Episodes

  • Should you do anything about rising interest rates?

    Should you do anything about rising interest rates?
    Jun 14 2022
    Some investors have been spooked by the RBA hiking interest rates by 0.75% over the past two months, particularly since it has spent the past two years telling us that rates would not rise until 2024. Higher interest rates at the same time as rising prices (inflation) are a two-fold blow for household budgets. Where are interest rates heading? The banks predict that the cash rate will rise by a further 1.40% to 1.50% by March 2023. Money markets have priced in a cash rate that is more than 2.60% higher by March 2023, but most commentators feel this is too hawkish, and unlikely to happen. The theory is that, due to higher inflation, the cash rate should return to the neutral rate as soon as possible to avoid monetary policy adding to inflationary pressures. The neutral rate is when the cash rate is neither economically expansionary nor contractionary. Most commentators believe the neutral rate is between 2% and 3%. Ironically, inflation may force rates to fall again Australian inflation is currently 5.1% p.a. and will certainly read higher in the June quarter. Inflation in other developed economies is approaching 10%. But anyone that's visited a supermarket or petrol station lately knows that inflation is a lot higher than what the CPI measure reflects. This higher inflation has already dampened consumer and business confidence, which will cool economic growth (GDP). The neutral cash rate might very well be between 2% and 3% when prices of goods and services are at normal levels. However, given the backdrop of much higher prices, it is very likely that the natural rate is closer to 1% to 1.5%. Therefore, if the RBA raises rates too far at the same time prices are very high, it will result in a decline of economic growth (GDP). In fact, last week CBA forecasted that will happen and the RBA will cut rates by 0.50% in the second half of 2023. Don't overreact to recent rate rises I was watching TV with amusement last week. Reporters were interviewing people about the RBA's recent 0.50% rate hike. People were talking like interest rates were 10%! Of course, I shouldn't be surprised at the alarmist nature of TV! The reality is that interest rates are still very low by historical standards. By the end of this month (i.e., after the most recent rate hike filters through to mortgage rates), standard variable home loan (P&I) rates will be around 4.75% p.a. and investment (IO) rates approximately 6.10% p.a. Of course, new borrowers are offered hefty discounts of 2% p.a. or more off the standard variable rate. Therefore, most discounted home loan rates will be in the high 2%'s to low 3%'s. The average standard variable rate over the past 20 years was 6.36% p.a. according to RBA data. And 20 years ago, the average interest rate discount was only 0.70% p.a., so the actual average discounted rate would be closer to 5.50% p.a. Therefore, even if the RBA hikes rates by 1.40-1.50% as the banks expected, standard variable interest rates will still be about 1% below the long-term average. Avoid fixed rates for now The fixed rates that the banks offer customers are dependent upon the banks cost of funds e.g., how much it costs them to borrow for 3 years. Given that the interest rate curve is unrealistically steep, which makes borrowing more expensive for the banks', fixed rates are financially unattractive. For example, 3-year fixed rates are high 4%'s and 5-year fixed rates are typically above 5% p.a. Two things may occur over the next year that will put...
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    15 mins
  • 6 case studies: The importance of holistic advice

