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If you believe the rhetoric coming from the industry funds, they would have you believe Financial Planners don't want to work with them, because we are greedy, commission taking middle men/women, who care only for ourselves. I'm sure we've all heard this type of line trotted out through advertising and/or interaction with a fund itself. But could there be another reason? One where you're interests are being looked after? The following example may provide some insight into why Financial Planners don't like Industry Funds.
Chronology of Events:
Moreover, the client then received an email directly, espousing the virtues of the Industry Fund and
"We recently received a request from your financial adviser to access your account information. It's fantastic that you’re taking a keen interest in your superannuation and general finances and we will work with your adviser to provide any requested information."
So far so good. This sounds pretty positive. But then "Many of ......’s advisers have worked in the industry for over 15 years and are not paid commissions, so you can be sure that their recommendations are in your best interests. Our team of financial advisers operates Australia-wide. Please contact .... Advice if you would like to arrange an appointment with a .... financial adviser"
I'm sorry, but this doesn't sound like an organization trying to work with the client's financial planner. This sounds like a marketing arm trying to cast dispersion on the client's financial planner to try and win business for their own financial planning business. If I was being suspicious, I might also think that they want the client to leave their financial planner so that they don't have to answer uncomfortable questions about stuffing up their contribution strategy. Either way, I don't see how their actions in trying to 'win' a client away from a competent adviser who is acting professionally for their client can possibly be in the clients best interest?
This is just one of many examples of why a professional financial planner may not like dealing with Industry Funds. They don't communicate with us, they ignore instructions, they try to overcome shortcomings by directly marketing to the client, they try to break the client/planner relationship etc etc. Why oh why wouldn't we want to work with organisations like that?
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The federal budget was handed down last night and there is generally plenty of extra money we will all be paying, whether that is through reduced payments received from the government or by additional taxes. On the whole however, there also seems to be plenty of common sense measures.
Superannuation remained relatively untouched, however they are proposing to get rid of the excess non-concessional contribution penalties. These were the ones that could see you paying as much as 93% (and in some cases higher) tax on contributions if you made a mistake and put more in than you should have. This was always a stupidly punitive measure and its about time that it was abolished.
There are some tough measures for the age pension scheme, and clients will have received our summary of these. However, while they do reduce the amount that clients receive, a simple analysis of demographics tells us why this was necessary. For example, when the age pension was introduced in 1909 the male life expectancy at birth was 55, 10 years below the age pension age. The average age expectancy of a male born now is 80 which is 15 years over age pension age. Add to this the expectation that the number of people over the age of 65 will double and those over 85 will quadruple over the next 40 years and you can see the problem. It may be politically unpalatable but it's our expectation that we haven't seen the end of these types of changes.
The water however is significantly muddled by some of the popularist comments made by competing politicians. Frustratingly, their comments grab a good headline but don't add up. Clive Palmer this morning said they would oppose the co-contribution for medicare because a pensioner on $300 per week who needed to go to the doctor every day (surely a minority) would be spending a third of their money on seeing the doctor. If we assume you are going to a 7 day medical centre then the total co-payment would be $49. The last time I studied maths, $49 was not one third of $300.
Also, why do the opposing side say that the budget measures are unnecessary because our debt levels are less than other OECD countries? If we look at the financial positions of many of these countries, I would suggest this is a fact we should be forever grateful for, not using it as an excuse for why we're doing OK. If this is the yardstick by which we are measuring financial health, perhaps we should look to aim a little higher.
So is this the budget we needed to have? Who knows. I suspect they are all lying to us. But if we are to stay the lucky country it seems to be common sense that we have to do something differently to what has gone on in recent years.
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Warren Buffett has been one of, if not the most, influential and successful investors of our time. His investment company Berkshire Hathaway has delivered a compounding return to its shareholders since 1965 of 19.7%pa and this has been accomplished by adopting a very active investment style. So it is perhaps surprising that his Will asks for his estate to be invested in the S&P 500 Index.
Buffett has long advocated that the index would beat any active strategy over time. He once famously made a $1 million bet with a New York asset manager that any five funds they picked would be beaten by the index after 10 years. It is interesting to consider why such a successful active manager would adopt the view that passive will beat active over time. We see many reasons, but here's just a couple.
