Tag Archives: Financial Planning

Will cash remain king?

By Robert Wright /May 28,2024/

Cash has been one of the best performing defensive assets over the past three years. When compared with global bonds (a riskier asset class), a typical portfolio of term deposits would have returned a cumulative 12.6% in comparison to -8.5% for global bonds over the three years to December 2023. With interest rates expected to stay higher for longer, cautious investors would be right to question whether other asset classes are worth the risk. But are the tides changing?

On paper cash still appears to be king; however, these healthy returns are attributed to accelerated inflation and rising interest rates, an environment we may be moving away from. Inflation has been trending downwards for months and rate cuts are predicted to begin before the end of 2024.

In this paper we explain why we believe now is a good time to revisit your asset allocation.

What is a bond?

A bond is a loan made by an investor to a borrower, generally a company or government. Typically, the borrower pays the investor interest (coupons) periodically over the term of the loan and then returns the initial value (principal) of the loan back to the investor at an agreed upon future date.

Bond values are linked to the borrowers perceived ability to pay back the loan as well as interest rates. For example, when interest rates rise, newly issued bonds offer higher coupons, making them more attractive and equivalent existing bonds with lower coupons less attractive, reducing their value.

How do bonds differ from term deposits?

Bonds are expected to provide higher returns over the long term because investors require compensation for assuming investment risk. Bonds also provide the opportunity for capital growth as well as higher income. This compares with term deposits where interest payments are lower but guaranteed by a bank – providing more security. Whilst income is guaranteed, the real value of a term deposit often diminishes over time due to inflation, which erodes your purchasing power (figure 1).

 

 

 

 

Figure 1 also shows that bonds are subject to greater risk over shorter time horizons which means they won’t be suitable for everyone. Your initial investment can go down in value and when you invest in funds this can be offset through the distributions, reducing your income. This primarily occurs when interest rates are rising and become unpredictable as they have in recent times.

Investors need to determine, with support from their adviser, whether trading term deposits capital guarantee for the potential increased return of a bond investment is suitable to their circumstances.

Why now?

In an environment where inflation is trending down and rates are expected to be cut, long term bonds should perform well as this is the environment when you typically experience the most capital growth (see figure 2). Term deposit rates are also forward looking. In other  words, you don’t need to wait for central banks to reduce cash rates before you start to see term deposit returns fall. There are already signs of this happening. Whilst  very recent, 1-year term deposit rates came down by 0.05% in January and we expect this trend to continue (although this won’t necessarily be a smooth journey). Whilst seemingly insignificant, this could be meaningful for larger investors. Particularly where capital growth has no role to play and investors don’t require the capital guarantee of cash.

What happens if the economy deteriorates?

If a recession were to occur, interest rates are more likely be cut quicker to encourage spending, resulting in bond prices rising. This would be supported by increased demand as investors move away from higher risk assets such as equities. If we don’t enter a recession and achieve a soft-landing scenario, rates will likely trend down more slowly to bring inflation in line with central banks’ targets; once again favouring bonds due to the inverse relationship between interest rates and bond values.

 

 

 

 

 

 

Conclusion

We believe it is critical to take a diversified approach to investing to help manage portfolio risks through different market conditions. The balance and mix of assets will depend on each investor’s ability and willingness to take on investment risk as well as how much of their capital they need guaranteed.

That said, we believe now is a great time to be reassessing your asset allocation. Investors looking for capital growth who don’t need capital guarantees should consider introducing bonds into, or back into, their investment portfolio and doing so before central banks begin to cut rates.

While cash rates may seem alluring, it is important to remember the distinct roles bonds and cash play in a portfolio. Cash is best reserved for short-term spending needs that require a guarantee as it will not provide the long-term capital growth and inflation protection of other assets.

It may seem daunting as we have been through a period of significant market volatility but over the long term, we have high conviction that bonds will provide better risk adjusted return outcomes for investors who are able to take on the increased risks offered by bonds.

As always, we recommend speaking to your financial adviser to get tailored advice based on your unique circumstances prior to making any investment changes.

 

Source: Perpetual

Seven lasting impacts from the COVID pandemic

By Robert Wright /May 28,2024/

Key points

  • Seven key lasting impacts from the Coronavirus pandemic are: “bigger” government; tighter labour markets; reduced globalisation and increased geopolitical tensions; higher inflation; worse housing affordability; working from home; and a faster embrace of technology.
  • On balance these make for a more fragmented and volatile world for investment returns. But it’s not all negative.

