Profile Blog - Category ‘Financial Planning’

Of all the decisions we make, investments ought to be the most rational. We should be able to whip off our rose-coloured glasses, replace them with green eyeshades and choose the lowest-cost investments with the highest-expected returns to create a diversified portfolio.

However, as with so many things in life, our emotions often get in the way of this rational approach. We buy shares in a company solely because a friend recommended it. Or, we innately believe the higher-priced product is always better, even though we have no evidence to back this gut feeling.
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SMSF auditors are expected to focus more clearly on specific details and evidence around a fund’s investment strategy in the coming year as the industry continues to feel the ripple effects from the ATO’s diversification letter campaign of 2019.

       

 

SMSF trustees could expect a “more conservative approach” from their auditors this year, meaning it was likely further evidence and documentation could be requested during their fund’s annual audit process.  SuperConcepts general manager of technical services and education Peter Burgess told SMSF Adviser recently.

“Trustees may be asked to provide further evidence of transactions, asset ownership and valuations of assets, particularly whether the fund has unlisted investments,” Mr Burgess said.

“Where the fund has a large exposure to a single asset or asset class, the trustees may be asked to provide further evidence via a trustee minute, addendum or revised investment strategy that they have properly considered the fund’s investment objective, the risks of making the investments, asset diversification and the liquidity and cash-flow needs of the fund.”

SMSF auditor and Tactical Super director Deanne Firth said the ATO’s letter campaign to 17,000 trustees last year had shaken many in the industry out of their complacency when it came to constructing a detailed investment strategy.

“For years, trustees have used a set and forget approach to their investment strategies or had the [asset] ranges so broad that they didn’t need to update the strategy,” Ms Firth told SMSF Adviser.

“In fact, a lot of investment strategies date back to the fund establishment where they signed the strategy that came with the deed. Now the ATO has made it clear to trustees that they want to see evidence of consideration and, especially if the fund isn’t diversified, evidence that they understand the risks of their strategy.”

Ms Firth said she expected 2020 to be “the year of investment strategy updates”, with trustees taking the time to review their strategy and potentially further diversify their portfolio.

 

By: Sarah Kendell
Source: Peter Burgess and Deanne Firth
06 January 2020
smsfadviser.com

 

 

 

A question that comes up for many people saving for retirement is how best to invest when they only have small amounts of money available at a time.

         

For some, it might be because they are early in their investing journey, just out of school or starting in the workforce. Others might be raising their sights to investing after paying for an education. Some are thinking about retirement as they close in on paying off their home.

The common thread is that large sums of money aren't available for investing in one go. Rather, the hope is to put away something every month and watch it grow.

So how best to proceed?

The first step is setting goals by knowing where you want to end up. Planning sounds dull but it is critical to have clarity around where you are, where you want to be and how long you have to get there. Your plans should also include contingencies for when things go wrong.

Then, make sure you focus on building an emergency fund.

Former heavyweight champion Mike Tyson has a famous line: “Everybody has a plan until they get hit. Then, like a rat, they stop in fear and freeze.”1

Getting 'hit' could mean a job loss, a medical emergency or any other unplanned essential spending. It can derail the best of plans. An emergency fund protects from this risk. It should be kept safe from market risk and easy to access quickly.

It's also important to continue to make debt repayments. The higher your debt, the less is left over each month to save. In retirement, debt payments directly reduce your spending power. Many financial advisers over the years have said the first task they work on with many new clients is:

  • understanding where the money goes (i.e. budgeting)
     
  • getting debt under control because only as debt is manageable, is it realistic to start thinking about investing.

This is when the critical step of moving from being a saver to investor can occur.

When there are only small amounts spare each month, the single most critical thing is to find investments that have low fees.

Fees eat away at investments and this is especially true when your monthly contributions are low.

Exchange traded funds are a great low-cost investment that can be purchased with as little $500 to start with. And, depending on the ETF you buy, they can offer the benefit of instant road market diversification as well.