The first is that there is only so much alpha (the return above the beyond the market that is sort after by active managers) to go around. The markets are huge, but they are effectively a closed system and so for every 'winner' there has to be a 'loser' in the search for alpha. Now there are some fantastically smart people out there in management land, but one of the problems is these people are not fund managers for altruistic purposes. They want to get paid, and generally very handsomely. There is nothing wrong with that, but it does diminish the returns available above the market return. The second challenge is that as active managers trade in and out of stocks, they incur transaction costs as they buy and sell and tax costs when they sell at a profit. And being active, this activity generally has a higher cost associated with it than a simple passive market investment. Again, this diminishes the amount of their potential out performance.
The result of all this activity is that the number of funds that actually outperform the index is very small. Add to this the fact that past performance doesn't predict future performance and you will have a very hard time picking a consistent winner. So instead of trying to, you can choose a fund of funds approach which invests across a range of managers with different styles and views on the market. Would this make sense? Well, it might, but you are more likely to end up with an expensive equivalent of an index fund.
This makes it sound like an easy decision. And it would be, if there weren't some fund managers who beat the markets for a long time. If you happen to be invested with them, enjoy it but don't fall in love with them. Statistics are not on their side in the long run. Its also probably more a question of luck on the investor's or adviser's part than it is good research. That's not to say there wasn't a lot of work that went into choosing that particular manager but there are just too many variables that go into the manager's performance that are outside of your (and perhaps their) control.
This doesn't mean that we are against taking specific views on companies and/or managers. Some managers may add something to your portfolio that is not easily replicated in an index (whether that is due to a financial, moral or social belief for example). Or the company may have certain characteristics that appear particularly attractive at an attractive price. What we would generally say is that if you're going to act on those views you need to have carefully considered reasons for doing so. Because the likelihood is that for all its foibles the market is a more predictable and dependable choice.
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A lot has been said about the proposed legislative shift toward having Superannuation Pension income streams deemed for Centrelink purposes,
rather than the current system of deductible amounts. It is a big change from a planning perspective as it means we have yet another grandfathered structural
consideration to remember before giving advice.
From what I can see, the change will mean that more income is attributed to a person/couple, but that in many cases this will have little
effect if any on the amount of pension actually received. Certainly, other planning considerations would eclipse the minor loss of pension. There are
exceptions to this however, so the choice to commute an existing pension suddenly becomes harder, and clients can expect to have multiple pension
accounts going forward (so much for simplifying the system).
What the change does do however is make the effects (whether small or large for an individual client) very sensitive to future changes in
the deeming rates. Current rates are only 2% and 3.5% (below and above threshold respectively) which by historical standards is very low. In 2008 these were 4% and 6% respectively and if rates revert to these levels the effect on pension payments could be substantial.
I’m a bit perplexed by the rhetoric in the media about how this creates a disincentive to saving in superannuation and will cause major problems
for those on pensions or approaching pension age or looking to retire. At this point I’m seeing it as a mountain made out of a mole hill for our clients.
What are the other effects of the change? Well for advisers who deal with Centrelink quite a bit the answer to this is clear. The paperwork and
calculation reductions will be massive (and that’s just in my tiny office, imagine Centrelink). Every time a pensioner does a partial commutation this
requires a recalculation of the deductible amount that relates to the income test. Every Time! Deeming would do away with that and the corresponding
reporting. Relevant numbers would become largely irrelevant. No more looking up life expectancy tables every time a pension is commuted and recommenced, made
reversionary etc. Even the detail of income stream product forms probably become redundant.
Last but not least, gone are the worries about how to classify additional monies required by a client during the year. Is it income (more than
reported to Centrelink) or is it a commutation? What are the negative effects of either option? These questions no longer apply if the remaining capital amount
is simply deemed.
So this change seems to me to be something that potentially has little if any effect on the basic payments made to people on the age pension. It will cut down
the administrative complexity in the system to a large extent. However, the individual result on a client by client basis can vary significantly depending
on their circumstances and these change over time. So the planning complexity has increased.
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I see that Treasury has again put out their estimates of what the Superannuation system is costing the government in lost revenue. Apparently it is still around $32billion and the underlying implication is that something should be done about it (especially for a government trying to save money). My only hope is that the government doesn't actually use these figures to make any decisions.