 Introduction

It’s four years since the COVID lockdowns started. The pandemic ended when it morphed into the less deadly Omicron variant in late 2021, but just as a sound can reverberate around a room the effects of the pandemic continue to reverberate in economies. Putting aside the long-term health impacts this note looks at 7 key lasting economic impacts.

  1. Bigger government and more public debt

The malaise of the 1970s ushered in “smaller” government in the 1980s in the Thatcher, Reagan, Hawke and Keating era. But the political pendulum started to swing back to “bigger” government after the GFC and COVID has given it another push. Memories of the problems of high government intervention in the 1970s have faded and there is rising support for the view that government is the solution to most problems – via regulation, taxes, spending or education campaigns. The pandemic added to support for “bigger” government: by showcasing the power of government to protect households and businesses from shocks; enhancing perceptions of inequality; and adding support to the view that governments should ensure supply chains by bringing production back home. It’s combining with a desire for governments to pick and subsidise clean energy “winners”.

 

 

 

 

 

Source: IMF, Australian Government, AMP

IMF projections for government spending in advanced countries show it settling nearly 2% of GDP higher than pre-COVID levels. The success of governments in protecting households from the worst of the pandemic has also reinforced expectations they would do the same in the next crisis. The pandemic ushered in even bigger public debt just as the GFC did. While high inflation helped lower debt to GDP ratios in 2022 it’s settling at higher levels than pre-pandemic.

 

 

 

 

 

Source: IMF, AMP

Implications – While there may initially be a feel good factor, the long-term outcome of “bigger” government is likely to be less productive economies, lower than otherwise living standards and less personal freedom. It will take time before this becomes apparent though. Meanwhile, higher public debt means: less flexibility to respond with fiscal stimulus to a crisis; a greater incentive for politicians to inflate their way out; and interest payments being a high share of tax revenue.

  1. Tighter labour markets and faster wages growth

In the pre-pandemic years, wages growth was relatively low and a key driver was high levels of underemployment, particularly evident in Australia. After the pandemic, labour markets have tightened reflecting the rebound in demand post pandemic, lower participation rates in some countries and a degree of labour hoarding as labour shortages made companies reluctant to let workers go. As a result, wages growth increased, possibly breaking the pre-pandemic malaise of weak wages growth.

 

 

 

 

 

Source: ABS, AMP

Implications – Tighter labour markets run the risk that wages growth exceeds levels consistent with 2% to 3% inflation.

  1. Reduced globalisation/more geopolitical tensions

A backlash against globalisation became evident last decade in the rise of Trump, Brexit and populist leaders pushing a nationalist gender when the benefits of free trade were being questioned. Also, geopolitical tensions were on the rise with the relative decline of the US and faith in liberal democracies waning resulting in a shift from a unipolar world dominated by the US, to a multipolar world as regional powers (Russia, Iran, Saudi Arabia and notably China) flexed their muscles. The pandemic inflamed both – with supply side disruptions adding to pressure for the onshoring of production; conflict over the source of and management of coronavirus; it heightened tensions between the west and China; and it appears to have added to nationalism and populism. So, the days of global free trade agreements and falling defence spending seem long gone for now. Rather we are seeing more protectionism (e.g. with subsidies and regulation favouring local production) and increased defence spending.

Implications – Reduced globalisation risks leading to reduced potential economic growth for the emerging world and reduced productivity if supply chains are managed on other than economic grounds. And combined with increased geopolitical tensions resulting in more defence spending it could result in a more inflation prone world than was the case.

  1. Higher prices, inflation and interest rates

A big downside of the pandemic support programs was the surge in inflation. The combination of massive money printing along with a big increase in government payments to households (e.g. Job Keeper) resulted in a massive boost to spending once lockdowns were lifted which combined with supply chain disruptions, also flowing from the pandemic, to cause a surge in inflation. Inflation is now starting to come under control as the monetary easing and spending boost has been reversed and supply has improved again but the pandemic has likely ushered in a more inflation prone world by boosting “bigger” government; adding to a reversal in globalisation; and adding to geopolitical tensions. All of which combine with aging populations to potentially result in more inflation.

Implications – Higher inflation than seen pre-pandemic means higher than otherwise interest rates over the medium term which reduces the upside potential for growth assets like shares and property.