They come with one main caveat however – watch your brokerage costs. At $500, $10 of brokerage means the ETF will need to rise 2 per cent just to break even. If your next purchase is $100, that $10 brokerage means you need a 10 per cent gain to recover your funds.

That can get expensive over time.

An alternative for people with regular small amounts to put away can be unlisted managed funds. Minimum investments in managed funds are higher than ETFs—often between $2000 and $5000. But they have the benefit that some managed funds allow fee-free regular contributions that are often as low as $100.

Ultimately the decision is a balance of how much you have to start with and how often you intend make further small contributions.

Once the vehicle is decided, the next decision is asset allocation, or how much of your investments are allocated to an asset class like stocks, property or bonds.

One of Vanguard's most closely-held tenets is that diversification is one of the most important predictors of investing success. Investing in managed funds and ETFs offers a wide range of diversification at very low cost, allowing small investors to access professionally managed, well diversified portfolios in a single investment.

Some people procrastinate about starting on the investing journey because they don't have a sizeable pool of savings but ultimately you are better off investing small amounts over the long term, than not at all.

 

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
24 February 2020
vanguardinvestments.com.au

 

1. https://www.sun-sentinel.com/sports/fl-xpm-2012-11-09-sfl-mike-tyson-explains-one-of-his-most-famous-quotes-20121109-story.html

 

The coronavirus pandemic is having profound effects on Australian families, communities, businesses, the financial markets and the global economy.

       
Many people have lost their jobs and there is much uncertainty around the depth and duration of the current crisis. Governments and policymakers across the globe have announced unprecedented fiscal and monetary packages to provide some offset to the downturn.
 
The Australian Federal Parliament has approved the JobKeeper payments ($1500 per fortnight), boosted JobSeeker payments up to $1100 per fortnight, and allowed the unemployed and people whose hours have been cut by 20 per cent to dip into their retirement savings to help them weather the coronavirus crisis.
 
People will be able to apply online through the myGov web site to access up to $10,000 of their super, tax free, before 1 July 2020, and then another $10,000 after the new financial year begins, also tax free.
 
While some will have to access these funds to make ends meet, others may have a choice. Should they or should they not use the early access to superannuation?
 
How early withdrawals add up
 
Withdrawing superannuation funds now means an investor selling part of their portfolio in a depressed market, crystallising current losses and giving up the benefits of eventual recovery in investment markets. It will also erode the investor's retirement wealth by forgoing future compound interest.
 
Consider the impact that an early withdrawal could have on an investor's superannuation balance. The calculations below are for a balanced multi-asset managed fund containing a mix of equities and fixed income, with an average net return of 6 per cent per annum.
 
For an investor who has 20 years until retirement, the value of a $10,000 withdrawal is estimated to be worth $32,100 at retirement. Over the course of 40 years, the impact of the $10,000 withdrawal on the retirement savings climbs to $102,900, while a $20,000 withdrawal means an investor would have $205,700 less at their disposal. For this investor who chose to withdraw funds right now, it could mean delaying retirement for a number of years.
 
Comparing potential withdrawal impacts at different ages
 
Investor's current age Years to retirement Value of $10,000 at retirement Value of $20,000 at retirement
67 0 $10,000 $20,000
57 10 $17,908 $35,817
47 20 $32,071 $64,143
37 30 $57,435 $114,870
27 40 $102,857 $205,714
 
Source: Vanguard calculations
Notes: This is a hypothetical scenario for illustrative purposes only. All values are nominal.
 
A disciplined approach
 
Global evidence supports the importance of disciplined saving for retirement outcomes.
 
In 2018, the World Economic Forum named low levels of savings by individuals amongst the six key challenges facing the retirement system worldwide. Many people delay retirement savings until they are in their 40s or 50s. This is not unusual as at each life stage, more immediate financial priorities come first – for instance, saving a deposit to buy a home, paying down a mortgage or investing in kids' education. In addition, more often than not, savings intended for retirement do not last until retirement; sometimes they are drawn for medical emergencies or critical housing repairs, or during periods of unemployment.
 
