Retirement villages: look beyond the brochure

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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. 
 

i http://www.retirementliving.org.au/wp-content/uploads/2017/03/Contract-Finance-Model.pdf

Expand your horizons with ETFs and LICs

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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. 
 

Why now?

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

 

 

Introducing the new smart(er?) home

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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

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.