2018 Budget

Budget 2018

The 2018 budget was in my view a positive budget in relation to Financial Advice, Taxation and Superannuation.  You will hear lots of negatives from the media, they really do not know anything else.  

What we have been given are tax cuts for those earning below $200,000, tightening measures on business and family trusts which are either avoiding tax or not completing correct documentation and some sensible changes to Superannuation to protect small balances, find lost super and allow older people to top up their super.

You will hear negatives in relation to the tax cuts, complaints will be in relation to the size of the tax cuts for different income earners. The person earning $40,000 will save $540 in tax where as the person making $200,000 will save $7000 in tax.  I agree that the figures vary greatly, however, we have a staggered tax system and there is no way around this, the increase in the low income rebate has helped in this area.

Measures around business are positive, the government is trying to ensure that all compliance work is being completed and tax avoidance measures are being closed down.  

This is a positive for business owners; it will save business owners from more red tape and stop future tax increases.  I have little concern for those who want to try to exploit the system and pay less tax.  It only increases the tax cost to the rest of us who play by the rules. 

With the ABC having had its budget cut by $84 million, I do not expect to see any positive comments from them about the 2018 Budget.  Keep in mind that their annual budget is still $1.2 Billion per annum.

Below is some more detail on the measures that this Budget will undertake.

Let’s talk tax.

Individuals will see less tax taken form their pockets with a range of measures which for 94% of Australian workers will leave them better off.

1.       Low income tax offset threshold will be increased starting 2017-2018       meaning the lower income earner will start feeling the benefits in their tax return this year.

2.       Medicare levy will NOT be increased from 2% to 2.5% - No need for NDIS funding.

3.       Supplementary payments to veterans or spouses will no longer be taxed from the 01/05/2018.

4.       Tax bracket changes from July 2024 will see significant tax savings for anyone earning less than $200,000. However this is still 6 years away, not time to get excited yet, but it will eliminate bracket creep for the majority of tax payers.

Businesses compliance

Business will have a number of measures affecting them most are to ensure that businesses are paying the correct amount of tax.  It will facilitate shutting down a number of tax avoidance schemes and ensure that businesses are working within the taxation framework.  It will also focus on contract workers to ensure all payments are declared to the ATO and the correct level of tax is paid.  This will ensure that the ATO is collecting the correct amount of tax and put pressure on those businesses doing the wrong thing.

1.       Small Business $20,000 instant write off will be extended to June 2019. That is good news and should stimulate spending.

2.       Research and Development rules for claims will be tightened.  This area was subject to excessive claims.

3.       Rules around Div 7A loans will be tightened ensuring tax is paid correctly.  Focus is on trust distributions, ensuring that the rules are complied with and correct tax is paid.

4.       Deductions for vacant land will be denied bringing these expenses back to being capital in nature if the property is not held for development or farming.

5.       Non-compliant payments to employees or contractors will not be an allowable deduction forcing businesses who employ contractors to report all payments made to contractors to the ATO, at the same time some new industries will be added into this category.

6.       Tightening up on significant global entities to ensure that the correct amount of tax in paid on worldwide income.

7.       Capital Gains Tax (GCT) Discount is removed from Managed investment trusts. The CGT will be paid by the beneficiary and GCT relief applied depending on their tax status.

8.       Tightening up on Family Trust tax avoidance schemes in relation to circular trust distributions.  These are Trust behaving badly and avoiding tax.   These measures will ensure everyone is paying their share.

9.       Increase in information exchange regards tax between countries to ensure overseas income is included in the Australian tax return.

Superannuation

We have only seen sensible changes to the Superannuation rules, all of which enhance superannuation benefits.

1.       Self-Managed Super Funds (SMSF’s) from July 2019 will be able to have as many as 6 members.  Most funds have 1 or 2 members;  not sure if there will be a big demand for 6 members but we may see kids start to get involved in the parent’s SMSF.  The catch will come if one party is in Pension Mode as you will not be able to segregate assets.

2.       ATO will put measures in place to ensure that any Personal Concessional deductions are correctly recorded on the individual’s tax return as well as their SMSF return.  Ensuring that tax is paid in the super fund and the member gets the benefit of the deduction.

3.       Work test exemption for people age 65-74 with less than $300,000 in super. This will allow these retirees to add to their superannuation.  Given that qualification to the age pension is looking to be extended out to age 70, this work test exemption is a sensible and a well over due change.

4.       Insurance Opt In -  if you meet the following requirements Superannuation funds will need you to opt in for insurance from July 2019.  This measure will protect small superannuation balances from being eaten up by fees.  The conditions for this to apply are:

a.       Balance less than $6000

b.       Members under age 25

c.       Super funds who have not received a contribution for 13 months

5.       Fee protection measures:

a.       Funds with a balance of less the $6000 cannot be charged more than 3% pa in fees

b.       Exit fees on all superannuation balances will be banned

c.       ATO will expand their matching rules to ensure any super fund with balances below $6000 which are sent to the ATO are proactively processed in an effort to re-unite them with their owner.  No more lost super.

For the majority of us already doing the right thing this budget is all positives and no negatives.  For anyone a bit slack on compliance you have time to get it right and sorted before the required dates. You cannot say you have not be warned.

