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Wealth Brief The Wealth Brief is brought to you by
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Edition 11
In this issue Top 7 investment tips for the next 10 years............................................................1 A business budget is a living thing!............................................................................1 Protect your greatest asset... your income! ...........................................................2 Where’s your Super gone? .............................................................................................2
A tax effective alternative to managed funds........................................................3 Son leases SMSF commercial property......................................................................3 Is this the right time to invest in the property market? ...................................3 Don’t fall into these traps when choosing a mortgage ....................................4
Top 7 investment tips for the next 10 years Nobody has a crystal ball to predict what will happen with markets over the next year, let alone ten years! However, there are underlying principles that have always applied and we suspect always will. Successful investment means having long-term strategies yet being able to adapt to take advantage of opportunities along the way. Before investing, there are four critical issues to consider: • Over what time period are you prepared to commit money? • What level of risk are you comfortable with? • How will you diversify your investments? • What are your financial goals and are they realistic? Over a ten-year period there will be peaks and troughs in all markets and your strategy needs to take advantage of these cycles. Your focus should be on the whole portfolio. Don’t panic if returns for fundamentally sound investments suffer in the short-term.
Tip 1. Research before you invest Share and property markets are not fully efficient and some assets are under-valued but have potential capital growth. Continual research will identify the time to change the balance between different market sectors and take advantage of economic cycles.
Tip 2. Focus on fundamentals A unique business model, a strong balance sheet, and exceptional management are criteria to look for in a company. Location, access to amenities
and uniqueness are critical for a successful property investment. In the long term, it’s the fundamentals not the rhetoric that counts.
Tip 3. Select good fund managers
financial pain of margin calls if your gearing falls outside an agreed limit.
Tip 6. Consider small companies
Fund managers can apply far greater time and resources into selecting assets and monitoring them than you can. Unless you have the time and the ability leave it to the professionals.
Some smaller companies will grow much faster than the general market in the next ten years, But many will fail. Intense research and diversification is vital in this sector as well as Choosing an expert fund manager or advisor.
Tip 4. Adopt a counter cyclical approach (The Warren Buffett way)
Tip 7. Be open to alternative investments
Following the herd is a sure way to lose money. For instance, in a booming property market there are going to be very few good value buying opportunities. Alternatively, a fall in shares prices as we are currently seeing can make many quality blue chip companies good value. There is no bell that rings at the bottom of the market? So buy quality and never sell, just like Warren Buffett
The financial services industry is dynamic and new opportunities are always emerging. “New” doesn’t necessarily mean successful so care and research is required. For example, “absolute return” funds and agribusiness investments are becoming more sophisticated and less risky. The use of capital protected or put options can give you peace of mind.
Tip 5. Manage your gearing Borrowing to invest remains an excellent strategy to build wealth. Whilst interest rates are low, it is tempting to increase exposure to more debt. However, be aware of the risk to your overall portfolio from an increase in rates and the
However, there are two other issues to consider. Firstly, use the most appropriate tax structure for your investments. Superannuation is probably the most tax effective investment vehicle. And, review your portfolio regularly to look for buying opportunities that will improve likely future performance.
A business budget is a living thing! It’s now 2 months into the new year and the hours you spent setting your annual budget are probably a distant memory, but now it’s time to get your budget out again and compare your progress since Jan 1st. A budget is a living document… it is the underlying tool that sets the direction of your business… it’s your guide to success.
By printing off your Profit & Loss report at the end of each month then doing an actual-tobudget comparison it will help you focus on areas that might need your immediate attention. Maybe revenue on a certain product or service is down, or your expenses have blown out. Knowing this on a monthly basis means that you can deal with it immediately and employ strategies to remedy any variations. Leaving it
until the end of the quarter, the half year or the year, will not give you as much control and place extra stress and strain on you and your cashflow. If you’ve been putting it off, don’t waste another minute… get your budget out of the drawer and print off your financial statements. Take control and guide your business to the success you deserve.
Protect your greatest asset…….your income! Whether your employed or self employed you should give serious consideration to the consequences of not having income replacement cover. What are the benefits?
How does it work?
• Receive up to 75% of your pre tax income if you are unable to work due to illness or injury.
Income replacement allows you to protect what is potentially your greatest asset, your ability to generate income. If you are unable to work for an extended period due to illness or injury how will you meet your mortgage repayments and other bills and expenses.
