With Australian household debt to income ratios at record highs, it is vital to ensure that you have adequate personal risk protection cover in place to provide security for your home loan.  It is also critically important to consider your cover needs if another family member has provided a guarantee to assist you in obtaining the loan.

Unfortunately, in the excitement of buying a home, very few prospective or existing borrowers consider the consequences of not being able to work due to sickness or accident, or the financial impact of death, particularly with loans held jointly with a spouse, or with an additional guarantor.

Loss of income in the event of disability, even for a short period, will place stress on the ability to meet mortgage and/or personal loan repayments, and day to day living expenses.  Without adequate Income Protection cover, you will erode savings, and risk falling behind in your mortgage payments.  If you default on your loan, the bank may commence legal proceedings to repossess your home or pursue a guarantor to seek payment of the liability.

In the event of the death of a borrower, the person who inherits the home, or is a surviving joint tenant will be responsible for the debt.  If the property owner was a sole borrower, the bank may request the payment of the outstanding loan amount.  If there is a shortfall in the sale price versus the loan amount, the bank may sue the beneficiary to recoup the balance of the loan.  Without adequate death cover in place, you may be putting your surviving family at risk!

Many homeowners falsely believe that they will have adequate protection via the default cover offered through their superannuation fund if they are temporarily unable to work, suffer permanent disability, or death.  Unfortunately, there is often a huge discrepancy between the amount owing on the average mortgage, and the cover held via super.

It is crucial to understand that the Death/Total and Permanent cover offered via many funds is unit based, and will decrease significantly as you get older.  The rate at which the cover reduces during your working life is typically much faster than the rate at which a mortgage is paid off!

The Income Protection cover offered by many superannuation funds may only offer a minimal benefit for a maximum period of 2 years, which in many cases will not cover mortgage payments in addition to other costs of living.  In the event of claiming on your Income Protection held via super, the benefit may be reduced based on your pre-disability earnings, and other offset provisions.

Some facts to consider in relation to covering your debts:

• For every home destroyed by fire, 3 are forced to be sold due to death, and 48 are forced to be sold due to disablement.

• 1 in 6 men and 1 in 4 women are expected to suffer a disability between the ages of 35 to 65 that causes a loss of 6 months or more off work.

• 2 out of 5 Australians will suffer a critical illness such as Cancer, Heart attack or stroke before they reach 65.

Here at The Investment Collective, we have friendly advisers who specialise in risk insurance. If you would like to review your personal cover requirements contact us today.

Please note: The information provided in this article is general advice only. It has been prepared without taking into account any person’s individual objectives, financial situation or needs. Before acting on anything in this article you should consider its appropriateness to you, having regard to your objectives, financial situation and needs.

Recently we have been able to gain exposure for our clients to the wholesale corporate bond market. We see this as a great alternative to the recently issued bank preference shares as they are lower risk, and offer greater protection in the advent of a market downturn.

Firstly, what is a bond and how do they work?

A bond is simply a loan or an IOU from an investor to an issuer (such as the government, a bank or corporation). Think of the loan you take out from the bank to buy a house. The bank expects to be repaid interest and principal. If you fail to make the payments you break the contract and the bank has rights to recover its funds. Bonds work in much the same way. The investor agrees to lend money to the issuer who must then honour that legal obligation by paying back interest and principal. The interest payments (coupons) are typically made by the issuer twice a year and the principle is paid back at maturity.

Bonds are traded on a market much like shares and their price fluctuates from day to day. Generally speaking, we will aim to hold the bonds until maturity when they are paid back at face value – usually $100. As such, we are not overly concerned with the day to day fluctuations in price and holding bonds until maturity will also reduce brokerage as there will be no exit charge. If, however, an investor wants to sell their bonds before maturity they do expose themselves to the risk of selling below their purchase price and they will incur brokerage.

Different Types of Bonds:

Fixed Rate bonds – A fixed rate bond pays a fixed amount for the life of the bond, known as the coupon rate.

Floating rate bonds – A floating rate bond pays income linked to a variable benchmark. The margin over the benchmark is fixed and set when the bond is first issued, and income will rise and fall over time as the benchmark changes.

Inflation-linked bonds (ILBs) – An ILB is a security linked to the consumer price index (CPI) or inflation. Therefore the capital value of the bond grows with inflation.

