Debt - the good, the bad and the ugly

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. 
 

Good debt

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. 
 

Bad debt

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.

Life insurance inside or outside super?

If you’ve got super, chances are you’ll have some default insurance included and the option to buy more at an attractive price. It’s a cost effective way to get a basic level of cover, but holding insurance inside super does have some downsides.
 

Forms of super insurance

There are three types of insurance you can hold inside super: life, total and permanent disability (TPD) and income protection insurance. Many super funds automatically insure their members and will provide a (relatively small) payout if, for example, they die or suffer a debilitating accident. But the level of default cover is likely to fall short of your needs.

Canstar found that while young families typically need around $680,000 of life cover, the average default life policy is only $200,000.

Nevertheless, you can pay a little extra to top up your insurance through your super fund if you want more cover. There are three big advantages to doing this:

  • These policies are relatively inexpensive because super funds can buy in bulk and pass on the discount they receive to members;
     
  • These policies are easily accessed. You’ll typically have your application for insurance approved without having to be examined by a doctor or provide detailed medical information;
     
  • You pay for cover from your pre-tax income because the cost of premiums is taken out of the super contribution your employer deposits in your fund.
     

What’s the catch?

Some life insurance is better than none, but there are downsides of a one-size-fits-all solution. Super funds get bulk-buying discounts on the basis that they purchase standardised ‘off the shelf’ policies. Such a policy may or may not be suited to your individual needs.

Automatic default cover also means younger, healthy members are subsidising older and less healthy members. And while paying for insurance out of your super contributions can help your cash flow, it’s money that’s being diverted from your retirement nest egg.

You also need to keep in mind that insurance taken out through your super isn’t portable; if you switch to another super fund that insurance will cease. Payouts can take a while because the insurer pays the super fund, which then pays the claimant.

If you fail to make a binding beneficiary nomination, or your super fund doesn’t offer binding nominations, the super trustee will decide who gets your benefits if you die. That beneficiary may be taxed more heavily than would be the case with a retail policy. And finally, the insurance ends when you retire.
 

Going outside

Getting insurance outside of super can be a little more expensive and time-consuming but it’s worth considering for a number of reasons.

  • You’ll have access to a wider range of policies. That means you can find one that’s more tailored to your individual needs.
     
  • You can’t get trauma insurance through super, but you can in a retail policy.
     
  • Payouts tend to be faster and you’ll have more capacity to ensure a death benefit goes to the beneficiary you want it to.
     
  • If you’re in good shape, your premiums will reflect this.
     
  • While you’ll be using your after-tax income to pay for it, income-protection insurance is tax deductible.


Another issue with income-protection policies through super is that they are linked to your current income. This may be unusually low when you make a claim due to, for example, having gone part-time to look after children. In contrast, retail income protection policies can offer a guaranteed benefit.
 

SMSFs and insurance

It’s not just big public super funds that can provide insurance cover. If you have your own self-managed super fund (SMSF) you’re legally obliged to consider the insurance needs of members when drafting your fund’s investment strategy. Life, TPD and income protection insurance can all be purchased through an SMSF but it won’t have access to the discounts large funds enjoy. Plus, you generally need to undergo a medical examination before receiving cover, so there are few advantages of holding insurance inside your SMSF.

If you would like to discuss the best insurance solution for your family’s needs, please give us a call.

How to prepare for climbing interest rates

Interest rates have been low for so long it’s tempting to think low rates are the new normal. So when the Reserve Bank suggests that a cash rate of 3.5 per cent is the new ‘neutral’, people take notice. Even the Prime Minister warned Australian householders to prepare for higher interest rates ahead.i

The official cash rate has been held at a record low of 1.5 per cent since August 2016, but in recent months the Reserve Bank has begun preparing the ground for higher rates. The Reserve Bank says it now considers the ‘neutral’ cash rate to be 3.5 per cent. Neutral is central bank-speak for the sweet spot where growth is supported without pushing inflation too high.

Then in a speech on July 26, Reserve Bank Governor Philip Lowe made it clear that rates will only rise once there’s a gradual lift in wages growth and inflation.ii As things stand, he’s in no hurry.
 

Wages, inflation keep rates low

Annual wages growth is currently running at below 2 per cent, which means many workers are standing still after inflation is taken into account. The annual rate of inflation eased from 2.1 per cent to 1.9 per cent in the June quarter, below the central bank’s 2-3 per cent target band.