  1. Worse housing affordability

At the start of the pandemic, it was thought the economic downturn and higher unemployment and a freeze in immigration would cause a collapse in home prices and they did initially fall. But not by much as it was quickly turned around by policy measures to support household income, allow a pause in mortgage payments and slash interest rates and mortgage rates to record lows. What’s more the lockdowns and working from home drove increased demand for houses over units and interest in smaller cities and regional locations. As a result, Australian home prices surged to record levels. Meanwhile the impact of higher interest rates in the last two years on home prices was swamped by housing shortages as immigration surged in a catch up. The end result is now record low levels of housing affordability for buyers (who are hit by a double whammy of higher prices relative to incomes – see the next chart – and higher mortgages rates) and renters (who have seen surging rents).

 

 

 

 

 

Source: ABS, CoreLogic, AMP

Implications – Ever worse housing affordability means ongoing intergenerational inequality and even higher household debt.

  1. Working from home likely here to stay

While there has been a return to the office, for many its only two or three days a week. Basically, the lockdowns resulted in a step jump towards working from home (WFH). A UK study of over 2000 firms is indicative. It showed that while around 90.8% of employees were fully onsite in 2018, last year this had fallen to 62.3%, with 30.2% with hybrid (working in the office and at home) arrangements. Similarly, the ABS found 37% of employed people in Australia regularly worked from home. Of course, this masks a huge range with industries with a high proportion of computer-based workers having more hours working at home. And firms expect this to remain the case. There are huge benefits to physically working together around culture, collaboration, idea generation and learning but there are also benefits to working from home with no commute time, greater focus, less damage to the environment, better life balance and for companies – lower costs, more diverse workforces and happier staff. So the ideal is probably a hybrid model. The proportion of workers in a hybrid model may even rise as new firms are quicker to embrace WFH.

Working arrangements for UK employees

 

 

 

 

 

Source: K Shah, and others, Managers say working from home here to stay, CEPR

Implications – Less office space demand as leases expire resulting in higher vacancy rates/lower rents, more people living in cities as vacated office space is converted and reinvigorated life in suburbs and regions.

  1. Faster embrace of technology

Lockdowns dramatically accelerated the move to a digital world. Everyone was forced to embrace new online ways of doing things. Many have now embraced online retail, working from home and virtual meetings. It may be argued that this fuller embrace of technology will enable the full productivity enhancing potential of technology to be unleased. The rapid adoption of AI will likely help.

Implications – This has meant a faster embrace of online retailing (up from 7% of retailing pre-pandemic to around 11%) at the expense of traditional retailing, virtual meeting attendance becoming the norm for many (even in the office) and business travel settling at a lower level.

Concluding comments

Perhaps the biggest impact is that the pandemic related stimulus broke the back of the ultra-low inflation seen pre-pandemic. Together with bigger government and reduced globalisation, this means a more inflation-prone world. So, a return to pre-pandemic ultra-low inflation and interest rates looks unlikely. It’s not all negative though – apart from the faster technology uptake, the global and Australian economies have come through the last four years in far better shape than might have been imagined at the start of the lockdowns!

 

Source: AMP

Millions to get more Age Pension starting from 20 March 2024

By Robert Wright /May 28,2024/

Government Age Pension payments increased on 20 March, so if you’re one of the millions of eligible Australians, you’ll have a little more to spend.

The increases are designed to help address inflation and cost of living increases. Here’s what happened.

Age Pension payments increase in March 2024 due to indexation

Here are the maximum Age Pension payment rates that came into effect from 20 March, which are paid fortnightly, along with their respective annual equivalents. Single payments rose by $19.60 per fortnight, while combined payments for couples increased by $29.40.

Maximum Age Pension payments from 20 March 2024

  Fortnightly* Annually*
Single $1,116.30 $29,023.80
Previous payment $1,096.70 $28,514.20
Couple (each) $841.40 $21,876.40
Previous payment $826.70 $21,494.20
Couple (combined) $1,682.80 $43,752.80
Previous payment $1,653.40 $42,988.40

*Includes basic rate plus maximum pension and energy supplements

The payment rate increased 1.8%, indexed to inflation. Payments last increased in September 2023 and are likely to change again when they are next assessed this coming September.

Tip: Depending on how much super you have, you may be eligible to receive Age Pension payments in addition to income from your super savings.

Income and assets test thresholds increase for the Age Pension

The government reviews the Age Pension income and assets test thresholds in July each year. The upper thresholds also increase in March and September each year in line with Age Pension payment increases.