Why Bonds?

Some key benefits of bonds include:

• Regular income – the bond’s interest accrues daily and is generally paid twice a year.
• Diversification – bonds provide a different type of return on shares and property.
• Liquidity – although it is our intention to hold the bonds until maturity, bonds can be bought and sold prior to maturity.
• The minimum investment for bonds is $10,000. This is much lower than a managed fund where the minimum is usually $20,000.
• Lower risk – many of the recent bank hybrids contain caveats that put the owners capital at risk in the advent of a downturn. These hybrids also do not allow the holder to be rewarded should the bank perform better than expected.

If you would like to learn more, please contact us today. One of our friendly advisers would be delighted to speak with you. Please note that the above has been provided as general advice, it has not taken into consideration your personal circumstances or financial goals.

The far right and the far left are equal in their attempts to inflame this Islamo-Christian divide, with the result that the ill-informed jump on a dangerous bandwagon.

My Facebook page is the recipient of dozens of admonitions and representations that someone or another is doing something bad to someone else.  Often ill-informed or downright kooky, there is no effective mechanism to knock out these damaging pronouncements, and simply commenting is, excuse the French, pissing into the wind.

Take the issue of Sharia Law for example.  Now I am no expert in the field, but first of all, it strikes me that the general take-home message behind Sharia Law is not that much different to that of the Old Testament.  The idea of “an eye for an eye” is found at Exodus 21.24.  In management, I am a big fan of it, just this week threatening a self-assured young employee that I’d “cut his balls off” if he stuffed up a second time on account of not listening to important instructions.  Not surprisingly his commitment to the task has grown exponentially, even with the availability of Western Anesthetic.

More seriously, Facebook posts are now focusing on Sharia Lending.  Apparently the Koran states,

“Those who charge riba are in the same position as those controlled by the devil’s influence… As for those who persist in riba, they incur Hell, wherein they abide forever” – Qur’an 2:275

Riba translates as usury, which is the action or practice of lending money at unreasonably high rates of interest.  Riba is therefore not interest, but the pricing and charging interest in a (supposedly) unfair or extortionate manner.  The pricing of interest in western markets is well institutionalised, and takes into account inflation and risk.  In a well-informed, competitive and well regulated market, it is near impossible to charge extortionate prices.  That is why in the west, we place so much importance on competition policy and consumer protection.

The translative subtlety between riba and interest has opened a loop-hole for Islamist scholars, many of whom have opted for a direct interpretation.  They say any interest is against Sharia law, because (they claim) it is a form of “effortless profit”, or extra earning that is “not the result of exchange”.  Such an interpretation is a careless application of the truth.  Whether as an individual or an intermediary, it is not effortless to accumulate money which can be lent out in the future.

And isn’t taking on the risk that someone might not repay you a form of exchange.  Interestingly, just last week I set up a loan where the terms included paying it back within a year, with 30 percent interest.  “Oh, no, the evil of it” I hear you all say.  But what if I told you all the banks had said no, creditors were at the door and it was the only way to save a business, 5 jobs and the owners’ retirement savings.  Isn’t the business owner getting something pretty tangible in exchange for someone taking on this risk, pretty much no questions asked?

Semantics aside, it is possible, even easy, to borrow under Sharia law.  The loans are structured so that the “lender” actually buys the asset and arranges for the borrower to buy it piecemeal.  So a Muslim schoolteacher might buy a house worth $500,000 on the market by making just 30 easy annual payments of $36,324.  Sound familiar – too right it does – it’s what we call in the West an operating lease.  In an operating lease, the asset is owned by the lessee until all the payments are made.  Those of you that are familiar with financial math will immediately grasp the fact that given the annual payments and the value of the house, you can easily derive an underlying interest rate – in this case, 6 percent.  Muslims know this – they and their near neighbours invented algebra.

Given all this, why focus on Sharia loans as “evidence” that Muslim people are not compatible with The West.  Unequivocally religiously motivated suicide bombing and religious murder is incompatible with Western doctrines, but if someone likes operating leases over traditional housing loans, what’s the big deal?  In fact, perhaps The West should explore expanding the application of operating leases, to farmers and graziers in particular.