    6 case studies: The importance of holistic advice
    Jun 7 2022
    Our goal is to inspire our people to adopt a holistic approach when making financial decisions. That's because financial decisions often include several interrelated considerations and consequences, including financial planning, cash flow, taxation, borrowing and so on. Also, taking a holistic approach ensures no opportunities or risks slip between the gaps. Often, the best way to make a point is to tell relatable, real-life stories. Therefore, to demonstrate how valuable a holistic approach is, I have shared six client stories below. What is a holistic approach? Traditionally, financial services have been very siloed. If you have a tax question, you ask your accountant. If you have a mortgage structuring question, you ask your mortgage broker. If you have a question about super, you ask your financial advisor. You get the point. However, the problem with this approach is that financial matters tend to be interrelated. What seems like a basic mortgage question could have tax and/or financial planning consequences, which a mortgage broker cannot be expected to have the necessary experience and knowledge to address. A holistic approach recognises that many financial decisions require a multidisciplinary approach. At ProSolution Private Clients, we ensure that our team provides a collaborative response to help clients make fully informed financial decisions. Case studies Below is a selection of six case studies explaining how our clients have benefited from our holistic approach. Whilst these case studies are based on actual events, we have avoided including names or financial information to preserve confidentiality. (1) Business plan integrated with personal financial plan Our client recently established his own professional services business. He was achieving some excellent financial results (in a relatively short period of time) and was able to share a business plan with us. We used this business plan to formulate advice regarding a few important matters. Firstly, we ensured that he had flexible business income structures to help minimise tax. Secondly, we developed a long-term financial strategy which addresses how he was going to achieve business and personal goals. Upgrading the family home was a priority. And finally, and perhaps most importantly, we developed a financing (borrowing) strategy to ensure these plans could be implemented with the banks help. This approach ensured all interrelated matters (i.e., tax, borrowing and building wealth) were optimised. (2) Tax planning whilst maximising borrowing capacity In some situations, safely maximising a clients' borrowing capacity can be the most important goal, as without the ability to borrow, their financial plans cannot be implemented. Unfortunately, many accountants do not appreciate how important this can be. In addition, because they don't understand how banks assess loans (which isn't always logical or predictable), they often structure a clients taxation arrangements in a way that inadvertently limits their borrowing capacity. This prevents them from investing and consequently jeopardises their long-term goals. We had a client that was self-employed, and his plan included several property acquisitions, including a family home upgrade. Our accountants and mortgage brokers worked closely together to develop a solution that minimised tax and maximised the client's borrowing capacity. Doing so required the mortgage broker to select the right lender/s which then allowed the accountant to accommodate its credit policies. Magic happens when your mortgage broker works closely with your accountant. (3)...
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    22 mins
  • "Timing" the market can be more important than "time in" the market

    "Timing" the market can be more important than "time in" the market
    May 31 2022
    Most people are familiar with the saying that "time in the market is more important than timing the market". It is very true that holding a quality investment for many decades will mask imperfect timing. However, for some asset classes/investments, timing can be very important. Most markets move in cycles Most people understand that markets move in cycles. To generalise, an asset class can be over-valued (particularly during a boom cycle), under-valued (after a bust cycle) or fairly valued. If you had have invested in the US tech index (NASDAQ) in November 2021 you would have lost about 30% to date. This is a lesson in poor timing. $100 invested would now be worth $70. An investor needs a 43% return just to get back to $100 again (breakeven). It's worth noting that every fundamental indicator highlighted that the NASDAQ has been overvalued for some time. Of course, a bull market can last a lot longer than anyone can anticipate which invites people to ignore these fundamental indicators. Mean reversion: what goes up, must come down If we acknowledge that most markets move in cycles, then it is obvious that we should invest in undervalued or fairly valued asset classes and sell asset classes that are overvalued. Taking this approach leverages the power of mean reversion as I explain in this blog. Investment-grade property has much flatter cycles It is important to define what I mean by "investment-grade property". Investment-grade property is an asset that has produced a solid historical capital growth rate, underpinned by a strong land value component and scarcity. As such, investment-grade property benefits from perpetually strong demand at a level that exceeds supply. These assets are generally located in well-established, sort after, blue-chip suburbs. Property is a lot less volatile than shares - about half the rate. I suspect there's two reasons for this. Firstly, property is a necessity. We all need a roof over our heads. It is not a discretionary asset, like shares are. Secondly, due to high transactional costs (agent fees, stamp duty, etc.), property isn't traded (bought and sold) in the same way shares are. For example, the volatility of the median houses price in Melbourne since 1980 is 9.1%. The average capital growth rate over that period was 8.3% p.a. Therefore, two-thirds of the time investors should expect the annual growth rate will range between 0.8% and 17.4%[1]. That compares favourably to share markets which tend to have volatility rates of 18-20%. Therefore, two-thirds of the time share market returns will range between -11% and +28% - a much wider range. Timing the property market is less important This chart sets out long-term growth patterns for property in each capital city. It is noteworthy that property tends to eb between two cycles being growth and flat. Of course, it would be great if you could accurately pick when each cycle will begin and end, but you can't. It is very difficult (read impossible). Markets cycles can last longer than you may expect. For example, Melbourne's apartment market is a good example of this - it's been flat since 2010. Perhaps on...
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    15 mins
  • Be prepared for a few years of turbulence... and opportunity