• Maintain your family’s lifestyle without the added financial pressure while you recover. • You can select from a range of waiting and benefit periods to suit your budget • The premium you pay for this cover is tax deductible.
Rather than putting your family’s lifestyle at risk, income replacement could pay you a monthly benefit of up to 75% of your income to replace your lost earnings.
Most policies will offer a range of waiting periods from 14 days up to 2 years. There are also policies that can pay a claim on accident after a few days and are especially suited to anyone doing manual work. You can also select from a range of benefit periods with maximum cover normally paying a claim up to age 65.
What is your future earning capacity ? The table below gives you an indication of what you could earn by the time you reach 65, and how much financial risk you are taking by not insuring your income.
Age now
Current income (pa)
25
35
45
55
$40,000
$3,020,000
$1,900,000
$1,070,000
$460,000
$60,000
$4,520,000
$2,850,000
$1,610,000
$690,000
$80,000
$6,030,000
$3,810,000
$2,150,000
$920,000
$100,000
$7,540,000
$4,760,000
$2,690,000
$1,150,000
Assumes salary will increase by 3% pa and no employment breaks.
Call your risk specialist or financial advisor to discuss further.
Where’s your Super gone? If you have had many different jobs with different employers over your working career you will probably have superannuation accounts in many different funds. Apart from costing you extra in fees, there are more serious concerns of which you should be aware. Investment strategy Choosing the right investments for your situation is critical to maximising your retirement nest egg. Super is for the long term and just 1% extra in returns every year can make a significant difference. For example, if you were earning $45,000 and just contributing 9% of your pay to super, you would have $141,127 after 20 years if the fund earned 7% pa. If it earned just 1% pa more, you would have $16,409 more!
being a nuisance, the big danger is your super fund loses contact with you. There are millions of dollars in “lost” superannuation accounts in Australia with more ‘lost’ super accounts added to the list each month.
Lost super
Paperwork
Super funds have systems to identify members who are “lost”. It usually means they have had mail returned as undeliverable usually because you have changed address. But they can also declare your account as “lost” if your previous employer is no longer making contributions.
More than one fund means more than one annual report and statement and more than one account to keep track of. Apart from
The Australian Tax Office has a database of “lost” members under their “SuperSeeker” service. You will need your Tax File Number
and (ideally) details of past employers to enable them to search for lost accounts. They can be contacted on 13 10 20 or www.ato.gov.au. Alternatively a service is available that will search many “lost money” registers including super. service can be found on www.findmysuper.com.au. Whichever way you do it, the key is to get your super all together now and make it work for you. Talk with your financial adviser to work out the best strategy for you
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A Tax effective alternative to managed funds An Insurance Bond is an investment offered by life insurance companies that combines the benefits of a managed fund with the security, tax and estate planning benefits of a life insurance policy. Unlike a managed fund, where investors pay tax on earnings at their marginal rates, the Bond is a tax-paid investment, because the tax on earnings is paid by the life office at the rate of 30%. It does not affect an investor’s personal income tax or annual tax return obligations, unless a withdrawal is made in the first 10 years. If the Bond is held for 10 years from the original investment date and subject to the 125% additional contribution rule, there is no personal tax impact on any withdrawals. The Bond is designed for investors seeking to invest tax-effectively in the longer term for themselves or for their children; those in higher
marginal tax brackets wishing to minimize taxable income; and investors wishing to defer personal tax on investment growth to future years or seeking certainty in estate planning and wealth transfer. Whilst Bond earnings withdrawn within the first 10 years are usually included in assessable taxable income, the capital component of any withdrawal is free from personal tax. Additionally there is a tax offset of 30% on the earnings, and this may be used to offset tax on other income. Withdrawals are also free of personal income tax in the event of death, disability, illness and financial hardship. Anyone aged 16 years
(10-16 with parental consent) and over may own a Bond. The Bond may also be owned by multiple individuals or by a company or a trust. If the Bond owner is the life insured, the owner may nominate a beneficiary who can receive the Bond proceeds tax free upon the death of the life insured, bypassing the estate and any potential challenges. A bond owner over age 16 can transfer Bond ownership to another party at any time. This may be done without any personal tax implications to the new owner (if transferred without consideration) whilst retaining the Bond’s tax status.