Not only that, the Christian Bible also contains many admonitions regarding the charging of interest, Leviticus 25:35-37, Deuteronomy, Exodus 22:25, Luke 6:34-35, Psalm 15:5 Romans 13:8, Matthew 25:27, Ezekiel 22:12, and Proverbs are some.  To me, the most interesting of these is Psalm 15:5:

“Who does not put out his money at interest and does not take a bribe against the innocent? He who does these things shall never be moved”

Islam or Old Testament, it seems that the idea that charging interest on borrows is in some way generally undesirable.  This is something I have thought a lot about in my financial career, and the conclusion I have come to is that borrowing limits the ability of an individual to be themselves and to achieve fulfilment (personally or in God, however you wish to view it).  Think of all those people trapped in jobs they hate, simply to pay the mortgage, or of women in unhappy marriages, because (perhaps amongst other things) the mortgage prevents them from setting their own destiny.

Perhaps the last work belongs to William Shakespeare, who through the eyes of Lord Polonius observed:

“Neither a borrower not a lender be,

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry

This above all: to thyne ownself be true.”

By David French

If you study any formal course in finance it won’t be long before you are faced with the concept of “time value of money”.  What it means is that there is a cost to the delay in receiving money, and so we say that “a dollar received today is worth more than a dollar received in the future”.

There are two reasons why it is better to receive a dollar today than a dollar in the future.  First, if you receive a dollar today, then you can invest it and get an additional return.  Second, there is always a risk that you will receive less than promised, or nothing at all.

For more numerate readers, that you might consider accepting 97 cents now, rather than $1.00 in a year time.  If with certainty, you could earn 3 cents in interest over the year, then (taxes aside) you would be just as well off taking the 97 cents now, as waiting a year for your $1.00.  If you could pay off a loan, say a credit card, with the money received now, you might be as well off taking 85 cents now, rather than wait a year and pay credit card interest.  Essentially, the more risk you might not receive the money in the future, and the greater the return you can gain from investing the money now, the less you would be prepared to accept now.

So in finance, time has a clear monetary value and as touched on above, the methods of working out that value are well-established.  But what about other ways of putting value on time?

Applying the time value of money concept, it’s quite clear that getting something signed off or delays in finishing a project can be costly.  That’s probably obvious when considering large constructions – delays in finishing a big hotel (for example) mean there is a lot of money sitting around earning nothing – but it applies just as much to day to day activities that we all undertake at work.

When the tax office stuffs you around, when the local council continues to vacillate over an approval, when legislative changes or indecision prevents you from making a choice, all of these things create risk and delay.  They stall the receipt of revenue, they create project risk and the burn time you could be spending on other things.  Sometimes these delays and problems are so bad that they involve employing additional people.  Overall, the delays themselves make it more expensive to do business.

Perhaps the monetary side of that is obvious, but there are personal and social costs too.  Not building an efficient road network or a high speed rail link between Sydney and Melbourne steals people’s time.  Small amounts each trip perhaps, but over one’s life, time that adds up – time that could be spent with the family, time spent fishing or at golf, time spent blowing the froth off a few with good friends.  Perhaps that sounds trite, but I put it to you that those people who create delay, who don’t do their jobs well, who don’t care, who give you the run-around, who are attending to their personal stuff while charging you, who go on strike during your holidays, these people are stealing your life.

In an era where for many of us work is demanding, and responsibilities of all types high, it’s time we started to take a stand on time-thieves.  It’s time business recovered some of the ability to select and fire employees, to insist that Government departments and officers are held accountable, simply to enforce the social contract implied through employment and regulation.  Failure to do this means business operators will have to change more and more for producing the same goods and services, and those that cannot will simply drop out.

That’s what you can look forward to if the current combination of individualism, workplace bias, and allergic reaction to productivity improvements is not addressed.

Please note: The information provided in this article is general advice only. It has been prepared without taking into account any person’s individual objectives, financial situation or needs. Before acting on anything in this article you should consider its appropriateness to you, having regard to your objectives, financial situation and needs.

With interest rates at historical lows, investors now have to work extra hard to achieve a decent return on their money. But don’t forget that it is the after-tax return that counts – which is why investors with money invested in Australian shares can benefit from gaining an understanding of the Dividend Imputation System and how Franking Credits work.

