Tag Archives: Financial Planning
How to help grow your money through compound interest
By Robert Wright /August 21,2023/
Earning interest on interest: learn how the power of compounding can send your savings rocketing.
Key takeaways
- Compound interest enables you to earn interest on interest which is accumulated over time.
- The effect of compound interest becomes extremely powerful over a long timeframe as the amount of interest earned grows.
- Investing in your super is one of the most effective ways to potentially maximise the benefits of compound interest.
Einstein has repeatedly said that compound interest is the eighth wonder of the world. While it may appear complicated, it’s actually a relatively simple concept that can accomplish extraordinary things over time.
What is compound interest?
Compound interest enables you to earn interest on interest which is accumulated over time.
Metaphorically speaking, it’s like planting a tree. When that tree grows, it produces seeds that allows you to plant other trees. Those trees will also grow and produce seeds of their own. So with enough time, you could turn one tree into an entire forest.
The difference between compound and simple interest
When it comes to earning interest, or a return on your money there are two types of interest you could earn.
Compound interest enables you to earn interest when you invest a sum of money; but in addition to this interest, you’ll also earn interest on the interest you’ve earned.
With simple interest however, you’ll only earn interest on your original sum of money invested. For instance, if you invest $10,000 into a savings account and earn 5% interest compounded annually, in the first year your interest earnings will be $500 (5% x $10,000).
However, in the second year, your interest will be calculated based on the original amount you invested, plus the interest you earned in the first year – $10,500. In total over 3 years, you would have earned $1,576.25 in interest.
With simple interest, your interest earnings won’t increase year on year so you’ll continue earning just $500 over the 3 year period leaving you with $1500 in interest earnings.
Compound interest is a long term investing strategy
The effect of compound interest becomes extremely powerful over a long timeframe as the amount of interest earned grows.
Warren Buffett is the epitome of someone who values long term investing. He attributes the majority of his success to identifying good businesses and companies with strong fundamentals to buy and hold for the long-term.[1] He then let the magic of compound interest work for him.
One thing that is important to remember is that investing in the beginning doesn’t reap many rewards. It isn’t until years later that you feel the true power of compound interest working for you.
Get started early
Because compound interest is generally most effective over a long timeframe, in order to truly see its potential, the earlier you start investing your money, the better. So it’s generally really not about how much you’re investing but more about how much time you’re allowing your money to grow.
How you can earn compound interest
Bank account
One way to earn compound interest is through a bank account. While this approach carries very little risk, it’s generally unlikely that your returns will be enough to outpace inflation so this is something to keep in mind.
Super
Investing in your super is one of the most effective ways to potentially maximise the benefits of compound interest.
Why? Time is on your side. The more you contribute to your super early on in life, the higher potential for that money to grow by the time you need it as a result of compound interest.
Of course though, you need to bear in mind that you cannot access your super until you meet a condition of release. This includes reaching the legal age for retirement, among other things.
Dividends
When you’re paid dividends from shares, you can withdraw that dividend as cash or you can reinvest it back into the issuing stock. This means you’re earning dividends on dividends, also known as compound interest.
The bottom line: When it comes to investing, compound interest and time are truly your best friends.
Source: MLC
[1] http://www.arborinvestmentplanner.com/warren-buffett-strategy-long-term-value-investing/
Understanding your investment options
By Robert Wright /August 21,2023/
Investing is full of jargon and technical terms that can make getting started or managing your investments seem intimidating. Here are some of the key terms to help you better understand the different options available to you.
Common investing terms
There are a few terms that you’ll see repeated when we’re talking about investing.
Bonds – Bonds are a way for corporations or governments to receive a loan from investors for a promised rate of return over a specific period. Bonds can be issued to pay debts, build new facilities or raise funds for future growth.
Cash – Cash investments are savings accounts and other easy to access funds like cash management trusts and money market funds. Cash investments are stable and low risk, generally growing slower than inflation or the increase in prices of goods and services over time.
Diversification – Having a diverse group of investments means that you spread your investments across different companies or sectors (for example, shares or fixed interest). This way, if one sector underperforms or has a loss, you have other investments that may perform better and help balance out any losses.
Another way we diversify our investment options and portfolios is by using different investment managers, with different approaches to investing. In some cases we use multiple investment managers in the same option. These are called multi-manager portfolios.
Dividends – Dividends are a portion of profits or earnings paid to shareholders. They are paid on a regular basis and in some cases can be reinvested into the business in the form of more shares. This can provide shareholders with ongoing income.
Domestic Markets – Domestic markets, shares or companies refers to the variety of investments that are connected to that country, either through where they operate or the investment exchanges on which they reside. In Australia, we would refer to Australian bonds as domestic bonds. Likewise, a US-based fund would refer to the US stock market as the domestic market.
