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Archives for February 2019

The Global Financial Crisis?

Just over 10 years ago we were in the midst of what is now known as the Global Financial Crisis (GFC). I recall at the time a flurry of job losses from the financial services industry, Australian banks and the collapse of the American investment bank Lehman Brothers. Our country just avoided a technical recession but it felt like one for many people.

The GFC referred to a period of severe stress in the global financial markets and banking systems between mid-2007 and early 2009 as the US housing boom ended and defaults increased. Banks’ access to short-term borrowing evaporated and funding account holders withdrawals were problematic.

Why did the US housing boom impact the world economy?  For many years prior to the GFC, house prices in the US grew strongly as banks and other lenders were willing to make highly profitable increasingly large volumes of risky loans to buyers. The loans were risky as the lender did not closely assess the borrower’s ability to make loan repayments. You might recall the nickname NINJA (no income, no job, no assets) loans, symbolising the lack of documentation the banks and other lenders had to provide to secure funding.

Financial innovation allowed banks and other lenders to reduce their lending risk by packaging these risky loans into mortgage-backed securities (MBS) and collateralised debt obligations (CDO). In the US, over $500 billion USD in CDOs were issued in both 2006 and 2007 (source). Credit rating agencies provided these financial products with a high credit rating signalling to investors that they were low risk. The high rating allowed pension funds, governments, US and global banks to invest. Many investors borrowed large sums to purchase high yielding ‘low risk’ MBS and CDOs without understanding the complex and illiquid nature of the underlying investment.

When the US housing boom ended and defaults increased the demand and liquidity for MBS and CDOs evaporated and prices dived. MBS and CDOs could only be sold at a large loss of up to 95 percent (source).

The systematic problems started in the United States and rapidly spread across the globe. Banks and other financial institutions stopped lending as they were unable to easily assess how badly a potential borrower was impacted by the toxic debt. This credit freeze spread globally, many companies were unable to access funds and those that could, found there was a substantial increase in the cost of debt making the venture unprofitable.

In the wake of the turmoil, central banks globally lowered interest rates rapidly (in many cases to near zero) and lent large amounts of money to banks and other financial institutions that could not borrow in financial markets. Central banks also purchased financial securities to support markets.

Governments increased their spending on infrastructure to support employment throughout the economy, Australia handed taxpayers $1,000 relief money and guaranteed deposits and bank bonds. Governments also increased their oversight of financial firms that must assess more closely the risk of the loans.

The severity of the Global Financial Crisis caused a global economic slowdown that led to unprecedented government bailouts and economic stimulus globally. The support from governments and central banks paved the way to an economic recovery.

Please note, this article provides general information and advice only. If you would like tailored financial advice, please contact us today.

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What To Know When You Start Investing

Generally speaking, there are two ways to make more money in life: by working day in, day out, or by letting your money and assets work for you.  Now I can only speak for myself, but letting my assets work for me sounds much better than grinding away at the office for the rest of my life (not that I don’t love my job!).

It may sound like prudent practice, but leaving your entire life savings under a mattress will not give you any return or increase in capital (in fact, after inflation your buying power has actually decreased).  Even leaving your money in a bank account will only generate a minimal return.  On the other hand, investors can earn additional money through dividends and distributions from their investments or by purchasing assets that increase in value.

The purpose of this article is to introduce you to the world of investing and provide clarity on key concepts that we are often asked about by our clients.

When should I start investing?

If we ignore transaction costs and the cyclicality (ups and downs) of markets, the answer to this question would be an easy one: RIGHT NOW! The power of compounding interest means that you are better off investing as soon as possible so your future returns are off a higher base.  This concept is best conveyed in the chart below.  Chart 1 shows that an individual who invests $100,000 today (Blue) for 20 years at an 8% return will earn $96,000 more than an individual that invests the same amount, earning the same return, only 3 years later (Orange).  In the fourth year, Blue would earn 8% on $126,000 ($10,000) whereas Orange would earn 8% on the initial $100,000 ($8,000).  Therefore, it seems the early bird gets the worm after all!