Son leases SMSF commercial property Question: I have a Self Managed Superannuation Fund (SMSF) and am looking at buying the commercial premises from which my son operates his Gym and Fitness Centre as an investment.
a business property that is leased by the trustee of an SMSF to a related party or is the subject of an enforceable lease between the trustee and related party is not an “in-house asset”: section 71(1)(j) SISA.
What are the rules on acquiring business property in your SMSF and can my son lease the commercial premises owned by my SMSF?
The catch is that the property must be “used wholly and exclusively in one or more businesses carried on by any entity”. This means that your proposed situation should pass the test. However, if your son lived in the flat at the back of the Gym, it probably won’t pass the ‘wholly and exclusively test’. This is due to the general rule of the ATO that considers any residential use of a property as not falling within that definition.
Answer: There has been much confusion in the past in relation to the rules in relation to purchase of business real property by a SMSF. The ATO’s Draft Ruling SMSFR 2008/ D3 endeavors to clarify these issues. While the Ruling is yet to be finalised, it does give us some clarity from the ATO. The legislation states that business real property that is acquired from a related party of a SMSF will not contravene the prohibition on acquiring a related party asset provided that the property is acquired for market value by the SMSF trustee: section 66(2)(b) Superannuation Industry (Supervision) Act 1993 (SISA). Similarly,
The Draft Ruling indicates that 2 basic conditions must be met before a SMSF or any other entity relating to or dealing with the SMSF can be said to hold property under section 66(5) SISA. • The SMSF or the other entity must hold an eligible interest in real property. This interest may be a freehold interest in the property,
leasehold interest or interest in crown land in the property of the definition. That is, the relevant entity must hold a freehold or leasehold interest in real property (which could include fixtures attached to the land such as buildings) or an appropriate interest in Crown land; and • The underlying land must satisfy the business use test in the definition, which requires the real property to be “used wholly and exclusively in one or more businesses” carried on by any entity. There should be no issue with your son leasing from your SMSF as it will provide income for your SMSF. However, as always, you should seek professional advice so that all your circumstances can be considered. Brett Davies Lawyers
Is this the right time to invest in the property market? When is the right time to purchase an investment property? Like shares, property should be considered a long-term investment – as the saying goes, the key is time in the market rather than timing the market. So while the right time to purchase a property might be simply when you can afford to, it is hard to ignore the possibility of getting in at the right time of the market. While statistics vary from one centre to another, most cities are experiencing their lowest rental vacancy rates for many years. This is leading to high demand and a sharp increase in rents, with the Australian Bureau of Statistics saying that rents have risen 7.1% in the 12 months to March 2008, the fastest growth since
1991. With the shortage of rental properties, further sharp increases in rents are expected. Housing prices have now been steady, or in some areas have fallen over the past 12 months. This together with the fact that interest rates have started to decline, makes investment property financially attractive. The supply of rental properties is influenced by many factors but some of the most significant are: • Building costs have continued to escalate while the price of established properties has been static or even fallen. • Due to recent slight falls in property prices, net yields on investment property have are currently around 5% a year.
• The global credit crisis has caused significant downward volatility on the stock market and creating nervousness among investors in all markets. • Lower marginal tax rates have made negative gearing less attractive to some investors. • The tax benefits of superannuation have resulted in some investors selling their property to invest in super. The aim of property investors is that the net effect of these pressures on rents will lead to an increase in housing prices over time.
Don’t fall into these traps when choosing a mortgage Not doing your research and choosing opinion over expertise
you have paid over and above your regular repayments, then you may be disappointed.
It is very important to not be too influenced by what you hear from family and friends, who may be in a completely different financial or lifestyle situation to you.
Features to consider are:
Going direct to your current lender for your new property loan and not researching loans offered by other lending institutions may seriously disadvantage you. We are living in an increasingly competitive mortgage landscape that sees aggressive competition amongst the banks. Can you guarantee your current lender will provide the loan arrangement that best suits you? You had better be sure because you will be paying it off for quite a few years!
• Redraw facility • Offset facility • Internet/branch access • Extra repayments availability • Penalties • Ongoing fees
Ignoring associated fees and costs Although it may be tempting to let your judgment be overshadowed by the standalone interest rate you should consider other fees such as application, deferred establishment, rate lock, monthly, break, switch and redraw.