    Be prepared for a few years of turbulence... and opportunity
    May 24 2022
    I think we need to be prepared for the possibility that the next couple of years might be a bumpy ride in terms of the economy, financial markets, interest rates and so forth. The media thrives on higher levels of uncertainty, so be prepared for plenty of doomsday predictions and lots of negativity. The silver lining is that negative sentiment almost always creates attractive long term investment opportunities, but you must be on the lookout for them. Inflation is not demand driven It has been well documented that the cost of living has been rising in Australia and around the world. Australia's inflation rate is currently 5.1% p.a. (as measured by CPI), but anyone that's been to the supermarket lately knows that prices of many products has risen by a lot more than this. Inflation is a problem in many other countries too - NZ inflation is 6.9%, UK is 9.0% and US is 8.3%. Inflation occurs because demand for goods and services exceeds supply. Inflation can be demand driven (i.e., when demand is above normal, but supply remains at normal levels) or supply driven (i.e., supply is below normal). I certainly acknowledge that some sectors have experienced levels of consumer demand that are well above normal levels, particularly during lockdowns. However, at this stage, I think inflation is mainly driven by supply chain shortages. Therefore, to cool inflation, demand must be reduced to below normal levels. Unfortunately, that means financial pain for some people because household budgets need to be strained to the point that people buy fewer goods and services than they would otherwise need to buy. That will be achieved either by higher prices (market forces) or higher interest rates (RBA), or both. Cooling supply driven inflation is generally painful, especially when wages aren't rising nearly as fast as prices. https://twitter.com/barereality/status/1526819407435026432?s=11&t=Vl92S8uqUmuNXQEI7PnHSg But interest rates must return to normal ASAP almost regardless of inflation One year ago, I wrote that interest rate expectations can change very quickly, and we shouldn't get seduced into thinking they won't rise. Last year many commentators were suggesting that interest rates might not rise for many, many years. Today, the same commentators are predicting multiple increases in the coming months. The reality is that interest rates were at emergency settings (zero) for a very good reason - Australia was in lockdown! But that is no longer the case and interest rates must return to more normal levels as soon as the economy can afford it. If interest rates were left at zero for too long, there would be severe negative long-term consequences. The big question that economists are currently wrestling with is what do normal interest rates look like? It is likely that the neutral interest rate is probably a lot lower than it used to be. The RBA thinks it's around 3.5% but most...
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    18 mins
  • Should you plan to give or receive an inheritance?

    Should you plan to give or receive an inheritance?
    May 17 2022
    A lot has been written about the good fortune of baby-boomers in that, overall, they have enjoyed a long period of economic, share market and property market prosperity. Whilst they haven't enjoyed the full benefit of compulsory super (which only began in 1992), other assets such as property has certainly compensated for that. This means an inheritance tsunami will hit the next generation over the next two decades. Baby Boomers are expected to bequeath $224 billion each year in inheritance by 2050, representing a fourfold increase in the value of inheritances over the next 30 years. This creates a huge financial planning opportunity for many families. At the same time, it invites you to think about the value of assets that you plan to leave your beneficiaries. (A) Planning to receive an inheritance There are many factors that you must consider if there's a chance that you may receive an inheritance. Do not rely on it, but certainly plan for it The size of any potential inheritance and your family's circumstances will typically determine whether it's prudent to rely on receiving an inheritance when developing your personal financial plan. Whilst you might expect to receive an inheritance, we all know that circumstances can quickly change. For example, the expected benefactors (often parents) might end up spending all their money or losing it (poor investments) or changing their mind and leaving it all to charity. Anything can happen. You also must consider your family's circumstances. If there's a risk of conflict (between potential beneficiaries) then it's possible you may not receive what you expect or you may be involved in a long legal battle. Any experienced estate lawyer will tell you how often money issues upset and ruin otherwise well-functioning and happy families. Money and family rarely mix well. How can you factor it into your plans? If you are confident that you will receive an inheritance and that you are unlikely to experience any family conflict, then you may take this into account in your own financial plan. For example, you might be comfortable borrowing additional monies to invest on the assumption that the inherence will assist you in repaying or reducing this debt when you retire. Or perhaps you might prioritise your lifestyle expenditure now (and invest less). I must say that I am often reluctant to include inheritance when developing a financial plan for my clients, because it is just so uncertain - anything can change. If possible, I prefer to develop a strategy that does not consider inheritance and treat it as "icing on the cake" if its ever received. Receive it tax-effectively Typically, I prefer my clients to receive all inheritance via a testamentary trust. For this to be an option, a testamentary trust must be included in the benefactor's will. A testamentary trust offers a few advantages. Firstly, it can distribute to minors (your children or grandchildren that are less than 18 years old) and the income or capital gains are taxed at adult tax rates, which means each child can effectively receive circa $20,000 p.a. without paying any tax. This can be a great tax planning tool. Secondly, as it's a discretionary trust, it provides a lot of flexibility as to how income and capital gains are to be distributed which means it's a good gift-making vehicle. And finally, it provides a level of asset protection for the recipients. If you expect to receive an inheritance you need to check with the benefactor whether their...
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    15 mins
  • Patience & discipline: Two vital traits of every successful investor