How much should I start investing with?

Unfortunately, for us investors, we do live in a world with transaction costs such as brokerage so it can be unwise to invest small amounts of money where your returns will be “eaten up” by these costs.  A common brokerage fee structure for a number of retail stockbroking firms (including our own) is:

  • $55.00 for trades up to $10,000
  • 55% for trades over $10,000

As an example, if I buy $15,000 worth of shares and sell them a year later for $16,500, I would earn $1,500 in capital gains minus $173 in brokerage (buying and selling) to have a net capital gain of $1,327.   This example shows that a reasonable capital return of 10% has been reduced to 8.8% after fees.  Now, imagine if I only invested $1,000 and sold my shares for $1,100.  My $100 (10%) capital return would reduce by $110, leaving me with a measly -1% return – which isn’t very sexy at all.

So, what does this all mean? If you are an individual that wishes to purchase some Australian shares, I would recommend building up cash to a level that minimises the ratio between brokerage/investment.  If you are interested in creating a portfolio with a number of assets, I would recommend coming into one of our offices for a consultation (if you are good at something, you don’t do it for free).

How much risk should I take?

This is an extremely important question and one that can be the difference between living comfortably in retirement or couch surfing at your grandkid’s place.  The amount of risk you take on is also dependent on your investment goals.  For example, an 85 year old trying to provide for their retirement would have a much more conservative approach to investing than a 28 year old who is trying to build wealth to purchase their first home.

In addition to understanding your goals, at our firm, and in the advising community as a whole, we require our clients to complete a risk profile questionnaire, which provides a clearer picture of exactly how to risk averse they are.  The results of this questionnaire then distinguishes which risk profile our clients fall into and how their money should be invested.  The financial advisory industry uses five risk profiles:

  1. Conservative
  2. Moderately conservative
  3. Balanced
  4. Growth
  5. High growth

What should I invest in?

The answer to this question is a direct result of what risk profile you are aligned with.  There are five main asset classes that we invest in at our firm.  They are, in ascending order of riskiness:

  • Cash
  • Fixed interest: corporate, government or semi-government debt
  • Property and infrastructure: shares or holdings in property and infrastructure assets
  • Australian shares: shares listed on the ASX
  • International shares: shares listed on foreign stock exchanges

The proportion of your wealth that you should invest in each asset class is dependent on your risk profile.  For example, a balanced portfolio at our firm invests 5% in cash, 35% in fixed interest, 20% property, 30% Australian shares and 10% international shares.  The holdings in cash and fixed interest will ensure that 40% of your portfolio is invested in assets that will preserve your capital while paying some income.  The 20% of property holdings provides investors with the potential for capital gains while maintaining some level of capital preservation and income.  The 40% held in Australian and international shares provides exposure to riskier assets that can provide greater capital gains and income in the form of dividends.

Another benefit of investing in different asset classes is to diversify your portfolio and take advantage of the low, or even negative, correlation between some investments.  Correlation is a mutual relationship between two variables (assets).  By way of example, Chart 2 shows how the defensive fixed interest asset class increased by 2% from October to December 2018 as investors fled the riskier Australian shares asset class that decreased by 8% over the same period.  If you were invested entirely in Australian shares, you would have lost 8% of your capital whereas you have only lost 3% if you were invested 50/50 across the asset classes.

If you have been going to sleep on a mattress full of your life savings every night, or if you are interested in learning more about investing, please feel free to come into one of our offices to have a chat.  Our investment team relishes any opportunity to educate people on the benefits and techniques of investing and there is nothing more satisfying than helping others unlock the power of sitting back, and letting your money work for you.

Please note, this article provides general advice and information only. It has not taken your personal or financial circumstances into consideration. If you would like more tailored investment or financial advice, please contact us today.

Read more articles in our Financial Literacy series. 