The central bank is also reluctant to put more pressure on borrowers while household debt grows faster than income. The level of household debt to income has increased from about 148 per cent in 2012 to a record 190 per cent in March 2017. For households with a mortgage, the figure is closer to 300 per cent.

So what can you do to make the most of today’s low rates and soften the impact of higher rates in future?
 

Quit the bad debt habit

Make the most of low interest rates to pay down expensive debt such as credit cards and personal loans. Credit card interest rates begin at around 12 per cent and rise to as much as 20 per cent on popular rewards cards.

One strategy is to consolidate personal debts into your mortgage and save up to 15 per cent in interest. You also need to increase repayments on your mortgage, otherwise you could be paying off your credit cards for 20 years or more.
 

Lock in fixed rates

If you have a mortgage and an increase in interest rates would blow a hole in your budget, then think about fixing all or part of your loan.

The best fixed rates for two and three-year terms are currently around 4 per cent, not much more than the best variable rates on offer.

Bear in mind that fixed loans are less flexible than variable loans. You can’t make extra repayments or redraw funds and there are penalties for exiting a fixed loan early, even if it’s to sell your home. One popular solution is to split your loan into fixed and variable amounts for peace of mind with the flexibility to make extra repayments or redraw funds if necessary.
 

Make extra repayments

If you have a variable rate mortgage, then it’s a good strategy to use any extra savings or lump sums to reduce your loan while rates are at historic lows.

You can tip this money into an offset account where it will reduce the interest you pay, but this only works if you’re disciplined and avoid the temptation to dip into your offset account for everyday spending. You may be better off making additional ongoing or one-off loan repayments; they will still be available for a rainy day if you choose a loan with a redraw facility.
 

Catch the rising tide

Higher interest rates are not all bad news. If you’re a saver or depend on income from investments, higher rates can’t come quick enough.

If you would like to discuss ways to reduce debt or grow your savings and investments, don’t hesitate to call.
 

i ‘Prepare for interest rates to climb, Malcolm Turnbull warns’, by David Ross, The New Daily 20 July 2017, http://thenewdaily.com.au/money/finance-news/2017/07/20/malcolm-turnbull-warning-interest-rates/

ii “The labour market and monetary policy’, speech by RBA Governor Philip Lowe, 26 July 2017, http://www.rba.gov.au/speeches/2017/sp-gov-2017-07-26.html

High-frequency trading on regulators' radar

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High-frequency trading is one of the biggest developments on global share markets since tickertape machines were replaced by computers. While traders and regulators argue the merits of the trend, the challenge for private investors is to understand what it means for them.

High-frequency trading – or HFT for short - uses powerful computer algorithms and high-speed cable networks plugged directly into exchanges’ computer systems to exploit small price differences.

Critics say this has the potential to manipulate the market while supporters say it results in greater market liquidity and lower fees. The truth probably lies somewhere in between.

On any given day HFT accounts for more than half the turnover on the New York Stock Exchange. There are no reliable figures for the Australian market but it is estimated to be much less than that.

High speed, high volume, low margin

High frequency traders make money by moving millions of shares a minute, aiming to earn a fraction of a cent on each share traded. The sheer volume and speed of the trades, executed in milliseconds, is why ordinary investors can be left flat-footed when computers malfunction or the algorithms are faulty.

This is what happened during the so-called ‘flash crash’ of May 2010 when the US sharemarket plunged 10 per cent in minutes, bringing a shadowy corner of the market into the open.

Controversy around high-frequency trading has simmered ever since but it recently reignited following the release of the book Flash Boys by Michael Lewis. He claims high-frequency traders have rigged the market at the expense of investors.

The head of the Australian Securities Exchange, Elmer Funke Kupper says regulatory settings and structural differences between Australia and the US mean that concerns about the practice are not relevant here.

But not everyone is convinced. Industry Super Australia has accused high-frequency traders of skimming $2 billion a year from local investors.

Increased regulation

Regulators have begun to respond to the trend but a comprehensive and co-ordinated response will take time. The US Securities and Exchange Commission is investigating the practice amid accusations that it is little more than insider trading.

Closer to home, the Australian Securities and Investments Commission (ASIC) is concerned that high-frequency trading has the potential to undermine trust and confidence in the market.