Environmental, Social and Corporate Governance (ESG) – ESG is the consideration of an investment beyond its financial performance. It often includes social and environmental factors, like its impact on the climate, the gender or cultural diversity of staff and leadership or general benefit to society. Investors are increasingly applying these considerations as part of their investing decisions.
Equities – Equities are another name for shares. Equities can be bought directly on the share market or through an investment option.
Fees – A fee is the amount charged by a fund to manage your investments. Fees may vary based on factors including the cost to manage an option, the size of the investment and the management style.
Geared Investments – Geared or ‘leveraged investing’ is a way to borrow money in order to increase the size of an investor’s original investment. Geared investments are often made with higher risk assets like shares and property.
International and Emerging Markets – International markets can give investors access to a variety of investments including shares, securities, property or bonds from nations other than their own.
International markets can be volatile because of international trade relations or fluctuations in currency value. There is more risk with less stable countries, like those in economic or political turmoil, and less risk in more stable countries.
Emerging markets are international markets that focus specifically on growing and developing economies like China, Brazil or India.
Investment Manager – An investment manager is a professional person or organisation who has been appointed to manage money in an investment option on behalf of investors. One or multiple investment managers may be appointed to an investment option. They generally have specialised expertise in the area they represent, like property, bonds or shares.
Investment managers are selected for their strengths in certain areas as well as organisational stability, solid investment process and a history of strong performance. We also use a specialist investment consulting and research firm when selecting managers.
Managed Fund – A managed fund pools your money together with other investors to buy a variety of assets like shares, bonds or property. Managed funds can be invested in single or multiple asset classes and have single or multiple investment managers.
Risk – Risk in investing is about understanding, anticipating and accepting the potential for financial loss in an investment. All investing has an inherent level of risk.
Risk can be seen as an option underperforming against expectation. Investors can spread their risk by diversifying their investments.
Securities – A security is a way to purchase a portion of an asset such as infrastructure, a property, loan or business. For example, shares are type of security that makes it easy to purchase a portion of a business.
Securities can be bought, sold or traded. The value can change based on market conditions, the value of the asset, expected income or general market conditions.
Share – A share or stock represents the purchase of a portion of a business. The value can increase or decrease based on a variety of factors including general market conditions as well as industry and company performance and challenges.
Some shares have lower volatility and provide strong regular dividends without necessarily increasing in value.
Short Selling – Short selling, or shorting, takes place when an investor believes the price of an equity (like a share) will go down. They arrange to sell shares on the market with intention of repurchasing them for a lower price later on. A short position is generally very high risk and can result in large losses if the price of the equity increases.
Mandate – A mandate is an agreement with an investment manager that sets out how money will be invested. It includes performance benchmarks and expectations, acceptable investments and investment ranges.
A mandate’s structure means that the investments are managed in a unique way for our investors, different from the investment manager’s options with other organisations. This gives CFS greater flexibility around the option including administration and reporting to investors.
Product Disclosure Statement – A Product Disclosure Statement (PDS) is a review of all relevant product information for an investment option. You should always read the PDS before making any decisions about the relevant products. It offers information including the investment managers, risk measures, objectives and minimum suggested timeframe.
Units and Unit Pricing – The unit price tells you the value of the package of investments it contains. Investments are packaged in units that are made up of a variety of assets, like shares, bonds and property. Investing this way gives you the ability to invest in ways that you may not otherwise be able to access as an individual investor.
Reading an investment option
We use a standard description to quickly review and compare different investment options. Here’s what you should look for:
Objective
A sentence or two on what the investment option is designed to achieve and the timeframe to achieve it.
Minimum suggested timeframe
How long an investment professional suggests you hold, or remain invested in, an option in order to achieve the stated investment objective.
This is only a suggestion and should not be considered personal financial advice. Because financial markets can be volatile and unpredictable, it’s good to regularly review your investments with a financial adviser to ensure they meet your needs.
Risk
A snapshot of the expectation that an investment option will deliver a similar number of negative annual returns over a 20-year period.
Generally, the higher the level of risk an option has, the higher its return is expected to be. You should review the associated risks to see if the option is suitable for your needs.
Strategy
A description of the way the investment option is structured with some details about its contents and the reasons why those investments were chosen.
Investment category
A quick way to organise different options by their typical range. These categories are not standardised across the investment industry, so what is considered ‘growth’ in one organisation might be considered ‘moderate’ by another. You should read the full details of an option before making an investing decision. We’ll break down the different investment categories a bit later.
Allocation
A quick view of the different assets, or types of investments, contained in an investment option. In some cases, the assets are given a range, (i.e. between 15-25%), which indicates the minimum and maximum ranges that may be held in the option at any time. The investment manager may make changes within that range for different reasons including market volatility. Not all investments offer an allocation benchmark.