This is the same rot Treasury trot out every year in relation to Super and it is then systematically pulled apart by economists and professional bodies. The tax concessions may cost the government $16b, but compared to what? If the money was retained by the companies and taxed at corporate rates? If the money was paid as wages and taxed at marginal rates? If the super system costs the government $16b its costing employers $75b (the total cost of the payments being made less the corporate tax that would be payable on that extra profit. - yes I know there are non-SGC contributions but there has to be some assumptions - doesn't there Treasury). Why does it cost employers - because Super is additional to wages.
Now if it is accepted that Super is additional to wages, and wages generally get spent, the apparent tax foregone on earnings from Super is actually not a
cost at all because its savings money that wouldn't otherwise be there. The income they get from taxation of Super earnings is simply a cost offset, so this actually reduces the net cost of a concessional Super system (so now it is much less than the $16b). If we assume the $1.6trillion in super earns 4% taxable earnings this equates to $9.6billion. Gosh, the cost is diminishing pretty sharply.
Then you look at where this money goes and the economic benefit of having such a massive amount invested. This money is helping build businesses (which make money and pay tax), build infrastructure (which improves efficiency, which increases profits and increases the tax take) etc.
Then we look at the reduced welfare that is paid as a result of Super as an asset in retirement. This is hard to calculate, particularly if looking forward to
when the Super system itself is mature, as well as the uncertainty of demographics, legislative changes etc. however it could be done - again with a number of assumptions. But again this reduces the cost of our concessional system.
Finally, lets look at the countries around the world where everyone is reliant on the government for their age pensions. How's that working out for them? There has to be a positive for the certainty that governments can derive from knowing that they will become the financial backup, rather than the primary provider of retirement incomes. There is also a benefit in people becoming more educated about money, engaged with saving and becoming more self reliant (at least to a greater extent).
Every year Treasury lament the exorbitant cost of Super. But they seem to take a very myopic view in deriving their figures.
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In a study by James Fairweather - Martin Currie Investment Management, 2008 a number of psychological factors were discussed as they relate to making decisions about investment. They raise some interesting challenges for investors and managers because it seems that to make good decisions, you may often need to overcome human nature.
People generally are driven by emotion and the need to socialise rather than to be logical. To some extent this helps explain why we will talk to friends and family about the economy and investments and are just as likely to draw conclusions from these interactions as from empirical or factual evidence. If these two sources of information agree, then our feelings about what we believe to be the case are very strong. If they disagree, we will tend to view the empirical evidence with a healthy degree of scepticism and our emotional state (driven by social contacts) will tend to prevail.
Secondly, in making investment choices, once we have made up our minds that we have a particular view on a market, an individual stock or fund, it takes a lot to make us change our minds. In fact research has shown it can take 2 – 5 observations of contrary information, to change the opinion we initially formed. This perhaps goes some way to explaining why markets tend to run upward too far in a bull market, and down too far in a bear market. In a bull market we know that prices are getting too high, but before we change our positive opinion, we want to see more proof. This is exacerbated by the fact that as we search for more proof, the market continues to move higher.
In the face of huge quantities of information, often expressing contrary points of view, we also have trouble imposing a logical decision making process. We develop rules of thumb to help overcome the information overload, which we show great faith in although they tend not to be very accurate. To compound the problem our commitment to our first impression means it is very hard to change our minds. Paradoxically, the more committed we become, the less often we are right. Then, even if we do formulate a viewpoint that is contrary to the norm, we feel very uncomfortable having this point of view, question why we would feel we know better, and have trouble forcing ourselves to act contrary to the group. The result of these factors acting collectively across markets, is that we invariably have market bubbles and market crashes.
Perhaps we should all be careful of the discussions we have over the Christmas barbecues and family get togethers this festive season and add Investment to the banned list of subjects along with politics and religion (although given the occasion its perhaps a little hard to ignore religion). Lets enjoy beating the English at cricket and watching the boats race to Hobart. Save investment for less social occasions lest we hold our thumbs to the wind, draw strong conclusions about which way its blowing, decide to go with the flow and put a dent in the new year before its even begun.
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Smart phones are a great tool for both personal life and business. The ability to carry around your calendar, access emails, create pdfs for filing, save to and retrieve from cloud sourced archives like dropbox – these are all fantastic features that make life easier and add to productivity.