ASIC has threatened to introduce a pause on trades for half a second before being executed. This has been introduced successfully in the US by the IEX exchange in an effort to remove the speed advantage exploited by high-frequency traders.

ASIC also has its eye on so called “front running”, where high-speed traders test the market to see what price buyers and sellers will accept then jump in ahead of them with large transactions.

The human touch

The one advantage mere mortals have over computers is judgement. If a company’s share price plummets then rebounds faster than a bungee jumper, the cause is more likely to be a computer glitch in a remote trading room than any fundamental problem with the company.

Extreme volatility is a feature of modern financial markets and is probably here to stay. But the challenge for investors is the same today as it was decades ago.

If you focus on the fundamental value of an investment, diversify your holdings and ignore the swings and roundabouts of daily price movements, you will reap the rewards in the long run.

Along the way you may even profit from market fluctuations by picking up quality stocks that have been dumped by traders who focus on price not value.

If you would like to discuss any of these issues in light of your investments, don’t hesitate to contact us.

Investing: An emotional business

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Common sense may say that the time to invest is when markets are down, but the reality is that most investors wait until markets are running hot before they get on board.

Then, terrified of losing money, when the market starts to fall, they sell.

The psychology of an investor plays a significant role in what drives financial markets and explains in part why the prices of many assets, including property and shares, go through booms and busts.

Two common characteristics of human behaviour that tend to play havoc with many investors’ decision making and investment markets are fear and greed.

Fear may prevent you from buying something when it appears to be out of favour because of the possibility of losing money. Greed may encourage you to aggressively chase returns into investment opportunities beyond your normal comfort level.

There is another type of investor who may be less worried about the risk of losing money in the short term. They are more focussed on the possibility of long terms gains based on their view of the company and broader economic conditions. This person may invest regardless of what the market is doing.

The same investor might prudently rebalance their portfolio back to a desired asset allocation using an objective rationale. For example, they might want to maintain a balance of 60 per cent shares and 40 per cent fixed interest so will buy and sell investments to ensure that mix is maintained over time.

Rather than make decisions rationally based on available information, most investors left to their own accord are much more likely to let their emotions drive at least part of the process.

It is because of emotion that most investors sell when markets are close to their bottom and buy when markets are nearing their peak.
 

Loyalty doesn’t always pay

Feeling loyal towards an underperforming company just because you have held the shares for a long time is no reason to keep holding them. Nor is buying shares in a company just because you are envious of others having them.

There are numerous investor behaviours that may be hard to identify and control. It may be dwelling on what has happened in the past as an indication of what may happen in the future or getting carried away and making over-zealous decisions when markets are running hot.

Reactions such as these can be common, particularly when markets are going through periods of boom and bust, such as we saw in the lead up to and during the Global Financial Crisis.

It is important to understand that investment markets are driven by more than just fundamentals and that investor psychology plays a significant role.

Just by understanding that emotion rather than logic can play a significant role in the decision making process can go a long way in helping you make rational decisions and, hopefully, avoid bad ones.
 

Common biases

There are several common biases that have been identified by psychologists as influencing investor behaviour; once recognised these biases may be resolved:

Herding : Safety may well come in numbers, except when the numbers are only growing because others are there. The reality is that large numbers of people can be wrong and when they are, the damage can be a lot worse. By following the crowd, or herding, individuals are more likely to buy when markets are near their top and sell at the bottom.

Familiarity : Investing in a company or an area you are familiar with is understandable, but there may be consequences if part of your aim is to have a diversified portfolio. For example, buying shares in companies in only your own country, while ignoring opportunities in other countries, fails to recognise the benefits of diversifying against geographical risk.

Anchoring : Nobody likes to think they have made a bad investment decision, but it doesn’t always pay to get set on something like a share price or old information. A company whose shares suddenly drop from $20 to $10 isn’t necessarily going to get back to $20 just because it was there once.

Loss Aversion : If there is a good way to destroy investment returns, it is to hang onto loss making investments in the belief they will come good and to sell winners quickly just for the instant gain. We do this because we feel more pain from a loss than we feel happiness from a gain.

The highly successful US investor Warren Buffet turned the phrase “be fearful when others are greedy and greedy when others are fearful” knowing that investors don’t always act rationally and when money is involved, emotions can run high.

The risky business of cryptocurrency investment

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You’ve probably heard by now of Bitcoin and other cryptocurrencies. In the space of eight years they’ve gone from a geeky novelty to big business and investors are beginning to take note.