    Patience & discipline: Two vital traits of every successful investor
    May 3 2022
    I find it ironic that the two common financial mistakes that people make are (1) not investing i.e., procrastination or (2) doing too much i.e., turning over investments, changing their mind and so on. Of course, not doing anything is an obviously bad thing as nothing comes from nothing. I wrote about this in March. But, sometimes reacting, changing, tinkering, selling, buying and so on can be equally as bad. The truth is that investing requires a lot of patience. The quote below from Warren Buffett's business partner since 1975, Charlie Munger says it perfectly. Look at those hedge funds - you think they can wait? They don't know how to wait! I have sat for years at a time with $10 to $12 million in treasuries or municipals, just waiting, waiting...As Jesse Livermore said, 'The big money is not in the buying and selling...but in the waiting.' - Charlie Munger When it comes to investing, doing nothing is often sometimes the most intelligent thing to do. Research demonstrates that buying and selling destroys wealth There's a commonly cited story about global fund manager, Fidelity conducting research into which investment accounts performed the best. It is said that it found that inactive accounts i.e., where the investor forgot that the account existed produced the best returns, on average. A study that included 66,465 investors concluded that portfolio turnover (i.e. buying and selling stocks) is inversely related to returns. That is, higher turnover leads to lower (about 5.5% p.a.) returns, on average. Whilst this study only considered stocks, the same would be true for every other asset class. Three reasons why you need the discipline to be patient If you have the discipline to be patient, you will enjoy much better investment returns for three reasons. (1) Markets move in cycles Most investment markets move in cycles. That is, a period of above-average returns follows a period of below average-returns, as shown in this chart of historic property returns. If you were unlucky and invested at the beginning of a flat growth period, it's likely that you must hold an asset for a much longer period to generate a return close to the long-term average (i.e., 7-8% p.a.). For example, generally, you must be prepared to hold a property for at least 10 years to enjoy the long-term average return (i.e., 7-8% p.a.). However, if you invest at the beginning of a flat period, you'll have to hold the property for 15 to 20 years. Returns should be similar in both cases (i.e., 7-8% p.a.). The difference is the distribution of returns over time. Investment-grade apartments are a good example of this - see here. (2) Returns compound Compounding capital growth takes time. As this chart demonstrates, the projected growth (equity) in the first decade of ownership is $580k. But in the third decade is projected to be $2.7 million! That is the power of compounding returns. The two key ingredients are (1) <...
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    14 mins
  • "Consistency" (not intensity) is the key to building wealth