As Australians live longer and spend more time in retirement, we require higher levels of savings to sustain our longer lifetimes and adequate lifestyles. The World Economic Forum estimates that combining auto-enrolment to superannuation, increasing savings over time and avoiding dipping into the superannuation savings prior to retirement is expected to increase wealth at retirement by 70 per cent.
 
Many people are currently doing it tough and will need to rely on the early access to superannuation as they do not have other means to support their families. For investors who have a choice, taking a long term perspective may prove to be beneficial. We recommend investors seek financial advice and explore other ways of obtaining financial assistance first.
 
Stay the course
 
Vanguard founder Jack Bogle famously said: “The courage to press on – regardless of whether we face calm seas or rough seas, and especially when the market storms howl around us – is the quintessential attribute of the successful investor.”
 
Historically bull markets last substantially longer than bear markets, and this downturn will eventually be over.
 
The best thing investors can do is to stick to their investment principles and philosophy, and “stay the course” to have the best chance for investment success.
 
 
Inna Zorina
Senior Investment Strategist 
Investment Strategy Group
15 April 2020
vanguardinvestments.com.au
 

GENERAL ADVICE WARNING

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients' circumstances into account when preparing our website content so it may not be applicable to the particular situation you are considering. You should consider yours and your clients' circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This website was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.
 

 

It’s a natural question about global policymakers’ multitrillion-dollar efforts to prop up economies and markets against the monumental threat of the COVID-19 pandemic. And the question has understandably taken a back seat to confronting immediate health and welfare challenges.

 

Now, as economic activity reemerges even as daily new confirmed cases of the virus top 100,000, we can start to address how governments can pay back their debts.1 For developed markets, at least, the situation may be less dire than some fear.

A rational response

It first may make sense to touch upon just how rational policymakers’ moves have been. The more than $9 trillion in spending, loans, and loan guarantees that the world’s largest economies have committed to countering the negative effects of the pandemic, while extraordinary, speak to the uniquely consequential nature of the challenge.2

A multitrillion-dollar global fiscal commitment

The illustration shows various countries’ outlays to battle the effects of the COVID-19 pandemic, by percentage of debt to gross domestic product, broken down by spending and revenue measures and by loans, equity, and guarantees. The figures are as follows: Mexico 0.8% of GDP for spending and revenue measures, 0.3% of GDP for loans, equity, and guarantees; China, 2.5% and 0.0%; Brazil, 2.9% and 4.2%; Canada 5.2% and 3.3%; United States, 6.9% and 4.2%; Australia, 10.6% and 1.9%; France, 0.7% and 13.9%; United Kingdom, 3.1% and 15.7%; Japan, 10% and 10.4%; Italy, 1.2% and 32.4%; and Germany, 4.4% and 29.6%.

Note: The bars show announced fiscal measures in selected G20 countries as a percentage of GDP.
Source: International Monetary Fund, as of May 13, 2020.

Few have disputed the potential for serious, long-lasting economic harm in the absence of such programs. That, alongside recognition that such outlays are unlikely to recur and the structuring of much of the fiscal response as loans rather than grants, makes such bold moves more palatable.

Loans and equity stakes can be thought of as government investment in those assets. Thus, any increase in debt from those disbursements could be reversed as those equities are sold or as the loans mature, except for a small percentage of possible bankruptcy losses. According to the International Monetary Fund, more than half the total fiscal response in the largest developed and emerging economies belongs to these categories.

To be sure, instituting such policy in the face of blaring headlines about triple-digit debt-to-GDP ratios requires steely conviction. For the group of major developed economies, the debt-to-GDP ratio jumped 24 percentage points in about two months. In comparison, a similar increase in global debt in response to the 2008 global financial crisis took two years to play out. The average debt level for this group of countries sits at 154% of GDP.