There’s an estimated US$US100 billion worth of cryptocurrency floating around in cyberspace. In the real world, there’s a small but growing number of Bitcoin ATMs appearing in the world’s metropolises. Heavy hitters including Microsoft, Virgin Galactic and Expedia now accept Bitcoin as payment, in certain circumstances.

For those looking to turn a (tangible) dollar, investing in cryptocurrency has proven to be lucrative. If you’d bought US$100 worth of Bitcoin in 2009, it would now be worth more than US$70 million, but there have been some stomach-churning falls along the way.

Mining for cyber gold

In the late 1990s, when online transactions were becoming common, tech geniuses started musing about creating a new decentralised currency. A developer using the pseudonym ‘Satoshi Nakamoto’ made those dreams a reality by creating Bitcoin in 2009.

The way Bitcoin (and its 900 or so imitators) works is that individuals and groups must ‘mine’ it, much like digging for cybergold. Those who solve a complicated problem using mining software and high-powered computing hardware discover Bitcoins. They can then sell these bitcoins, or whatever the unit of cryptocurrency is, on online exchanges.

Like conventional currencies, cryptocurrencies can appreciate or depreciate. As noted, Bitcoin has appreciated spectacularly as has Ethereum, its one serious challenger, which has soared from just above US$8 to US$300 in the first six months of 2017.

So, what’s the catch?

By definition, cryptocurrencies are not legal tender backed by the full weight of a nation state and its central bank. That raises several issues.

First, there’s the practical matter of being able to spend your Bitcoins. As mentioned, some companies and even a handful of government organisations around the world now accept Bitcoins, Ethereum or other cryptocurrencies as payment but the majority don’t. Australia’s private and public sector organisations have remained particularly unenthused about embracing cryptocurrencies. Which is somewhat ironic given many believe ‘Satoshi Nakamoto’ is Australian.

Of course, you can exchange cryptocurrency for the old-school kind. But this will involve using an online exchange or, if you’re lucky, an ATM. There are hefty transaction fees involved and sometimes long waits for the transaction to be processed.

Regulators are yet to greenlight conventional investment products such as exchange-traded funds based on cryptocurrency, despite attempts by fund managers to do so. That doesn’t look like changing any time soon.

An investor seeking windfall profits in a low-return environment may be tempted to overlook all these inconveniences. But what can’t be overlooked is that cryptocurrencies are high risk investments.

Doing your crypto-dough

For one thing, cryptocurrencies are hard to trace. That makes them perfect for tax evasion, money laundering and criminal transactions taking place on the ‘dark net’. Unsurprisingly, national governments have been at best suspicious and at worst antagonistic to them. That hasn’t prevented them from gaining traction. Nonetheless, it would only take a handful of major economies mobilising against them (as China has several times) for their value to tumble.

Unlike the traditional money overseen by central banks and governments answerable to those they govern, cryptocurrencies are at the mercy of the individuals who have developed them. While it hasn’t happened in any notable way yet, it’s not hard to imagine a scenario where those developers manipulate the currency, possibly by flooding the market to enrich themselves.

Finally, and perhaps most persuasively, cryptocurrencies run all the same security risks as anything internet related. Cybercriminals could steal your cryptocurrency; hackers can and have hacked cryptocurrencies and online exchanges can and have shut down leaving their customers out of pocket. In such circumstances, there’s unlikely to be a financial institution, law enforcement agency or regulatory body to provide recourse.

All these issues with cryptocurrencies may ultimately be addressed. They may end up being an asset class worthy of serious consideration. But for the time being, they remain a higher risk investment.

 

Home ownership in the spotlight

Housing affordability continues to be a major concern in Australia and not just for would-be first home buyers. It also affects pre-retirees forced to work longer to repay bigger mortgages and older Australians unable to downsize from large family homes due to a lack of affordable options.

The latest 2016 Census revealed a gradual decline in home ownership over the past decade from 68 per cent of all Australian households in 2006 to 65 per cent in 2016. And those of us with mortgages are more likely to be stretched to the limit, with over 7 per cent of home buyers paying more than 30 per cent of their income on mortgage costs.

It’s not only homeowners feeling the pinch. Rising house prices mean more of us are renting in the private market. Almost 25 per cent of households are renting privately, up from 21 per cent a decade ago; a further 4.2 per cent are in public housing. This puts upward pressure on private rents and increases demand for public housing.