    "Consistency" (not intensity) is the key to building wealth
    Apr 19 2022
    When it comes to building wealth, the truth is that unremarkable actions completed consistently for many years (decades) produce remarkable results. But because these actions appear unremarkable, people tend to overlook their importance. Also, sometimes, people are tempted to undertake intense and often risky "investments" as a shortcut to make up for past inaction. Unfortunately, this approach rarely pays off. Consistency beats intensity. This blog sets out the top 4 unremarkable actions that generate the most wealth if completed consistently over many years. Eliminate unconscious expenditure Holidays are expensive. And post-Covid, holidays are even more expensive. However, holidays tend to deliver a lot of happiness and satisfaction. We tend to think deeply about whether to book a holiday, where to go and how much to spend. This conscious approach to spending typically means we get good value for money i.e., in economic terms, maximise the utility per dollar spent. If you are reading this blog, it's very likely that you make wise, rational decisions about how you spend money. Therefore, your only potential weakness then is unconscious expenditure, which you must eliminate. Unconscious expenditure is when you spend money on items without thinking about it. These items tend to be small dollar value transactions. Most importantly, they tend to add little to your standard of living (i.e., utility), and as such, are a waste. A perfect example is the Stan subscription that I cancelled last month. My family hasn't watched anything on Stan for a few months, so it was a waste to continue to pay for it. Unconscious expenditure can add up to multiples of tens of thousands of dollars each year. How do you eliminate unconscious expenditure? There are two ways. You can track every dollar and cent you spend using an app like Pocketbook. However, for most people, this approach feels tedious, time consuming, and draconian. Instead, you need an approach that is simple and unintrusive so that you can stick to it for the long term. All my clients have had great success with the approach set out in this blog. If you can adopt a strategy that ensures you minimise or hopefully eliminate unconscious expenditure and stick to it for the rest of your life, it will probably literally save you millions of dollars. Invest regularly either in the share market or by making additional super contributions If you invest $500 per month for 20 years and earn a return of 7% p.a. (on average), you will accumulate $260,000. If you invest $1,000 per month, you will accumulate $520,000 (consisting of $240,000 of capital plus $280,000 of investment returns). You can accumulate substantial wealth by consistently investing relatively small amounts of money over long periods of time. The sooner you begin, the less you need to invest to produce substantial outcomes. For example, if a 25-year-old invested $500 per month, they would accumulate over $1.3 million by the time they were 65 years old! There are two main ways to invest money regularly. Firstly, you could make additional contributions into super (be careful to not breach your annual cap of $27,500). Or secondly, you could invest money in the share market. This blog sets out a very simple and cost-effective way to do that yourself. You must measure your progress You have probably heard these sayings; "what gets measured gets done" and...
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    17 mins
  • Should you ever sell property?

    Should you ever sell property?
    Apr 12 2022
    A common property investing rule-of-thumb is that you should "buy property and never sell". That's because prices always trend higher over time which means you benefit from compounding capital growth. Of course, the rule-of-thumb should be adjusted to include "buy quality property and never sell" to ensure you maximise investment returns. But the reality is, that sometimes the smartest thing to do, is to sell a property, even if it is a quality asset, if it helps you move forward towards achieving your goals. I discuss four of the most common scenarios where I have recommended clients sell property. Poor investment returns Of course, the most obvious reason for selling a property is that its past performance has been poor i.e., a low capital growth rate. But most importantly, you must form a view about whether future returns are likely to be acceptable or not. If the assets fundamentals are sound, then it's likely you should retain the asset. Sometimes investing requires patience and discipline, which I'll write more about in a few weeks. My previous analysis concluded that a property needs to underperform by at least 2% p.a. to warrant selling it. Therefore, if a property has only slightly underperformed (by say 1% p.a.), it may not be worth selling because doing so crystalises CGT liabilities and selling costs. I believe that there's almost never a bad time to buy a quality asset (property). By extension that means there's never a bad time to sell a dud asset. Whilst that is true to a large extent, it is wise to be strategic about it. A dud asset almost always has one or more impairments (e.g. located on a busy road). Afterall, that's what makes them duds. As such, they can be more difficult to sell in a balanced or buyer's market. As such, it is best to sell impaired assets in a buoyant (seller's) market. The rationale is that the high level of buyer demand and positive market sentiment may encourage some potential buyers to overlook the property's shortfalls. Illiquidity Investment property rental yields are relatively low e.g., a house might yield an income of 2% to 2.5% p.a. of its value and an apartment 3% to 3.5% p.a. before expenses. After subtracting expenses such as council rates, insurance, maintenance, property management and so on, you may receive a net rental income of 1% to 2% p.a. And that's before any interest expenses if you have outstanding mortgages. An obvious negative attribute of property is that its illiquid. That is, you can't gradually sell down your investment like you can with shares. Instead, it's a case of selling all or nothing. Investing a lot of your wealth in property whilst you are working can make sense because during that stage of life, you don't rely on (or need) investment income or capital to fund living expenses. However, when you are retired or approaching retirement...
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    17 mins