Dividend imputation was introduced in July 1987, one of a number of tax reforms by the Hawke/Keating Government. Prior to that shareholders suffered double taxation on their dividends. That is, first the companies paid tax on any profits they had made, then the shareholders were taxed again at their marginal tax rate when they received these tax-paid profits in the form of dividends. This double taxation was overcome through the introduction of the Dividend Imputation System.

The word “impute” means to “give credit for” and this is exactly what the imputation system does. It allows shareholders to receive credit for the tax already paid by the company at the 30% company tax rate, and pay tax only on the difference between that and their own tax rate. This means for an individual on the top marginal tax rate of 49% (including Medicare & Budget Repair Levy) will only pay the difference which is 19%.

Since 2000, provisions have been made to receive franking credits back as a tax refund where the tax rate is less than the company rate. Therefore, for a super fund in pension phase, where the tax rate is nil, the full franking credit will be refunded by the tax office.

Let’s take a look at this concept in more detail by using an example.

The Beauty of Franking Credits

Company XYZ Holdings Pty Ltd makes a profit from its business activities of $10,000 which is fully taxable. It pays tax at the current company tax rate of 30% which equates to tax paid of $3,000, leaving a $7,000 after-tax profit. The company can either reinvest some or all of this money back into the business or pay out some or all to shareholders as a dividend. In this example, XYZ Holdings Pty Ltd decides to pay out all profits to shareholders.

If there are 10 equal shareholders, each receives an after-tax dividend of $700, with a $300 franking credit attached (the tax paid by the company). Since the profits associated with the dividends have been fully taxed, the after-tax dividends are said to be 100% franked or fully franked.

The grossed-up dividend amount is $1,000 ($700 plus the $300 franking credit) and is included in the shareholder’s assessable income. Tax is then payable at the shareholder’s applicable marginal tax rate. The tax paid by the company (franking credit) is then used to offset the shareholders tax payable.

The table below shows the effects of taxation by comparing 5 individuals, all on different individual and superannuation tax rates:

*The above rate does not include the Temporary Budget Repair Levy; which is payable at a rate of 2% for taxable incomes over $180,000 to 30/06/2017.

Individuals 1, 2 and super fund members in accumulation or pension phase all receive tax refunds due to the tax rates being less than the company tax rate of 30%. The higher income earners, individuals 3, 4 and 5 have to pay tax on their $1,000 dividends but they have both reduced the tax payable due to the franking credits.

If you are interested in learning more, please contact us today. One of our friendly advisers would be delighted to speak with you.

Please note: The information provided in this article is general advice only. It has been prepared without taking into account any person’s individual objectives, financial situation or needs. Before acting on anything in this article you should consider its appropriateness to you, having regard to your objectives, financial situation and needs.

Whether we are talking about commercial activities, government, leisure pursuits or just day-to-day living the use of jargon is very evident. That is, specialised language concerned with a particular subject. The financial services sector abounds with terminology relevant to its activities and products and it can help the user of these services to sometimes simply go back to basics to make sure everyone understands what is meant by certain words or terms.

An oft-used phrase is “managed fund”. The product providers keenly push the potential benefits of their managed funds. For instance: easy diversification; expert money management; invest for income, growth or both; convenient regular savings plan. These benefits are fine, however, this marketing stuff does not explain how a managed fund works. Let’s lift the lid on the operation of managed funds and make sure we understand what is going on.

There are a variety of different styles and tax structures for managed funds. In later articles we will cover how entitlement to income and capital growth from the investments are handled, how superannuation funds and insurance bonds differ from managed funds that distribute their taxable income to investors, explain the differences between unlisted and listed managed funds and also how “active” funds contrast with “passive” funds. For now, let’s focus on plain vanilla unlisted managed funds where the investor is responsible for any tax on investment earnings.

These managed funds operate as unit trusts, a well-established and cunningly effective way of dealing with pools of money for collective investment where new participants in the pool can easily join and departing participants can be paid out without disrupting things for the other participants. The participants in these structures are called “unitholders”.
When a new unitholder joins (or an existing unitholder invests more money in the pool) new units are issued by the fund manager. When an existing unitholder leaves, their units are redeemed by the fund manager. So, new units could be issued and existing units redeemed every day impacting the number of units on issue. The price at which new units are issued or existing units redeemed is where the effectiveness of this structure comes in.

