Clients often wonder why as advisers we explore client’s risk profiles, and what does it really do? Risk profiling is a process for determining appropriate investment asset allocations for each investor.  There is no right or wrong answers, only what suits you.

The key components for establishing a risk profile are:

• What is the level of risk the client is comfortable taking?
• How much financial risk can a client afford to take?
• How much risk is required to achieve the goals with the financial assets at the client’s disposal?

What risk is a client willing to take?

At some point you will have encountered the classic risk vs return curve, that is to get the most return you must take the most risk.  The lure of the high prize must be traded off against the risk of significant loss.  Like at a casino, the odds are not always in your favour and a high-risk strategy can see high volatility and sharp rises and falls in a client’s portfolio. This may appeal to some clients but to others, this is a nightmare, it could mean an extension of your working career rather than early retirement or vice versa. Generally speaking, age is often a key factor associated with risk tolerance, the younger we are the more risk we are willing to accept and as we age, we slide back along the risk curve to a less risky asset allocation.  This is often termed as reducing “sequencing risk”.

How much financial risk can a client afford to take?

This component will often consider two items, stage of life and the number of assets available.  The younger we are, we have greater time to recover and rebuild from a financial setback.  Similarly, if we have a higher amount of financial assets at our disposal, we may choose to allocate a higher percentage of these targeting greater returns knowing we still have a sound financial base to fall back on.

How much risk do my goals need?

Something that many people ignore is that to achieve their goals, they simply do not need to take excessive levels of risk. The ability to recognize and discuss this is something to work through with your financial adviser.  Similarly, sometimes goals require a level of risky investment that is inappropriate to a client.  Discussion over conflicting goals and risk is very important to ensure you get the right investment plan for you.

Through each of these components of risk profiling, there are some common factors and gaining an understanding of these factors for each client is critical in the development of financial plans:

• Goals – what is it, how much, and what is the priority?
• Timeframe – what is the timeline for each of your goals?
• Investment capital – how much do you have to build wealth?
• Client age – how far into your life cycle are you?
• Liquidity, Income and Growth – do you require liquid funds for lump sum expenditure, do you require regular income from investments, are you focused on growth only?

In summary, the main issue isn’t if you have a high growth, balanced or conservative profile, the most important aspect is that your risk profile reflects you and your personal circumstances. Risk profiling is important for an adviser to review regularly with clients to ensure the clients’ thoughts and preferences have not changed over time and that the investment remains appropriate.

Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.

Debt. In a time where the Reserve Bank cash rate and similarly the interest rates for borrowing are the lowest we have seen, it has become a temptation for us as consumers to borrow.

So, what exactly is debt? Debt is the obligation for one party (debtor) to pay money to another (creditor). We almost all certainly have had a debt, and it remains one of the most common financial goals of clients to repay debt and be debt-free.

A case can easily be made that there is no such thing as good debt and that to owe money is always bad, but this does not have to be true.

Let’s break debt up into 3 areas. Good, bad and smart

Good

Often when it comes to a big-ticket item, debt may be the only option as a means of raising funds to purchase the good. The main item here is your home. A home can be seen as a key item that can be funded through rent or home ownership. The idea of rent being ‘dead money’ which could be used towards a home purchase through debt repayment, leads many consumers to the decision to borrow for their own home, and why not when the government also provides incentives for first home buyers. Another benefit is that under most circumstances, the primary residence is also capital gains exempt.

Knowledge is a powerful resource and with it can often come greater opportunity to build wealth through employment. Borrowing for study can be very beneficial to help get that new job or to ask for a pay rise. Care must be taken to ensure, when selecting a course of study, that the future benefit will be there. The Higher Education Loan Program (HELP) is a government support loan that may help fund further education.

The last item I will cover as ‘good debt’ is one to borrow for a small business. Being your own boss, earning a salary and controlling your employment are all very positive features. There is a greater risk with this loan given the history of failures of small businesses. Much of the business success will depend on your willingness to work hard to build and maintain the business, determining from the outset that the business will be profitable and be able to repay the debt, and gaining an understanding of the type of business and how to manage a business prior to commencing.

Bad

‘Bad debt’ involves the borrowing of money to purchase a depreciating asset often through a personal loan. We all know this one and are guilty of discretionary spending on items in this category. Loans of this type are typically at higher interest rates, only increasing the reason for defining them as ‘bad’.

Our most common item for ‘bad debt’ is the family car. It is often seen as a ‘good debt’ for the reason of the functionality it provides, but the reality is that in most cases, the value of a car depreciates (in cases of new cars by up to ~$5000 upon leaving the showroom). By the time of debt repayment, the vehicle is often worth less than 50% of the value initially paid. Boats, motorbikes and jet skis are all similar examples of ‘bad debt’ loans.

Credit card and ‘Buy Now Pay Later’ debt is by far the biggest issue of ‘bad debt’ for most Australian households. Our penchant for spending on consumables, goods and services ensure that many of us require these credit options. Whilst an increase in the use of debit cards (spending money you already have) has reduced credit card use; through COVID-19, with reductions on the use of cash and an increase in online purchases, we have seen this type of debt continue to increase. For more information on credit cards, refer to the article in The Investment Collective’s Winter 2020 Newsletter by Cheng Qian. Our ever-increasing desire for discretionary spending on clothing, music, holidays, take away meals and even that morning coffee can all contribute to bad debt.

Smart

The last category is smart debt. Often referred to as an investment debt or gearing. This debt involves borrowing money (at a low rate) to invest in a product that will hopefully have a higher rate of return to generate wealth in a faster manner. There is an obvious risk with this debt and that is the need to generate a return with a higher rate than that being paid, otherwise, there is financial loss. That is, whilst it can magnify a gain, it can also magnify a loss. This type of borrowing can provide an income tax deduction and enable a larger portfolio to provide greater diversification in your portfolio to reduce risk. Gearing should only be considered after discussions with your financial adviser to see if it is a suitable option for you and your financial circumstances and goals.