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Why You Should Salary Sacrifice To Super

For many of us, we are able to contribute to superannuation for our entire working lives. Thanks to the superannuation guarantee arrangement, employers are obliged to contribute a minimum percentage (currently 9.5%) of your earnings to your nominated super fund. While this might seem like a lot, depending on your ideal cost of living in retirement, you may wish to contribute additional money to boost your savings. One way of doing this is through salary sacrificing.

Salary sacrificing is where you establish an arrangement with your employer to pay a portion of your pre-tax salary to your super account as a concessional contribution. There are a few benefits to this:

  • Boost to your overall contributions to your super fund
  • Reduce your taxable income, therefore, paying less tax
  • Works as a forced saving so you don’t need to worry about putting money away to contribute later

To show you how this could work for you, here’s an example for someone earning $90,000 p.a.:

The above example shows how your after-tax pay would be affected if you salary sacrificed $10,000 in one year, the difference is $6,550 per year or $126 per week. If this looks too much for your circumstance, perhaps consider reducing your super contributions to $5,000. Now your take-home pay is $64,658, therefore an after-tax reduction of $3,275 per year or $63 per week.

Salary sacrificing is a great tool to help boost your super savings, however, there can be some traps for young players. Be sure to speak with your financial adviser to establish how salary sacrificing can best work for you.

Please note this article provides general advice and has not taken your personal or financial circumstances into consideration. If you would like more tailored superannuation or financial advice, please contact us today. One of our advisers would be delighted to speak with you.

Read more articles in our Financial Literacy series. 

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PAYG Tax: What Is It & Why Am I Paying It?

During our lifetime we all pay tax on our income at some point.  This is called Pay As You Go tax (PAYG).  In Australia, our PAYG is a progressive tax, which means the more you earn the more you pay.  This and all other taxes are defined as the contribution to the government revenue compulsorily levied on individuals, property, businesses, goods etc.  This money is used to provide those services we expect in our society, roads, hospitals, schools etc.

PAYG tax can be confusing, especially if you have a varied income.  Some weeks you will only earn a small amount and so may not pay tax at all but the next you will work extra hours perhaps even on a weekend and suddenly you lose a lot in tax.  In Australia, our rate of PAYG is based on our annual income but this is calculated based on each pay event.  Below is a table from the Australian Taxation Office (ATO) showing the individual resident rates of tax for the 2018-2019 financial year.

Taxable Income Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c for each $1 over $18,200
$37,001 – $90,000 $3,572 plus 32.5c for each $1 over $37,000
$90,000 – $180,000 $20,797 plus $37c for each $1 over $90,000
$180,000 and over $54,097 plus 45c for each $1 over $180,000

**These rates do not include the Medicare levy.

For a lot of people where the confusion will come in is when they are changing tax brackets because of their variable earnings.  If you are a part-time or casual worker but perhaps do some extra work during holidays or peak work periods you could see your weekly income move from the second tax bracket to the third, which means a significant increase in your tax for the week.  It doesn’t necessarily mean you are going to earn over $37,001 for the year but because our tax is calculated on each pay event you will be taxed that period as if you are.

For a working example, we have someone who works casually and this week earns $519 before tax.  They would pay $41 that week in tax.  The next week is busy and they work extra shifts and earn $769 for the week, the amount of tax is $102.  When we look at the weeks individually the employee has jumped up in tax brackets.  Come to the end of the financial year they have only earnt $30,000 for the year.  They will be issued with a PAYG statement showing this and also the amount of tax they are have paid throughout the year.  This is when the ATO will look at those amounts and a refund would be issued for the overpaid tax.

For many Australians they find this confusing and unfair, however, the alternatives can be even more confusing and can result in people having large tax bills at the end of the financial period to pay resulting in hardship and meaning that the Government doesn’t get the income it is expecting.  This can have serious flow-on effects for all of the economy.

Please note this article provides general advice and examples, it has not taken your personal or financial circumstances into consideration. If you would like more tailored financial advice, please contact us today.

Read more articles in our Financial Literacy series. 

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