The fund manager would value the investments held in the collective pool, typically every day where prices are readily available. These investments could include cash deposits, interest-bearing securities and listed shares. Physical properties are valued less frequently. So, the total value of the collective investment pool is calculated (let’s say this is $100,000,000) then the number of units on issue is sourced (let’s say this is 25,000,000 units). Dividing the value of the pool by the number of units on issue gives the worth of each unit (in this example $4-00 per unit). If no new units were issued nor existing units redeemed and the underlying value of the investments in the pool increased the next day to $100,500,000 then each of the 25,000,000 units would have an underlying value of $4-02. In practice the numbers would not be neat and round as shown here.

So, if new units are to be issued the underlying worth of each unit might be $4-00; many unit trusts would charge a small premium for issuing new units, so the actual issue price might be $4-01. A new investment of $25,000 would receive 6,234 units at $4-01 each. If existing units are to be redeemed the underlying worth of each unit would also be $4-00; many unit trusts charge a small amount for redeeming existing units, so the actual redemption price might be $3-99. A redemption of 5,000 units would receive proceeds of $19,950 at $3-99 each unit. The “buy/sell” difference between the issue price, redemption price and unit price is retained by the fund and is designed to avoid continuing unitholders being negatively impacted by transaction costs incurred when new units are issued or existing units redeemed.

So, unit trusts are a simple and effective way to administer pools of investments where new participants can join and existing participants leave with minimum fuss.

Please note: The information provided in this article is general advice only. It has been prepared without taking into account any person’s individual objectives, financial situation or needs. Before acting on anything in this article you should consider its appropriateness to you, having regard to your objectives, financial situation and needs. If you would like more tailored advice, please contact us today. One of our friendly advisers would be delighted to speak with you.

I’ve been a financial adviser for about 17 years, and have met with quite literally hundreds of clients. I’ve always found it fascinating to learn how people think and act in respect of their wealth. The conversations I have with clients tend to have common themes.

The financial planning process itself is pretty straightforward. At the initial meeting, I aim to understand the client; their current situation, objectives and preferences. After all, it’s all about them. Thereafter, I prepare recommendations in respect of appropriate strategies, structures and investments that will help increase the chances of them achieving their objectives.

As such, for me, it’s the interaction with clients that I find interesting. Listening to a client, and confirming back to them my understanding of their objectives and preferences is, of course, paramount in this process. This process can be straightforward or lengthy, as many clients are unclear as to exactly what their objectives are, and what they may need to do in order to achieve them.

My discussions with clients often come down to the same following points:

1. Spend less than you earn
2. Invest surplus income in quality assets that generate income
3. Review your investment portfolio on a regular basis
4. Structure your financial affairs as simply as possible, but no simpler
5. And when it comes to the investments themselves:
   • I don’t, and can’t, promise to ‘shoot out the lights’ on investment returns (Quite frankly, if I could do that on a consistent long term basis I wouldn’t need a day job!)
   • Risk, or the volatility in the value of your investments, always, ALWAYS, equals return
   • A risk is not necessarily a bad thing or something to be avoided (If you avoid all risk that the value of your investments would decline, all you’d be left with are bank deposits paying 1.75% per year.

So don’t avoid all risks, however, make sure that you understand the risks and receive an appropriate level of compensation for assuming them.

My aim is always to place my client in a position from which to make an informed decision. The decision is always theirs to make. I’m simply looking to provide constructive input to assist them.

If you would like to learn more about our services, please contact us today. One of our friendly advisers would be delighted to speak with you.

Two years ago Analysts/Consulting Owen Evans presented a seminar for clients entitled Fun with Vertical Fiscal imbalances.  A core message was that Australian Governments had effectively no clue as to the extent revenues would fall as a result of the mining boom, and that we were in for a lengthy period of declining living standards.  The response, Owen said, was that government would increasingly be confined to short terms and instability would become the norm.  Let’s look at some facts that have emerged since then.