Price growth easing

The national debate about housing affordability is understandably loudest in Sydney and Melbourne where the median price of houses and units is $880,000 and $675,000 respectively.i But residential property is always a tale of many markets.

While the constant warnings from some quarters that Australia’s housing boom is about to bust has not yet come to fruition, the rapid price growth of recent years appears to be slowing.

According to the CoreLogic Home Value Index, annual price growth eased from 12.9 per cent in March to 9.6 per cent by the end of June. In Perth and Darwin prices fell, while Brisbane and Adelaide posted modest gains. Hobart remains our most affordable capital city with a median price of $355,000 despite annual capital growth of 6.8 per cent.

Retiring with debt on the rise

The census also revealed that fewer of us own our homes outright. Mortgage-free home ownership is down from 32 per cent to 31 per cent over the same period. This could be due to more of us borrowing against the mortgage for renovations or investment, and higher home prices resulting in bigger mortgages that take longer to repay.

If this trend continues it could have implications for our retirement income system, which assumes that most people will retire with a home fully paid for. In a little over two decades the incidence of mortgage debt among people aged 55-64 has more than tripled from 14 per cent to 44 per cent.ii As more of us delay buying our first home until later in life, this trend is likely to continue.

To tackle housing issues at both ends of the age spectrum, the federal government announced some new measures in the May 2017 Budget.

New government incentives

The first of these is the First Home Super Saver Scheme. If the proposal is passed, first homebuyers will be able to make voluntary contributions of up to $15,000 a year to their super fund which they can withdraw to use towards a deposit, up to a maximum of $30,000.

In a move designed to free up more housing stock for young families, the Budget proposed allowing people over 65 to downsize and put up to $300,000 of the proceeds into super without it counting towards existing contribution caps. Couples could contribute up to $600,000. This may make downsizing more attractive for some, but it may not be the best strategy for everyone because the family home is exempt from the age pension assets test while super is not.

State governments have also stepped up assistance for first home buyers, with grants and stamp duty savings.

It remains to be seen whether these measures will significantly improve housing affordability for first home buyers or encourage Baby Boomers to downsize to a smaller nest.

Whatever your stage in life, we can work with you to help achieve your version of the Great Australian Dream.

i All housing prices from CoreLogic ‘Capital City Dwelling Values Rise 0.8% over June Quarter’ https://www.corelogic.com.au/news/capital-city-dwelling-values-rise-0-8-over-june-quarter

ii ‘Australians are working longer so they can pay off their mortgage debt’ http://theconversation.com/australians-are-working-longer-so-they-can-pay-off-their-mortgage-debt-79578

Where is the best place to stash your cash?

Australia’s historically low interest rates are great news for borrowers but a headache for savers. Whether you are a young single saving for a home deposit, a family saving for future education costs or a retiree seeking income, the hunt is on to find the best return on your savings.

In a survey by Westpac(i), 29.4 per cent of people said bank deposit accounts were the “wisest place for savings”. Real estate (24.6 per cent) and pay debt (16.5 per cent) were also popular choices, ahead of shares (9.5 per cent). And despite generous tax breaks, superannuation (5.2 per cent) limped in behind “spend it” (5.4 per cent).

Finding the wisest home for savings is not just about the highest return. If you are saving for a holiday or a home deposit, long-term investments such as shares or super are not appropriate.

Your appetite for risk and the amount you have available are also factors. Say you receive a $5,000 windfall, or identify savings of a few hundred dollars a month. Real estate is out of the question, so what are your options?
 

Play safe with bank deposits

Bank deposits come with a government guarantee up to $250,000, but safety comes at a cost. Five years ago term deposits were paying more than 6 per cent. Today, they are paying less than 3 per cent on average, only about 1.5 percentage points above inflation.(ii)

High interest savings accounts aren't much better, paying a fraction below 3 per cent and only if you are prepared to shop around.(iii) Unlike term deposits, these accounts have the added bonus of being at call, however most of the best rates are only for introductory periods or if you regularly deposit a minimum amount each month, so check the details.

If you put $5,000 in an online account at 3 per cent you would earn $150 in interest after one year and $808 over five years.
 

Pay off debt

If you have a mortgage or credit card debts, then using savings to reduce debt can be a winning strategy.