Whether you are eligible for the Age Pension depends on your age, residency and your income and assets.

If your income and assets are below certain limits (also known as thresholds), you may be eligible.

When determining how much you’re entitled to receive under the income and assets tests, the test that results in the lower amount of Age Pension applies.

Here are the income and assets test thresholds that apply as at 20 March, compared with previous thresholds.

Assets test thresholds comparison

The lower assets test threshold determines the point where the full Age Pension starts to reduce, while the upper assets test thresholds determine what the cutoff points are for the part Age Pension.

If the value of your assets falls between the lower and upper assets test thresholds, your entitlement will reduce.

The higher your assessable assets, the lower the amount of Age Pension you are eligible to receive.

Your family home is exempt from the assets test but, your investments, household contents and motor vehicles may be included.

Asset test thresholds from 20 March 2024

  Full Age Pension limit Part Age Pension cutoff
Single – Homeowner $301,750 (unchanged) $674,000
Previous threshold $301,750 $667,500
Single – Non-homeowner $543,750 (unchanged) $916,000
Previous threshold $543,750 $909,500
Couple (combined) – Homeowner $451,500 (unchanged) $1,012,500
Previous threshold $451,500 $1,003,000
Couple (combined) – Non-homeowner $693,500 (unchanged) $1,254,500
Previous threshold $693,500 $1,245,000

Income test thresholds comparison

The lower income test threshold determines the point where the full Age Pension starts to reduce, while the upper income test threshold determines what the cutoff point is for the part Age Pension.

Income includes things like payment for employment or self-employment activities, rental income, and a deemed rate of income from financial investments such as managed funds, super (if you are over the Age Pension age) or account-based pensions commenced after 1 January 2015.

Income doesn’t include things like emergency relief payments.

Income test thresholds from 20 March 2024

  Full Age Pension limit Part Age Pension cutoff
Single $204 per fortnight (unchanged) $2,436.60 per fortnight
Previous threshold $204 per fortnight $2,397.40 per fortnight
Couple (combined) $360 per fortnight (unchanged) $3,725.60 per fortnight
Previous threshold $360 per fortnight $3,666.80 per fortnight

If you have income between the lower and upper income test thresholds, your entitlement will reduce as your level of income rises.

For example, the Age Pension payment for a single person earning more than $204 per fortnight will reduce by 50 cents for each dollar earned over $204.

For a couple earning more than $360 per fortnight combined, the Age Pension payment for each person will reduce by 25 cents for each dollar earned over $360.

Tip: The Work Bonus may allow you to receive more income from working, without reducing your Age Pension.

The maximum Work Bonus balance that you can accrue is $11,800.

 

Source: Colonial First State

Mortgage vs super: where should I put my extra money?

By Robert Wright /February 16,2024/

It’s a dilemma many of us face – are we better off directing extra money to our mortgage or super? As with most financial decisions, it’s not a one size fits all approach and here are some factors to consider in deciding what’s right for you.

Key takeaways:

  • There may be tax advantages when you contribute to super, especially if you salary sacrifice or you’re eligible to claim a tax deduction for personal super contributions.
  • The power of compounding returns could mean that even small contributions to your super over many years could make the world of difference.
  • By making extra mortgage repayments, coupled with any potential increase in the value of your property, you will build equity in your property at a faster rate than if you were to make just the minimum repayments.

Building the case for super over mortgage

You might think your super is already being taken care of – after all, that’s what your employer’s compulsory Superannuation Guarantee contributions are all about. But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.

Making extra contributions to your super is a great way to boost your retirement savings. As an investment vehicle, super is a very tax effective way to save for the future.

The power of compounding returns

Super is a long term investment, at least until you retire, and potentially much longer if you leave your money in super and draw a pension after you retire.

This long investment term, coupled with the rate of tax on your super investment (generally 15%), means your money can add up and generate further investment returns on those returns. This is known as compound returns, or compounding.

The expenses of daily life can be considerable. Thinking about directing money to super might not seem like a priority when we feel overwhelmed by the effort to save a deposit for a home, paying down debt, and the costs of raising a family.

However, the benefit of compounding returns means that even small, frequent contributions can make a big difference down the track. It’s about striking a balance that is right for you today and remember, nothing has to be forever. As your life changes, you can simply adjust your contributions strategy to suit your needs.