Underlying investment managers
These are the professional investment managers and organisations that have been appointed to manage the money in the investment option. There may be one or more, which is known as a multi-manager fund.
Investment categories and asset classes
There are a few different ways we organise and categorise investments to make it easy to understand how they are structured.
Cash and deposits
Cash is invested in reasonably stable domestic currency, like bank bills. Cash is liquid, making it easier to quickly access funds as required. It also includes term deposits (money invested for a set period) and money market securities. Cash and deposits are generally low risk and provide a low, stable return.
Less liquid than cash and deposits, enhanced cash is invested in money market securities and some fixed interest securities.
Fixed interest
Fixed interest investments are investments made with a guaranteed rate of return. These are usually issued by corporations, governments or financial institutions to raise funds. They have a set rate of return, which is usually higher than cash but lower than higher-risk options like shares. The return comes from interest payments from the bond issuer. The amount of that return can change based on interest rate repayments.
Alternatives
Alternative funds may include a diverse mixture of investments including hedge funds or commodity trading like oil or livestock. Basically, anything that falls outside of the traditional shares, property, infrastructure, cash or fixed interest categories are called alternatives.
Property
Property investing generally involves buying a property or buying a stake in a building through a property security. These properties can be office spaces, industrial properties or retail. A company or trust (a group acting on behalf of the investors) generally hold, manage and develop these properties.
Infrastructure
Infrastructure is a broad term that refers to physical assets. It may include public transportation, toll roads or utilities like water desalination. It may also include social infrastructure investments in public housing, hospitals or prisons.
Infrastructure investments or securities (a portion of the investment purchased on a public market) are generally expensive and have high upfront capital requirements. They also feature low ongoing operating costs and have a reasonably stable return.
Shares
The most recognised method of investing, shares are part ownership of a company. They are generally bought and sold on a public stock exchange. Because of the general volatility of the share markets, shares are considered a high risk asset.
Over time, however, they tend to outperform other asset classes. The amount of risk can depend on the particular company invested in or the industry or region they come from.
Risk measures and categories
Risk is broken down into some general categories in order to help organise different investment options.
Because there is no industry standard around the naming of the categories, the level of risk may vary between funds. What is a conservative investment with one fund may be considered a moderate investment with another.
Risk is generally broken down into the following categories:
| Risk band | Risk Label | Estimated number of negative annual returns over any 20-year period |
| 1 | Very low | Less than 0.5 |
| 2 | Low | 0.5 to less than 1 |
| 3 | Low to medium | 1 to less than 2 |
| 4 | Medium | 2 to less than 3 |
| 5 | Medium to high | 3 to less than 4 |
| 6 | High | 4 to less than 6 |
| 7 | Very high | 6 or greater |
Source: Colonia First State
Expanding SMSFs for the expanding family?
By Robert Wright /May 19,2023/
It has finally happened. Recommended by the Cooper Super System review in 2010, put forward in the Federal Budget four years ago by then Treasurer Scott Morrison and finally passed on 17 June 2021, the maximum amount of members allowed in a Self Managed Super Fund (SMSF) has expanded from four to six.
Despite the previous maximum of four members, the vast majority of SMSFs had only one or two members therefore this increase did not exactly stop the press. Yet the question remains, why would an SMSF want six members and what are the disadvantages?
The most logical reason for a fund to grow to six members is to gather a larger pool of assets to invest. A larger amount to invest could open up residential and commercial property investment, or other nonstandard assets that require a large capital outlay, such as fishing licenses or marina berths.
Greater diversification for what many would consider standard assets, such as shares and managed funds, could be better achieved with six members.
Additionally, if the SMSF is paying fixed accounting and administration costs, having six members would also result in a lower cost per member.
If a large family is running two funds currently due to the previous four member limit, the funds can now be consolidated. However, it would be a capital gains tax event for the fund that is being closed down. Therefore consideration should be given to the unrealised tax position for each fund when deciding which to keep and which to close.
The main disadvantage of a six member fund is just that, the six members. The larger the fund, the greater number of people who are involved in the decision making process and the greater number of people who have to agree. With a greater number of members there is also the greater likelihood that there will be a falling out or there will be a marriage breakdown that could result in the division of superannuation. This would be particularly detrimental if the six member fund was established to invest in one large illiquid asset.
The chances of one of these unfortunate events occurring magnifies with each additional member, so it goes without saying that six member funds and the accountants and advisers that assist them will see their fair share of grief and the financial consequences that result.
For current SMSF trustees who are considering taking advantage of this legislation change, a review of the trust deed should be completed and a corporate trustee should be appointed if one is not already in place.