Basic variable home loan interest rates are currently between 3.5 per cent and 4 per cent, so any additional payments you make are earning an effective interest rate of at least 3.5% and that is an after tax equivalent, worth considering when comparing to regular interest earning bank accounts.(iv)

Even bigger savings can be made by paying down credit card debt. According to Canstar, credit card interest rates range between 7.99 per cent and 23.5 per cent.(v)

A $5,000 debt on a credit card charging 18 per cent interest will cost you around $900 in interest a year. If you make the minimum payment each month you end up paying $17,181 over 33 years. But increase your monthly payment to $246 and you cut the cost to $5,902 over two years, a saving of $11,279.
 

Build wealth with shares

If you are saving for a longer-term goal you can afford to take a little more risk for a potentially higher return.

Australian shares returned 11.8 per cent a year on average in the five years to June 2017 from a combination of capital growth and dividend income.vi

With $5,000 the easiest way to gain exposure to a portfolio of quality Australian companies is via an Exchange Traded Fund that covers Australian shares. Alternatively, if you already hold direct share investments you could purchase additional shares.

Secure your future with super

If you are saving for retirement, then it’s hard to go past super. Not only does super come with generous tax concessions but the long-term nature of your investment allows compound interest to work its magic.

According to research firm SuperRatings, the median balanced super fund returned 10.5 per cent in the 2017 financial year and 10.0 per cent a year over the past five years.(vii) ‘Balanced’ here means 60 per cent is invested in shares and other growth assets with the remainder in cash and fixed interest.

There are a wealth of options for savers who are prepared to look beyond traditional bank accounts.

Quality advice can help you get the most out of your savings so you can achieve your personal financial and lifestyle goals sooner, so please give us a call to discuss a tailored strategy.
 

i Westpac-Melbourne Institute Consumer Sentiment Index, June 2015

ii Canstar, viewed 26 July 2017, http://www.canstar.com.au/interest-rate-comparison/

iii Canstar, viewed 26 July 2017, http://www.canstar.com.au/interest-rate-comparison/

iv Canstar, viewed 26 July 2017, http://www.canstar.com.au/interest-rate-comparison/

v ‘Credit Card Interest: An Overview?’, Canstar viewed 26 July 2017, https://www.canstar.com.au/credit-cards/credit-card-interest-101/

vi Lonsec, https://irate.lonsec.com.au/MarketIndices

vii SuperRatings, viewed 26 July 2017, http://www.superratings.com.au/latest-returns/returns

Win the investment race

It’s been a volatile time on global investment markets, as shares and other assets are knocked about. At times like these it’s little wonder that more cautious investors decide it’s too risky to approach the start line.

No sensible person would take risks with their hard-earned cash for the sake of it, but the paradox of investing is that there’s no avoiding risk if you want to achieve financial security.
 

Risk vs volatility

Investing is an inherently risky business, but perhaps not in the way you think. While it’s common to hear people talk about volatility as a byword for risk, they are not the same thing.

In investment markets, volatility refers to daily price fluctuations. Risk, on the other hand, is the possibility that an investment will provide a lower return than expected over your time horizon or even a permanent loss.

Short-term volatility is only a risk if you need to sell investments after a big price fall. The longer your time horizon, the less important volatility becomes.


Here is a rundown of some of the main types of risk:

General market risk
This refers to the possibility that an investment will lose value because of a general decline in financial markets, due to economic, political, or other factors. Market risk can cause problems for investors who need to sell assets into a falling market, but it can also provide opportunities for bargain hunters.

Economic risk
This refers to the possibility of an economic shock or crisis that will cause panic selling, such as a debt crisis or a credit squeeze.

Interest rate risk
When rates are low investors borrow to buy shares and property, pushing up prices. When interest rates rise it’s more expensive to borrow to invest in shares and property so they tend to fall in value, while bank savings accounts and term deposits become more attractive.

Exchange rate risk
Exchange rates add another layer of risk when you invest in international markets or local shares with overseas operations. You can manage this risk to some extent by buying a hedged version of an overseas fund or shares in a local company that hedges its currency exposure.

Country risk
Sometimes particular countries face political or economic upheavals that spook financial markets. The Greek debt crisis and the Chinese sharemarket crash are two recent examples.

Sector risk
This applies to particular sectors of a market or economy. For example, the spread of the internet is disrupting the business model of companies in the media sector, while low commodity prices have hit companies in the resources sector.