In summary, commencing debt can be very tempting and even seen as a need, and at the right time and for the right reason, can easily be a justified option rather than saving the amount in full prior to purchase. Debt will always need to be repaid and when looking at commencing a significant debt, always take the time to discuss the situation with your financial adviser to see how it fits with your financial situation, goals and objectives. A well-managed approach to debt can ensure that no matter what category of debt (good, bad or smart) that it delivers for you.

Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.

Superannuation is something you simply cannot ignore. It is important that you engage with it throughout your working life, monitor how much you have and how it is invested.  So, let’s take a look at how superannuation impacts you as it progresses through various life stages.  From your first paycheck to the last, the contributions to your superannuation are building to finance your retirement.

First job

When you begin your first job, your employer is likely to direct your compulsory superannuation guarantee contributions into the fund that they use as a default (typically an industry superannuation fund).  It is important to note you have the choice of the superannuation fund that is used and you do not need to accept the default, but if another choice is made, you will require providing detail of the fund to your employer.

Employers MUST pay superannuation to an employee at a rate no less than 10.5% of the ordinary time earnings if you are over 18 or if you are under 18, but working more than 30 hours in a week.

The superannuation guarantee is for employees irrespective of work conditions, whether they are full-time, part-time or casual.

Superannuation guarantees are typically paid from each pay cycle, however, employers may choose to pay at least every 3 months.

Early work years/young family

It is a long time before you can access this money by meeting a typical condition of release, but remember that it is accumulating for your retirement and you should stay on top of what is happening.

Make sure that you have all your contributions going into one fund. When you commence a new job, you need to advise your employer of the fund details so that contributions continue to go into said fund.  In most cases, you will have a choice as to where your contributions are paid but possibly not if you are a government or university employee.  If you think a job has paid to a different fund, search for lost superannuation and roll them into one. Fewer admin fees mean more returns for you.

Check your statement each year:

• How much have you paid in administration and other fees?
• What has the performance been and can you compare it to another fund to see if it is keeping up?
• Is the chosen investment option still the right one for you?
• Are you paying premiums for insurance?
• Is the insurance sufficient or should you obtain other insurance possibly outside superannuation?
• Do you have a current beneficiary nominated?

This period in your life is likely to be the most financially challenging – marriage, children, mortgages and your career. For women, there may be a period out of the workforce while raising children and it is worth exploring paid parental leave with your employer to ensure you continue to build your superannuation for retirement through this period.

All of these issues mean that you may not be able to add to your superannuation from your resources and paying down your mortgage will be the highest priority, but you should attempt to allocate an extra amount to superannuation from your salary each pay period.  Settle on a small amount you will not miss, even if it is $10 each week.  As you age, try to increase this amount (i.e. if you get a pay rise, add extra to your superannuation contributions).  The most tax-effective way to contribute is via salary sacrifice – pre-tax salary, but you can also add from your resources.

You might consider seeing a qualified professional to review your financial situation and help you reach your future goals. If an industry fund is in use, does it meet your requirements? Do you want more say in your investments? Does the industry insurance meet your requirements?

In your 50’s and 60’s – approaching retirement

By now, your financial situation should be a little easier. Perhaps the kids have finished university/have jobs and left home and your mortgage is well under control (provided the interest rates do not stay up). Your superannuation balance will look healthy, and guess what, retirement isn’t so far away any more.

If you have not consulted a qualified professional, now is a good time to set some financial strategies in place so that your future needs can be met.

You might be thinking of some things you would like to do when you have more time and travel may be on top of the list.

Now is the time when you need to contribute as much as you can spare and that you will not need before you reach ‘preservation age’ – the age at which you can begin to draw from superannuation. For most people that is age 60.

Using salary sacrifice now will be a strategy that will work well for you. Part of your pre-tax salary is contributed to superannuation, and your take-home pay and the tax you pay personally will be reduced by maximising this amount if your budget permits. There are other strategies for higher-income earners, perhaps with a non-working spouse.  These include spouse contributions and contribution splitting.

In retirement

Now you have retired and are living off a pension drawn from superannuation. Once commenced, you must draw a minimum percentage from superannuation each year. At 65, this is 5% of your balance, but you may need to draw a greater amount (note the minimum in 2022/23 was reduced by the government to half of this amount due to the COVID-19 pandemic but it is to increase back to 5% from 1 July 2023).

It is vital that you manage your superannuation, or have it managed by a qualified professional so that what you have will last you for at least your life expectancy.  A male at age 65 can expect another 18.5 years based on typical life expectancy, so you need to watch and plan your spending.  At the time of writing, a couple wanting to live a comfortable lifestyle will need about $68,000 per year between the ages of 65 to 84.  This means that you will need to have accumulated nearly $640,000 to meet this need, along with receiving Centrelink age pension and that takes you to your life expectancy (Source – Association of Superannuation Funds of Australia – ASFA).

What happens if you live longer than your life expectancy? What happens if you need aged care?

These things mean that you will need to accumulate a greater amount of savings through your working life so that these needs in later life can be met comfortably and without placing stress on yourself or your family. The alternative is to reduce your expenses below the comfortable expenses target to something more in line with a moderate standard according to ASFA requiring around $44,000 per year for a couple.  Taking care of your superannuation through your working life will benefit you at the time that it is most needed.

Please note, this article provides general advice and has not taken your personal or financial circumstances into consideration. If you would like more tailored financial advice, please contact us today. One of our advisers would be delighted to speak with you.