There are also plenty of useful personal tools like a spirit level, flash light, calculators, plus any number of games if that sort of thing interests you. It’s all good stuff, and a lot of it can be downloaded for free.
I have always found having a torch or flash light app on my phone to be a pretty useful thing. So having recently changed to an Android phone I decided to download a torch app. I found about 2000 of them available in google store, chose one that had been downloaded by about 3 million people before me with great reviews (how can than many people be wrong) and hit install.
Now the fun begins. Because at this point you get a message that outlines all the permissions that you would be giving this app by consenting to download it. Well, it’s a flash light app so it would need to have use of my camera for the purpose of using my flash, and perhaps the internet for notification of updates. So I was appalled at what permissions were actually built into this ‘free’ app (and I searched though about 20 others and they all have frightening similarities).
If I had gone ahead with it, this little torch would have had complete access to my contacts, my phone and the ability to make calls without my consent, all network drives attached to the phone, my data connection, the ability to take pictures and video without my consent, my emails, my location and the ability to modify/delete content on USB storage. WHAT THE? All I wanted was a torch.
It raises some interesting questions about what ‘free’ might actually cost you. Now this app had been used by many, many people who clearly hadn’t suddenly found their lives
taken over by their flash light. But perhaps that’s only because the time isn’t right yet. The information about me they are being granted access to is in no way relevant or commensurate to the purpose of the app. So the question has to be, why they are asking for it.
Sad to say, I haven’t found a torch app that is satisfied with its station in life. So I continue to stumble around in the dark looking for my keys or stubbing my toes on the door jamb when all I wanted was a glass of water when everyone is asleep. But it’s a small price to pay compared to the possible costs of using these apps.
Don’t gloss over the permissions you are giving, because you’re
in a hurry to gain the utility offered by your smart phone. If you do, you may
just find out the price of free.
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In the last post we briefly looked at lifecycle investing concepts and sequencing risks, and mentioned that longevity risk may become a greater factor in our attempt to avoid sequencing risk. Like many things when dealing with an uncertain outcome, its all a bit of a balancing act. There are any number of unknowns and all the projections in the world are based on a set of imperfect assumptions that can and will change over time.
So how can avoiding sequencing risk cause a possible increase in the risk that you will outlive your money? Basically it is because in a product driven lifecycle investing world you are progressively deleveraging the risk out of your portfolio (at least that is the theory). Stripping the risk out, also means that you are probably stripping out the variability of returns, both good returns and bad returns, and this leads to a more predictable result.
In recent research conducted by Farellys, it was found that in searching for this predictability, you may simply be leaving yourself exposed to a different sort of risk. In the graph to the left you can see the portfolio (70% growth assets, 30% defensive) has been designed to meet the life expectancy of the individual investor, even under pessimistic investment return assumptions.
In the event that the expected investment return assumptions prove closer to the mark, the portfolio effectively has no longevity risk. The blue line shows the portfolio is capable of paying the required income in perpetuity. The line isn't smooth, there are plenty of ups and downs, but it is expected to last regardless of age.
Now what happens when we use a portfolio that attempts to control for sequencing risk? The lower levels of risk in the portfolio do as they are supposed to, in that they reduce the variability of returns. Looking at the graph to the right (30% growth assets, 70% defensive), you can see that all the lines have significantly less wriggles, meaning the portfolios are experiencing less volatility.
What we can also see however is that now the portfolio is expected to run out of money at some point in the future. Yes it is well past life expectancy but live 18 years longer and you will have completely depleted your funds. The pessimistic expectation has been improved slightly.
So in this scenario you have a potentially more stable portfolio, however it is expected to fail at some point should you live long enough. Contrast that to the first portfolio where it may fail, but this is not the expected outcome. The former portfolio is about controlling the downside, while the later control both the down and upside of performance. (I must stress, this doesn't necessarily make it inferior).
The points above all deal with portfolio risks at one level or another. However the risk we are really talking about here is the risk that comes from not knowing how long we'll live. Life expectancy (LE) is increasing and quite quickly. So how long are you going to live? Remember that LE tables are only dealing with the average. If the average is 84 and you make it to 83, the good news is that your LE is not 1 year. For every year you survive your LE actually goes up, because there were others less fortunate than you who didn't make it to the average age. That's the risk of planning based on averages.