Specific risk
This is the risk that a company you own shares in turns out to be a lemon. Or your investment property is in the path of a new freeway.

That may sound like a lot of risk, but without accepting some degree of risk you are unlikely to earn the returns you need to keep ahead of inflation and achieve your financial goals.
 

Managing risk

The amount of risk you accept depends on your personal tolerance for risk, your investment goals and your time horizon.

If you are close to retirement, you may wish to reduce the overall risk of your portfolio to protect your capital. Even so, it’s still wise to keep a portion of your money in higher risk investments such as shares and property to produce the returns you need to last the distance.

You can’t banish risk entirely but the good news is that most risks can be reduced or managed with some simple strategies. Diversification across and within asset classes and geographic locations is the best insurance against the risk of poor performance in a single investment or market.

If you would like to discuss your risk tolerance in the context of your investment portfolio, don’t hesitate to call.

Global markets navigate a sea of uncertainty

It’s almost a decade since the global financial crisis created havoc in financial markets. While the global economy continues to show signs of recovery, political uncertainty in Europe and the United States is creating fresh confusion on global markets as investors wait to see how current events play out.

It started just over a year ago when Britain voted to leave the European Union. ‘Brexit’ was followed by the surprise election of President Trump in the United States. Then the relatively unknown Emmanuel Macron won the French Presidential election. And most recently, UK Prime Minister Theresa May gambled on a general election to strengthen her hand going into the Brexit negotiations with the EU, only to end up with a hung parliament.

That’s a lot of unpredictable outcomes for one year. As every investor knows, markets don’t respond well to uncertainty. So what can we expect in the months ahead?
 

Brexit talks begin

Brexit negotiations are finally underway but Britain’s lack of political unity may prolong talks and weaken its hand. The process involves two stages – first there are technical negotiations over who gets what in the divorce. This will be followed by trade talks about the nature of Britain’s relationship with the EU and its 27 member states going forward.

Whichever way the talks go there are likely to be financial winners and losers. The early market response has been to sell down the value of the British currency and shares, although a weaker pound is good news for companies with foreign earnings.

The market has responded more positively to President Macron’s victory and the success of his new party’s candidates in France’s June elections. Macron has promised market-friendly reforms to boost the sluggish French economy.
 

As the Trump trade deflates

The market’s early positive response to the election of President Trump has lost momentum as key policy changes including tax cuts and infrastructure spending which were intended to boost economic growth now look in doubt.

With the focus on political uncertainty on both sides of the Atlantic, the US Federal Reserve’s latest rate rise barely registered on financial markets. The Fed raised its key interest rate for the third time in six months to a range of 1 per cent to 1.25 per cent, with one more rise anticipated this year. This signalled the central bank’s ongoing confidence in the slow but steady economic recovery.

Markets appear to be playing a waiting game, with no clear signal to push the US dollar or bond yields higher. After a record-beating run, US shares have held onto their gains but drifted sideways in recent months. The S&P 500 index rose about 18 per cent in the year to June.i
 

Australia’s growth continues

Closer to home, Australia’s record-breaking economic run continues. While growth slowed to 1.7 per cent in the March quarter, it was a far cry from the recession some pundits were predicting.

The residential property boom in Sydney and Melbourne is also cooling, with prices barely moving in the three months to May.ii While this is good news for homebuyers, it also gives the Reserve Bank more room to lower interest rates if needed. In recent months, the Aussie dollar has traded in a narrow band around US75c. This is up from its low of US68c in January last year, but longer term the trend is likely to be down as the gap between local and US interest rates closes and foreign money looks for better returns elsewhere.

Australian shares have performed well, up more than 11 per cent in the year to June.iii But to put this in perspective, along with the US market rise of 18 per cent, French, German and UK shares rose around 27 per cent, 34 per cent and 22 per cent respectively while Japanese shares were up 29 per cent.iv
 

Looking ahead

For local investors, Australian shares remain attractive for their yields but global shares are likely to continue to provide superior returns going forward.

If you would like to discuss your investment strategy in the light of current world political and economic events, don’t hesitate to give us a call.
 

i All market figures as at June 27.

ii https://www.corelogic.com.au/news/multiple-indicators-point-to-softer-housing-market-conditions

iii http://www.marketindex.com.au/asx200

iv https://tradingeconomics.com/stocks