The fiscal math behind debt sustainability

The illustration shows the percentage of debt to growth domestic product for selected countries from 2005 through mid-2020, when the average level after fiscal measures to battle the effects of COVID-19 stood at 154%. The illustration further shows three scenarios. Scenario 1 represents “grow the way out of debt, baseline growth”; Scenario 2 represents “grow the way out of debt, modest growth”; Scenario 3 represents runaway budget deficits.

Notes: Countries included in the calculation are Australia, Canada, France, Germany, Italy, Japan, Spain, the United Kingdom, and the United States.
Scenario 1 represents 4% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 2 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 3 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 5% budget deficit.
Source: Vanguard calculations based on data from Thomson Reuters Datastream.

As striking as those figures sound, most policymakers and market participants understand that debt sustainability—the cost of servicing debt compared with economic growth—is far more important than the cold, hard headline number. In that respect, although the health shock led to unprecedented emergency spending, our low-interest-rate environment is a favorable backdrop. It’s more than conceivable that developed-market economies can grow out of their newfound debt.

With solid yet realistic growth rates in coming years as economies bounce back from pandemic-induced contractions, we could see debt in these economies returning to pre-COVID levels by the end of the decade (Scenario 1 in the figure above). Moreover, even more muted growth assumptions are enough to put debt on a sustainable downward trajectory, thanks to the sub-1% 10-year yields at which governments are issuing their debt (Scenario 2).

Although fiscal consolidation—raising taxes, cutting spending, or both—is the tried and true method for tackling debt challenges, these scenarios don’t depend on draconian assumptions. Only modest fiscal austerity, in the form of budget deficits not larger than 2% or 3% of GDP, is required alongside modest growth to reduce debt-to-GDP levels. But some fiscal discipline is needed; runaway deficits won’t work. Not even sub-1% yields would be sufficient for a grow-out-of-debt strategy if fiscal deficits remained systematically above 3% (Scenario 3).

What about central banks?

Central bank actions over the coming months and years will also have important implications for developed markets’ debt arithmetic. In fact, everything central banks are doing to help their economies right now increases the odds of a sustainable debt scenario going forward. Although explicit coordination between monetary and fiscal policy would violate the sacrosanct principle of central bank independence, the reality is that the massive monetary accommodations in most developed markets in response to the pandemic will help significantly from a debt perspective.

Beyond policies of zero or negative interest rates, central banks will need to adopt forward-guidance frameworks. Global financial markets no doubt will respond better if they know what’s coming. The U.S. Federal Reserve, for example, will need to put a forward-guidance framework in place as soon as the U.S. economy starts to move from contraction to expansion, which Vanguard’s base case foresees occurring in the second half of 2020. Guidance could be timeline-driven, or it could depend on data outcomes such as when unemployment falls back toward more typical levels or when inflation rises toward targets around 2% in most developed markets.

Higher inflation could be beneficial, if central banks can finally achieve it. In normal conditions, higher inflation doesn’t help with debt reduction because bond markets eventually catch up through higher interest rates. But in rare circumstances like wartime spending or disaster responses, such as in this COVID-19 crisis, higher inflation can erode the value of one-off debt.

Of course, the greatest condition of all is the pandemic’s progression. A second wave of infection that requires another round of national lockdowns is a worst-case scenario—from both health and economic standpoints—that we unfortunately can’t rule out. On the other hand, a sooner-than-expected development of a vaccine or indications that we’ve achieved herd immunity would accelerate recoveries.

I don’t mean to suggest that everything is rosy. Recovery will take time and be uneven, coming later to sectors that depend on face-to-face interaction. And while our view on developed markets is sanguine, our outlook for emerging markets—which we don’t foresee being able to simply grow themselves out of debt—is far more challenging. But considering where we’ve been in recent months, just being able to discuss recovery in present terms offers promise.

 

 

World Health Organization COVID-19 Situation Report 146, June 14, 2020.
2 International Monetary Fund data as of May 13, 2020.

 

 

Roger Aliaga-Díaz
Chief Economist for the Americas
23 June 2020
vanguardinvestments.com.au

 

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