The SMSF member limit increase to six is good. It provides more choice in a superannuation environment which is known for restrictions and adverse government legislation changes. Opening up self managed superannuation funds to six members does increase additional investment opportunities, however serious consideration should be given to potential ramifications prior to proceeding down this path.
If you would like to discuss establishing an SMSF with six members, or adding members to an existing SMSF, please contact your financial adviser.
Source: Bell Potter
What to do when your fixed rate home loan term is ending
By Robert Wright /May 19,2023/
Many Australians were fortunate to lock in record low interest rates but this may be drawing to an end.
A large portion of mortgages will be approaching the end of their fixed term, leaving many households paying two to three times their current fixed rate.
In this article, we’ll explain what to expect when your fixed interest rate ends and how to prepare for it.
What happens when your fixed rate home loan ends?
When your fixed term is nearing its end, you’ll need to decide whether to re-fix your loan at a new rate, change to a variable rate or consider switching to a new mortgage provider.
If you don’t do anything before the fixed term lapses, on expiry your mortgage provider generally switches your loan to its standard variable rate, which can be much higher than some of the discounted options available to new customers.
The best thing to do is contact your provider and ask them about your options, including what rates they can offer you.
How to prepare
Consider reviewing your mortgage at least 3 months before the fixed rate expires, as this will give you time to implement changes if required.
Here are some steps to go about this:
1. Negotiate with your current mortgage provider
It’s worth speaking to your current provider in advance to find out what variable rate you’ll be paying. This gives you an opportunity to check out other rates available in the market and think about whether switching providers is a better solution.
You can also see if you can negotiate a better rate as this may save you a lot of effort in moving to a new provider.
2. Research what other mortgage providers are offering
Now is a good time to see how your loan stacks up against other loans out there. This will help you determine if you’re getting a competitive interest rate.
If you do find a better offer, switching providers can be a smart move but it’s important to look at the costs involved in switching, borrowing costs and switching fees, as these can often outweigh the benefits.
Before you make any decisions, crunch the numbers with an online mortgage switching calculator.
3. Consider re-fixing your loan
If you like the predictability that comes with a fixed rate loan, you can re-fix your mortgage with an up to date interest rate.
However, you will be locked into the new fixed interest rate for a period of your loan term, unless you choose to end the contract earlier which may result in break costs.
Be sure to also carefully check out the features of a fixed loan too, such as fee-free extra repayments, redraw and linked offset accounts. Many fixed rate loans do not provide these features.
4. Consider a split loan
If you’re struggling to decide between a variable or fixed rate, or if you’re keen on a combination of flexibility plus certainty, you can choose to have part of your mortgage fixed and part of it variable.
For example, you could have 60% of your loan on a fixed rate and 40% on a variable rate.
This approach can provide the best of both worlds. The variable rate component gives you flexibility, while the fixed portion shelters part of your loan from rising interest rates.
5. Get help from an expert
If you can’t decide which option is best for you, a mortgage expert may be able to steer you in the right direction.
Mortgage experts can look at your finances and recommend some of the best home loan options to suit your specific needs. They’ll also be able to guide you through switching to another provider if that’s the path you choose to take.
Get a home loan health check
A home loan health check could help you to:
- find ways to fine tune your loan
- get more certainty or flexibility on interest rate options
- reduce your repayments
- pay off your loan sooner.
6. Make extra repayments before your fixed rate ends
If it’s possible for you to do so, consider paying off as much of your mortgage as possible before you’re hit with a higher interest rate.
By reducing your mortgage balance before your interest rate increases, you could save a lot of money on interest payments before it moves to the new rate.
How to manage higher repayments
When your fixed mortgage rate finishes and your repayments start increasing, your finances may need to be reviewed to cope with the new reality of rising interest rates.
There are ways to help you save and potentially earn more money, which may compensate for the rate increase.
1. Review your budget
While it may not be an option for everyone, there are expenses you can cut back on such as:
- taking public transport to work to reduce petrol costs and parking
- online shopping habits
- expensive memberships that you don’t regularly use
- taking advantage of government and council rebates to reduce your energy bill
- switching to energy efficient appliances and lightbulbs
- reviewing your utility and insurance providers – there may be better deals on offer which could save you hundreds of dollars.
2. Increase your income
Looking for ways to increase your income can help you manage higher repayments once your fixed rate expires.
Consider asking your manager for a salary raise or look for a higher paying job.
You could also consider starting a side hustle like dog walking or online tutoring to make extra cash. Another option is to rent out a room or parking space.
3. Consider opening an offset account
An offset account is like a transactional savings account linked to your mortgage balance. The funds in this account can reduce the amount of interest you pay on your mortgage, so holding your savings here can be beneficial.
For example, if you have a $600,000 mortgage balance and $100,000 in your offset account, you’ll only be charged interest on $500,000.
Source: IOOF