Making your decisions based on honeymoon rates and giveaway offers Don’t make you decision based on a honeymoon (introductory) interest rate because you will be paying the ‘normal’ interest rate before you know it. A 0.5 percent discount on the interest rate for the first year or so will only benefit you in the short term and may end up making you much worse off over the long term. It is a good idea to pay at the ‘normal’ rate from day 1. This way you will be prepared for the end of the honeymoon period and you will have paid off more off your loan!
Comparison rates are often of assistance when looking at different loans’ overall ‘true cost’. Each loan’s comparison rate includes the interest rate plus fees and charges relating to it, reduced to a single percentage figure so you can easily compare. However, note that different amounts and terms will result in different comparison rates. Costs such as redraw or early repayment fees and cost savings such as fee waivers are not included but obviously may influence the cost of the loan, as will the changeable nature of variable interest rate loans.
Stretching yourself to the limit with repayments
Also, when deciding between variable, fixed or split rate, remember that just because the rate is the cheapest in the market doesn’t mean that loan will end up the cheapest in the long run. We all know a variable loan’s interest rate changes over time and a fixed loan’s rate has a limited timespan.
Although a lender may have approved the loan amount and term you applied for, you really need to make sure you can make those monthly repayments fairly comfortably for at least the next few years (when you may think about refinancing).
Another short-sighted mistake is to take giveaway offers, such as petrol or holidays, into consideration. For example, that higher interest rate on a giveaway offer loan will soon outweigh the benefit of the year-long discount on fuel that was offered.
You may be surprised to find that you need more loan features that you first realised. If the loan you choose does not have the facilities you need, e.g. allowing you to redraw on any money
• If fixed, the loan period for which it is fixed
• Overall flexibility
You may feel a certain loyalty to your current lender but this should not distract you from finding the most suitable property loan for you and your circumstances.
Not researching the loan features you need
• Variable, fixed or split interest rate
If you haven’t done so already, create a budget that lists every cost you incur over the year and break down those costs as per the timeframe of your expected loan repayments, which will usually be fortnightly or monthly. Include everything from vehicle maintenance to haircuts to magazines and morning coffees. You might be surprised at how much you actually spend over each period and how much you really have to put towards a mortgage.
Not factoring in interest rate rises Every savvy borrower factors in at least a 1 percent interest rate rise because mortgage
interest rates increase and decrease at times over the lifetime of the loan. You don’t want to get caught out by not budgeting for those rises! ‘Factoring in’ might mean you pay that little bit extra from the time you start repaying or you already have it in your budget for when a rise occurs. If you can factor in even more than 1 percent that will really help in the long run. Any extra money you put into your mortgage when rates are in a low and reducing cycle, as they are currently, will reduce the amount owing and will also reduce your eventual loan term, saving on interest cost. Even if you are paying off a fixed rate loan, that fixed term will eventually end so why not pay a little extra if you can afford to and the loan allows it. The rewards will definitely make it worthwhile.
Thinking property investment is a short term strategy Property investment can be exciting and a life-changing decision that can set you up financially, given the right choices and commitment to its long-term nature. A reliable short-term investment strategy is difficult to achieve for the average property investor. Sensible borrowers should consider property investment as a long-term strategy especially now house price growth is at a much slower or even negative growth in most states. Over the long term, there are many regions of Australia where good gains can be made if the buyer researches the area well and identifies the strengths and weaknesses of a particular investment. Investors should be aware that to gain a healthy profit they either need to create a capital gain by improvement or development. If it is purely a buy and hold strategy you should have a time horizon of at least 10 years or longer to gain a good return. Many investors looking for capital gain prefer long term interest only loan products such as lines of credit with split facilities, particularly where there is still some owner occupied debt to be repaid. This gives them flexibility and breathing space to afford managing loans on two or more properties. Resolving the confusion of comparing loans can often be as easy as speaking to a reputable mortgage broker. They typically have specialised software that assists them to compare multiple lenders and home loan products to help you choose the most suitable fit.
Disclaimer The information in this newsletter is of a general nature and is provided for illustrative purposes only. It is not intended to constitute advice of any kind. The information has been prepared without taking into account the objectives, financial situation, needs or circumstances of any particular person and should not be relied upon. You should not act on the information, rather it is designed for you to contemplate whether you should obtain professional advice if an issue may be of relevance, having regard to your objectives, financial situation, needs and circumstances. Authorised representative no 282461 of AAA Financial Intelligence Ltd AFSL: 312478
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