Low financial literacy: a serious threat to financial health

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Retirement readiness is low, both in Australia and internationally

Recently, the Aegon Center for Longevity and Retirement released its 2018 international Retirement Readiness Survey, a survey it has conducted annually since 2012. For each of the 15 nations surveyed, an Aegon Retirement Readiness Index (ARRI”) is calculated, ranking retirement readiness on a scale from 0 to 10.

A high index score is between 8-10, a medium score between 6 and 7.9, and, a low score being less than six. The results for workers in the fifteen surveyed nations (with a comparison with 2012 results, where available) are shown below:

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The “Jurassic Park” of financial advice

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The usual suspects’ advice practices again under scrutiny …

The latter part of April saw the Financial Services Royal Commission[1] examine some poor financial advice practices that had been brought to its attention. The Big 4 banks and AMP came under intense scrutiny, with the following areas highlighted:

  • Fees for no service, including continuing to charge the accounts of people who had been dead for some time;
  • Investment platform fees;
  • Inappropriate financial advice, that was allegedly in breach of the client best-interests duty that all planners must adhere to; and
  • Improper conduct by advisers.

While the poor practices highlighted resulted in a lot of adverse publicity for the banks and AMP (and, since, a number of board and executive resignations), they didn’t surprise us or, I suspect, most in the financial planning industry.

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Is the search for higher income yield misguided?

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Income yields are down, but should you worry?

The last few years have seen a fairly dramatic drop in the income yields obtained from typical balanced (i.e. roughly equal defensive and growth investments) investment portfolios. Reduced interest rates, lower rental yields on property and flat to declining dividend yields on shares mean that many retirees are no longer able to meet living expenses solely from the cash distributions (i.e. the income yield) generated by their portfolios.

There is often a reluctance to sell investments (i.e. draw down capital) to maintain desired spending. Rather, the apparent solution to the shortfall is often seen as higher yielding investments (e.g. higher risk fixed interest securities, including hybrids, high dividend paying shares and other structured products), with there being no shortage of financial product manufacturers happy to respond. However, yield enhancement always comes at the expense of a combination of increased credit risk, reduced diversification and/or increased taxation.

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Will investors benefit from a reduction in the company tax rate?

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Is a company tax reduction a second best solution?

The Government has proposed to reduce the large company tax rate from its current 30% to 25% by 2026-27. It argues that the reduction is necessary to keep Australia’s company tax rate internationally competitive and will create “jobs and growth”, ultimately leading to wages growth.

It’s been a hard sell, with those opposing the move citing, among other things, the budgetary cost and a lack of confidence in the reliability of so-called “trickle down” benefits to Australian workers.

We don’t propose to enter into the argument as to whether a drop in the company tax rate is a good or bad thing for the Australian economy. However, as a generalisation, we don’t think a tax on companies is a particularly efficient tax, given the scope for avoidance and that shareholders ultimately bear the tax burden. Most likely, it would be more effective to tax shareholders directly.

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What’s the fuss about interest only loans and offset accounts?

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Interest-only with offset: a winning product?

Interest only loans for residential property purchase, for both owner occupiers and investors, have been in the news lately. With no requirement to repay principal, the concern for financial regulators is that many borrowers don’t have the incentive to build sufficient equity “buffers” to cope with any falls in housing values and/or rising interest rates.

The rapid growth in interest only loans was considered such a threat to financial stability that in March last year the Australian Prudential Regulation Authority (APRA) placed a 30% cap on interest-only loans as a share of new bank housing loans.

In October 2017, Westpac chief executive, Brian Hartzer, made the shock admission to the Parliamentary Standing Committee on Economics that about 50% of Westpac’s housing loans were interest only. He also explained that his bank was expecting to comply with the APRA requirement by making interest-only loans considerably more expensive than traditional principal and interest loans.

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The changing shape of emerging markets

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Emerging markets have recently re-emerged

The two years to end December 2017 saw the MSCI Emerging Markets index (the most widely used benchmark for emerging market shares) massively outperform the MSCI World Index (the benchmark for developed market shares). Emerging markets recorded an annualised return of 19.2% p.a. for the period, compared with 10.8% p.a. for developed markets.

This stellar performance has escaped the attention of many, perhaps because the previous five years saw very lacklustre relative returns for emerging markets. They returned only 2.0% p.a. compared with developed market returns of 15.4% p.a. for the period from December 2010 to December 2015.

Soon after the worst of the Global Financial Crisis, many subsequently disappointed investors jumped onto the story that the future belonged to emerging markets – remember the BRIC excitement (i.e. Brazil, Russia, India and China) – with prospects for developed economies generally assessed as bleak.

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Forecasting share market returns

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Our investment philosophy relies on capitalism continuing to work

A key tenet of our investment philosophy is that it’s extremely difficult to reliably predict short term (i.e. out to five years) movements in share markets. Markets are very effective in distilling all that is currently known about individual companies, their markets and the relevant economic and political environment to determine “fair” values both for the companies that make up a share market and for the market itself.

Now “fair” doesn’t necessarily mean correct. But it does mean that it should not be an easy task to reliably outperform a share market index by identifying and buying “undervalued” companies (and, perhaps, selling “overvalued” companies) or by entering or exiting that market based on views of its future direction. There is a mountain of robust academic research to support this view of “fair’.

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Household Income, Wealth and Debt in Australia: an update

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A summary of household wealth and income

Every two years, the Australian Bureau of Statistics (“ABS”) releases its survey of Australian household income and wealth. The latest release[1] relates to the 2015-16 year. It provides the opportunity to update our “Household Income, Wealth and Debt in Australia” article of September 2015, that examined various findings from the 2013-14 survey, and to drill down a little to further into the growing level of debt held by Australian households.

The left hand side of the chart below shows how household wealth or net worth was distributed in 2015-16, while the chart on the right hand side shows how that distribution has changed (in 2015-16 dollars) over the 12 years since 2003-04. Some takeaways from the charts include:

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How “real” are your financial planning projections?

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It’s maintaining real spending power that matters

When clients consider how much they expect or wish to spend in the future, they naturally think about it in terms of today’s dollars. The implicit assumption is they don’t want price inflation to erode the amount of goods and services they are able to purchase.

In our cash flow modelling, we assume an inflation rate of 2.5% p.a., mid-way between the Reserve Bank’s target of 2-3% p.a.. With inflation at 2.5% p.a., the spending power of a $1 would be reduced to about 48 cents over a thirty year period.

So, while a financial projection that shows your investment wealth grows from, say, $1 million now to $2 million in 30 years’ time may appear impressive, after adjustment for inflation of 2.5% p.a. the future $2 million is only worth $953,000 in today’s terms i.e. you’ve actually gone backwards in spending power.

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Pitfalls of retirement planning

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Retirement expert reconsiders previous thinking

Most planning advice, both regarding saving for, and the enjoyment of, retirement, is given by people who are not retired. So, while the advice may be well meaning, it could inadvertently suffer from a lack of empathy with the realities of retirement.

In addition, the experience and expectations of current and previous retirees may differ significantly from that of the vast numbers of baby boomers that will increasingly dominate the ranks of the retirees over the next decade. As a result, retirement advice based on researching earlier generations may not be as relevant as desired.

A recent article in “The New York Times”, titled “Three Things I Should Have Said About Retirement Planning”, touches on the above issues. It is a confession by Paul B. Brown, who co-authored two books on saving for retirement in his 30s and 40s and is now aged over 60, that his typical advice suffered some inadequacies, now made apparent by his own life experience.

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