy and security is maintained, there’s something to be said for kicking back with your robot butler waiting on you, under auto-dimmed lights with the game on. Another cold beer anyone?
i Li et al, ‘Sustainable Smart Home and Home Automation’ International Journal of Smart Home, Vol. 10, No. 8 (2016) pp. 177-198. Available at http://www.sersc.org/journals/IJSH/vol10_no8_2016/18.pdf
For many people, debt is a dirty word. But not all debt is created equal. There’s good debt and there’s bad debt, and then there’s the good debt that can get pretty ugly if it’s not managed properly. Learning to use debt intelligently could make all the difference to your personal bottom line.
Debt is considered good when it helps you buy wealth building assets. That can be an asset that grows in value over time and /or provides you with income.
Borrowing is often referred to as leverage because it helps you get more for your money.
Shares and property are regarded as growth assets because, when chosen well, they should grow in value over time. Shares can also offer regular dividend income while investment property provides rental income. In both cases, the income you receive can be used to help meet your loan repayments.
In many instances you can also claim a tax deduction on the interest paid on your investment loan.
Debt is bad for your wealth when you borrow to buy assets that fall in value, don’t provide any income and are not tax deductible.
Using a credit card or a personal loan to pay for holidays or expensive toys is an example of bad debt.
The trouble with bad debt is that you can often be paying for it long after the holiday has worn off or that new car has halved in value. If your bad debt is on a credit card, then it can be all too easy to let the debt roll over each month.
When bad debt turns good
Used well, bad debt can be put to good use. If you are disciplined and pay off your credit card in full each month this can help you manage your cash flow. It might also allow you to leave money sitting longer in a high interest savings account.
Credit card debt turns ugly when you buy things you can’t afford and pay only the minimum repayment each month. Because of the high interest rates that apply to credit cards, your initial debt can balloon and take many years to clear.
When good debt goes sour
Using good debt to pay off bad debt could also cost you dearly. Say you consolidate your debts by increasing your mortgage. The end result could be that you spread the cost of that holiday over 20 years or more, dramatically increasing your total interest payments into the bargain.
The family home
Buying a home to live in will not provide you with income but it can still be regarded as good debt. Not only is it a form of enforced saving but in time it may also be used as leverage to fast track your wealth creation.
Once you build up equity in your home you can use this as security to take out an investment loan. Any income you earn from your investments— your good debt — can be used to make extra repayments on your mortgage. This can accelerate paying off your home loan and free up cash for more investments.
A power of good
Whether debt is good or bad, it’s generally wise to clear it as quickly as possible. Pay off your bad debts first - beginning with the debt that has the highest interest rate - as you should be able to take advantage of the tax concessions available on your good debt.
In years gone by it was common to wait until you had saved up for what you wanted. Nowadays the ease of obtaining credit can lead to reckless behaviour. But there’s still an important place for good debt.
Given most of us will spend many years in retirement and would like to be self-funded, borrowing to accelerate wealth can be a very successful investment strategy. It’s just important to remember to keep bad debt to a minimum and make sure you use good debt wisely — otherwise it can all turn a little ugly.