Understanding Investment Returns
Investment returns are often not what they first seem
There is often a lot of misguided talk, sometimes boasting, about the level of returns people get on their investments. This can leave some feeling as though they’ve missed out.
Before you get too caught up in what others are (apparently) achieving you need a good understanding of some important investment return concepts. You need to make sure you are comparing apples with apples and this is often very difficult to do.
We look at three fundamental issues that need to be considered when reviewing investment returns.
The Holiday House Is A Lifestyle Choice
The holiday house purchase decision: emotional or logical?
You’ve just spent two glorious weeks at the end of January at your friend’s beachside holiday house with your young family. The stress of the past year’s hard work has vanished and you’re feeling great. You’ve reconnected with your partner and your five and eight year olds have been reacquainted with a parent.
It’s about the worst time possible to make a rational investment decision but you decide that you should buy your own holiday house, now. A couple of hours drive from home, so that you and the family can recreate the bliss of the recent holiday every weekend.
Investment Return Volatility – A Potential Wealth Hazard
Investment return volatility is poorly understood
Most investors understand that in order to increase their expected future return, they have to accept a higher level of volatility (or variability) in the value of their investment portfolios. But beyond that, they do not understand just how damaging volatility can be to their wealth aspirations.
The amount of volatility you expose yourself to affects your probability of achieving a desired wealth outcome. In this sense, it is a forward looking concept. And, as such, it is an extremely important factor to take into account when designing and managing any investment strategy.
But this article reveals some poorly understood aspects of volatility, by looking backwards. That even when you know actual returns and actual volatility, wealth outcomes may vary dramatically.
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Why you need a personal cash flow budget
Surely the wealthy don’t need to budget …
It is true that some high income earners have no idea how much they spend, simply too busy making money to take the time to work out how they are spending it. And there are some people who consider you are not really wealthy if you ever have to ask how much anything costs. Budgeting is so demeaning.
However, it is no coincidence that all major businesses budget and account for their cash inflows and outflows. It is unlikely any lender or potential shareholder would provide them with funds if they didn’t. They would be viewed as financially irresponsible.
If you’re serious about personal wealth management, we believe that household cash flow budgets are a necessity, not a nice to have or something only the less well off need to worry about.
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Maximising Super Contributions – Beware
The super contribution rules changed from July 2007
If you’re planning on maximising your super contributions, it pays to be vigilant when managing and implementing your strategy. There can be a nasty sting in the tail if you’re not careful.
Prior to the introduction of “Simple Super” there was a limit on the amount of pre-tax contributions you could make to super. But after-tax contributions were unlimited.
The “Simple Super” changes not only put a limit on after-tax contributions. They also changed the nature of pre-tax contributions.
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Borrowing and Wealth Management
Attitudes to borrowing
We all know that many people have become very wealthy through the use of borrowing. These people are often lauded as brilliant entrepreneurs and we are encouraged to emulate their success. But the last couple of years have again starkly reminded us that borrowing also comes with considerable risk and, potentially, financial ruin.
Where does borrowing sit in a wealth management plan? There are many opinions:
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Employee Share Schemes – Are the proposed changes all bad news?
For many, receiving shares or options from your employer is a welcome benefit. There are usually no immediate tax or cash flow implications and you simply get access to a new investment that, hopefully, will grow in value.
The May 2009 budget proposed changes to the treatment of these benefits which are likely to affect both the issuance and immediate implications of employee share schemes in the future.
Currently, as a recipient of shares or options under an employee share scheme , you get the choice on when to pay tax on the benefit you receive. If you do nothing, you will be deemed to defer the tax until a later date (the “cessation time”). Alternatively, you can elect to pay tax on the discounted benefit upfront by making an election in your tax return.
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The ‘Secret’ to Wealth Creation
Will a good financial adviser create wealth?
Many in the financial planning and wealth management industry want you to believe they hold the secret to creating wealth. They’ll guide you into the right investments. They’ll use their superior technical skills to minimise tax. And, perhaps, they’ll suggest you borrow and invest to accelerate your wealth accumulation.
Some would want you to believe they can perform the financial equivalent of alchemy. But, realistically, the best a truly competent, professional adviser can offer is to help you develop and effectively use the financial resources or capabilities you already have.
In saying this, we do not want to denigrate the value of good advice. It can be substantial, particularly compared with the damage that can result from poor advice or naïve do-it-yourself wealth management attempts. But the ability to provide that value does depend on having some good raw material to work with.
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International shares: To hedge or not to hedge?
Strong Aussie dollar wipes out international share gains …
In our recent article, “Should you hold international shares in your investment portfolio?”, we argued that there are diversification or risk reduction benefits from holding international shares as part of a share portfolio. To keep it manageable, we did not directly address the exchange rate risk that comes with owning shares denominated in another currency.
However, with the Australian dollar (AUD) appreciating 36% against the US dollar (USD) and 25% against the Reserve Bank’s trade weighted basket of currencies over the six months to September 2009, we are concerned that some poor decisions are being made in response.
The past six months has seen strong local currency gains in international shares almost completely offset by exchange rate losses when converted to AUD. This has resulted in some investor disenchantment with international shares. The knee jerk reaction has been to either reduce the international share allocation and/or to choose share funds that are protected against exchange rate movements i.e. hedged.
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How far to financial freedom?
What you live off when you’re not working …
In our introductory meetings with potential new clients, we want to obtain a preliminary view of their “Net Investment Wealth”. It quickly gives us an idea of how far along the road to financial freedom or financial independence they have come and how far they have to go.
Net investment wealth is your net worth less your lifestyle assets. It’s the stuff available to live off when you are no longer earning income from your work.
To make the concept more concrete, consider Steve and Kate Wilson. Their assets and liabilities are shown below:
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