The graph to the left shows that as LE increases, the problem with the de-risked portfolio is that it increases your risk that the planned depletion of your funds is reached. While this may seem like a good idea at the time you make the plan (or your fund automatically adjusts your portfolio based on age rather than individual factors) but it is likely to feel less like a good idea the closer you get to portfolio depletion.
So controlling for sequencing risk when done through a non-thinking product facility is not necessarily the answer to all investor's worries. It should help the fund managers who won't have to answer to angry clients during periods of poor performance. But the investor may be condemned to a guarantee of mediocre performance and planned failure. Longevity risk remains perhaps the biggest risk for most retirees. While we all hope to live a long and enjoyable time in retirement, we just don't know how long that will be. Trying to control for the uncertainties in that equation is not as simple as it may seem.
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At a recent portfolio construction conference the buzz word/concept was one
of lifecycle investment. The basic premise of this concept is that the portfolio you might construct for a 20 year old would be different to the one constructed for a 60 year old. Namely, that the 20 year old can afford to take more risk and so can have a higher weighting to growth assets. The 60 year old would have a higher weighting to bonds and cash.
Now there is quite a bit of research behind lifecycle investing, and the main reason it has sprung to prominence in a post GFC world is its ability to control, to some extent, sequencing risk. This is the risk posed by poor returns right at the time when you have little time to recover and also have the largest sum of money at
stake. That is, generally just before retirement. A series of negative or subdued returns right at that point in time can have a much larger impact on your overall financial position than say, when your 30.
I have no particular problem with lifecycle investing theory per se. It is an approach that professional advisers use all the
time dealing with clients at different stages of their life. The problem I believe is where product providers take a ‘planning’ concept and try to dumb it down to a ‘product’ solution.
There are already large industry Super funds who are making mandatory changes to their default investment options, where unless instructed otherwise, everyone in their default option will be transitioned to a ‘lifecycle’ product over the next 2 years. What are the problems with this? Firstly, it assumes that every one of the same age has the same needs from their portfolio. This is obviously rubbish. It also will mean moving older client’s money into bonds at a time when these assets are at historical highs around the world. So it requires the movement into assets at a time when this may not make sense. Over a 30 year timeframe this may not be an issue, but imposing a short timeframe on the
transition may create the exact circumstances they are trying to avoid (sequencing risk).
There is also the chance that in attempting to avoid sequencing risk, these products may be increasing your longevity risk. But that is a topic for another article.
These are examples of the problems that come with ‘product’. It is an unthinking mechanism blindly imposing parameters that may or may not suit the individuals affected. The simple answer to this is to get some proper advice and
get involved with your super. If you’re in the lead up to retirement and in a changing default option, this may be more important now than ever.
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As we all muddle our way through the various financial crises that affect us at a personal, national and international level, we often crave the one thing that is cruelly denied us. Certainty. Our love of this elusive knowledge can be evidenced in many ways. For example, we may pay more for something with a clearly stated guarantee, even though the terms of the guarantee are no more than required by consumer law. Or the price of a poorly performing stock may go up after the company comes out and tells us that our fears were justified, simply because we now know our fears were justified and we needn’t have been more fearful. The more uncertainty there is, the more we are willing to pay for the knowable, or at least the perception of it. But you also need to stop and ask yourself, can we afford the price being asked.
Fear can make us somewhat myopic. From an investment perspective, uncertain conditions makes us focus squarely on the risk of capital loss. When conditions appear more certain
(emphasis on appear) we tend to focus on the risk of missing capital gain. Both can be very expensive over the longer term. Take a cash investment in the US as an example. Citibank is offering its platinum clients (those investing more the $500,000) a 10 year term deposit rate of 0.4%pa. In a time of great uncertainty about economic recovery, effects of economic stimulus, effects of winding back the economic stimulus, you can be certain of 0.4%pa for 10 years. No-one does retirement projections based on this level of return. Why? Because it doesn’t work out very well. If things turn out OK, investing for certainty will turn out to come with a cost that few can afford.
Usually (and I must stress usually), the time for being brave is when you’re feeling frightened, and the time for being frightened is when you’re feeling brave.