Building super early

To maximise your retirement savings while allowing compounding returns to do the heavy lifting, the best approach is to start early. The longer compounding continues, the bigger your savings could be. Entering retirement debt free is an attractive prospect. It can be easy to think that you need to repay your debt before you can start thinking about saving for retirement. However, it doesn’t have to be one or the other.

You can see the difference small, regular contributions could make to your final retirement income using the MoneySmart retirement planner calculator.

Tax benefits of super

From a tax point of view, super can be incredibly beneficial. Salary sacrificing some of your before-tax salary or making a voluntary after-tax contribution for which you can claim a tax deduction, can be effective ways to not only grow your retirement savings but also reduce your taxable income.

One great benefit of investing in super is that concessional (before tax) contributions are taxed at a maximum rate of 15%. This can be higher though if you earn over $250,000.

Mortgage repayments are usually made from your take home pay after you’ve paid tax at your marginal tax rate. Your marginal tax rate could be as high as 47%. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in an overall tax saving of up to 32%.

There is a limit on the amount you can contribute into super every year. These are referred to as contribution caps. Currently, the annual concessional contributions cap is $27,500. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any unused concessional contributions for up to 5 years. If you exceed these caps, you may be liable to pay more tax.

Tax on super investment earnings

The initial tax savings are only part of the story. The tax on earnings within the super environment are also low.

The earnings generated by your super investments are taxed at a maximum rate of 15%, and eligible capital gains may be taxed as low as 10%. Once you retire and commence an income stream with your super savings, the investment earnings are exempt from tax, including capital gains.

Also, when it comes time to access your super in retirement, if you’re aged 60 or over, amounts that you access as a lump sum are generally tax free.

However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, this means you can’t access these funds as a lump sum until you retire and reach your preservation age, between 55 and 60 depending on when you were born.

Before you start adding extra into your super, it’s a good idea to think about your broader financial goals and how much you can afford to put away because with limited exceptions, you generally won’t be able to access the money in super until you retire.

In contrast, many mortgages can be set up to allow you to redraw the extra payments you’ve made or access the amounts from an offset account.

Building the case for reducing your mortgage over super

For many people, paying off debt is the priority. Paying extra off your home loan now will reduce your monthly interest and help you pay off your loan sooner. If your home loan has a redraw or offset facility, you can still access the money if things get tight later.

Depending on your home loan’s size and term, interest paid over the term of the loan can be considerable – for example, interest on a $500,000 loan over a 25-year term, at a rate of 6% works out to be over $460,000. Paying off your mortgage early also frees up that future money for other uses.

Before you start making additional payments to your mortgage, it’s suggested that you should first consider what other non-deductible debt you may have, such as credit cards and personal loans. Generally, these products have higher interest rates attached to them so there is greater benefit in reducing this debt rather than your low interest rate mortgage.

Conclusion: mortgage or super

It’s one of those debates that rarely seems to have a clear-cut winner – should I pay off the mortgage or contribute extra to my super?

The answer, probably somewhat annoyingly, is that it depends on your personal circumstances.

There is no one size fits all solution when it comes to the best way to prepare for retirement. On the one hand, contributing more to your super may increase your final retirement income. On the other, making extra mortgage repayments can help you clear your debt sooner, increase your equity position and put you on the path to financial freedom.

When weighing up the pros and cons of each option, there are a few key points to keep in mind.

One of the key questions to consider is what is the likely balance you’ll need in your super? Work backwards starting with working through what retirement looks like for you, the type of lifestyle you’d like, and how much you need to live on each year.

From there, you can start to consider your sources of income in retirement. This is likely to include super but could also include a full or part Age Pension, or income from an investment property or other sources.

You can then start thinking about your current balance, contributions strategies and whether you’re on track to have enough saved to supplement your other retirement income sources.

The MoneySmart retirement planner calculator can help you to estimate how much super you may have in retirement and how long your super may last. You also need to think about how you plan to spend your money in retirement.

In most cases, there isn’t one set strategy that you should follow and it can quickly change as you grow older, start a family and reach retirement age. You should also consider whether you’ll need to access any additional funds you put aside before you reach retirement. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.

Home ownership and comfortable retirement are financial goals that many strive towards. If you reach a point where there’s some surplus cash flow to consider where to put your extra money, it’s a good dilemma to have.

Life is complex, so it pays to speak with a financial adviser before you make any big financial decisions when it comes to your super or mortgage.

 

Source: MLC