By a relatively large majority, UK voters elected via referendum to leave the EU. This was clearly a surprise to most commentators and markets, with Sterling and global equities markets getting thrashed on the day, the PM announcing his resignation (to take place by October) and roughly half the Labour Party front bench resigning. Watching it live was like watching lemmings jump into the sea below, a feeling exacerbated when the most interesting commentator turned out to be Lindsay Lohan.  Here are a few observations:

The short-term economic implications for the UK and Europe are clearly negative. The longer-term implications are also negative but may not be overtly visible. One must presume that global GDP growth falls very slightly over the next two years because of this. One also must conclude that interest rates are likely to stay lower for longer; and,

The direct impact on Australia and Australian listed companies is likely to be imperceptible. But there may be a small bias in favour of domestic-related businesses as opposed to exporters and interest rate sensitive stocks.  There is certainly no reason to think that Brexit will hasten a global economic recovery and for that reason, there is no rush to return to investing in mining and resources related industries.

The Brexit debacle was immediately followed by Australian voters demonstrating a significant swing toward a union leader from a Government roundly rejected by voters in 2013.  Preferring heart over head, Australia will probably end up with a hung parliament and a Senate controlled by individuals who variously want to ban live cattle exports (thereby effectively killing the NT economy), subsidise Tasmanian electricity generation and reintroduce financial transactions taxes, reintroduce tariffs that will increase the price of goods for everyone, and based on petitions of just 200,000 people, introduce rolling referendums to decide laws.  If you think that is kooky, consider that by the end of the year a boorish reality TV star could be the next US President;

These seemingly outcomes are both seemingly bizarre and based on a well-honed ignorance of what matters.

Western prosperity since 1946 has been based to a large degree on growth in trade, personal freedom and mobility, and increasing economic integration. The days of having three different electricity outlet types in the UK and 35 in Europe have been coming to an end. Brexit is a vote against trade, against mobility and against integration. In effect, 17m Britons voted for an immediate pay cut.  It seems unlikely that they would have done that, if they understood the impact.  The fact that two of the main proponents of Brexit have now stood down, suggests a total lack of belief in the BS they were peddling.

First, this is an unexpected outcome and following issues with US polling during the primaries it calls into question the capacity of western leaders to understand what exactly it is their constituents want or expect from Government.  Instead of making and delivering on policy Governments are deliberately pandering to interest groups/issues, because:

1. there is no point in trying to convince rusted-on supporters and;
2. because of the mistrust and pressures linked to a decline in living standards, we are living in a time where people are relying on their feelings for guidance, rather than education or logic.
3. Add to this the internet which is enabling democracy by popular engagement, with the consequence that many people have plenty to say, but not much knowledge about what they are saying.
4. Across the west we have an ageing population increasingly fearful of the impact of immigration.  It is borne of a nationalistic fervour and a desire to build barriers against all manner of perceived threats (but immigration in particular). 

A basic tenet of economics is that what is good for the population is not necessarily good for the individual.  Combined with the inability to measure voting intentions accurately combined with a willingness to vote against perceived self-interest (even if it is the general interest) suggests that unusual political outcomes may have become standard.  As a result of these factors, the gridlock that hampers decision making in many Governments is set to become more serious.

As we have said countless times in Client newsletters, we have entered a time of extended volatility and uncertainty and we are experienced in managing that.  This experience is critical when the main alternative to investing in markets is to put your money in the bank.  Interest rates of below 2 percent are about a third of the income generating capacity of most of the portfolios we build.  The choice to put your money in the bank ensures you lock in very low-interest rates, and that you are eating into an increased amount of your savings, just for day to day expenses.

In terms of the market outlook, Brexit will likely see markets unstable for a while.  But they were already unstable, and the portfolios we have built for clients have shown good results in withstanding that.  As we have said in Client newsletters, interest rates are unlikely to increase anytime soon, and in general that is good for the portfolios we build.

Given the trade advantages of the EU, we will be amazed if the long term outcome is not that the UK struck a deal with the EU such that most if not all of the primary economic advantages were retained, but that the UK exerted more control over its borders.  In this context, its worth noting that Norway subscribes to almost all of the EU rules, thereby retaining trade benefits, but without being a member (of course, it gets no say on how those rules are formed).

Overall, our view is that we are in for a very long period of sub-trend global growth and this will continue to result in global economic and social instability.  For many years there will be no free kicks and the rewards will go to those who can look beyond the emotion.  We believe that is the most valuable service that we can offer clients.

Originally published in our July 2016 newsletter, read more recent newsletters here.