This budget will deliver a plan to get back to a surplus on a steady and sensible path.  The only problem is that LNP will need to be in government for the next 10 years before the full benefits will be felt.  So it is up to you Australia to decide what our future will look like.

Short term gratification, or long term plan to prosperity!

Feeling Poor - Well maybe you are.

Information released this week from the IPA shows the change in cost of goods and services compared to wages growth. Over the past 20 years from 1997 to 2017 wages have increase 90% while the cost of services such as housing, electricity, rates, insurance, child care and education have more than double and some tripled the growth or wages. On the bright side other items such as food, clothing, household appliances, motor vehicles and electrical equipment have gotten cheaper or incurred cost increases less than wages. Overall inflation has grown slower the then wages.   

We are now in a two stage economy, if you have grown up kids, own your home with solar panels you have most likely been able to avoid most of the pain. For families however it is a different story, sure you can buy consumables at a far cheaper percentage of income but major expenses such as buying a home, child care, kids’ education, rates, insurance and electricity will clean out that saving account. Keep in mind that we also have very low interest rates at present, an improvement in the economy could see this change.

For many young families the cost of living has out grown wages, this will over time reduce the amount or money which can be allocated to savings. You need to start planning long term and make small sacrifices now that will allow you to retire comfortably or you can work until your 80 year old, your choice!

Getting ahead financially is a combination of saving money, reducing tax, return on investments and time. It is now more important than ever to get these four core principal’s right. Time is more important than ever, the cost of living is not going to reduce and I doubt wages will catch up to the already large increases in service expenses.

Talk to your financial adviser now, start early! If you put away a small amount each pay day in superannuation your future self with thank you. Extra contributions of $50 per week into super over your working life of 30 years could add as much as $250,000 to your retirement nest egg.

The secret is to start early!

Come in and have a free chat with our advisers at Grow Your Wealth and build a better retirement. Call 07 4771 4577 or email admin@growyourwealth.com.au to book a time.

Double Taxation

Bill Shorten wants your money.

We all love that end of year tax refund, but wait, what if the government decided that they would keep your refund.

Well today on the 13/03/2018 this is exactly what Bill Shorten has proposed and the ABC is championing. But only in regards to those rich people who own shares, so you will not be affected right! Wrong! If you have money in Superannuation then this will affect you, you will pay more tax on this income so the government can waste it for you. It is called double taxation.

Double taxation is when a company pays tax at 30% and then pays a dividend to the shareholder, on which the shareholder will pay further tax on the dividend. For example just say the company make a profit of $100,000 and pays $30,000 or 30% tax rate on the profit. This leaves the company $70,000 in cash to pay to the shareholder. Let’s assume that the shareholder pays tax at the average rate of 25%. So they will include the $70,000 in their personal tax return and pay $17,500 or 25% in tax.

On the initial $100,000 earned the company paid $30,000 and the shareholder paid $17,500 so in total the tax paid on the initial profit of $100,000 was $47,500 or 47.5%.

In 1987 the franking credits system was introduced to stop the double taxation, however, it was not until 1 July 2000 that the franking credits became refundable. This put a stop to double taxation and ensured that everyone paid the right amount of tax for their income level.

Taking the above example, a company paying a $100,000 dividend and paying $30,000 in tax, the new system in 2000 allowed the cash and the tax paid (imputation credit) to flow through to the shareholder. The Shareholder would declare income of $100,000 made up of cash of $70,000 and the imputation credit of $30,000. The shareholder would then pay tax on the $100,000 at their marginal rate of 25% or $25,000. The difference between the Imputation Credit of $30,000 and the tax payable by the shareholder of $25,000 if paid back to the shareholder as a tax refund. In this case the amount being $5000.

Under the new proposal by Bill Shorten, this $5000 refund due to the shareholder would be kept by the ATO. The slogan that the ALP is using and the ABC is repeating is that no extra tax is paid, is completely false and fake news. If the shareholder is not receiving the refund then they are paying more tax. In the above example the shareholders tax rate goes from 25% to 30%. (Please keep in mind that above example is for illustration purposes only.)

But who will this affect?

Everyone who has investments in superannuation, your superannuation hold shares which pays dividends to rich and poor alike. It will affect everyone in the same proportion, the company tax rate is 30%, imputations credits are paid at 30% means that the government will keep up to 30% of your income.

Example

Frank has $1 million in an account based pension (account based pensions pay no tax) his income from this pension is a $50,000 fully franked dividend. His gross income is $50,000 cash and franking credit of $15,000 a total income of $65,000. As pensions pay no tax, Frank would receive a refund of the $15,000 franking credit. Under the new proposal by Bill Shorten Frank would lose this $15,000 and the government would keep it.

Bob has $300,000 in an account based pension (account based pensions pay no tax) his income from this pension is $15,000 fully franked dividend. His gross income is $15,000 cash and franking credit of $6,428 a total income of $21,428. As pensions pay no tax, Bob would receive a refund of the $6,428 franking credit.Under the new proposal by Bill Shorten, Bob would lose this $6,428 and the government would keep it.

Sure Bob has lost less in dollar terms but I expect Bob would feel the loss more than Frank.

This proposal should never get up as it will only serve to increase the tax Australians already pay and hurt middle class Australia.

Self Managed Super Funds and Event Based Reporting obligations.

On the 01/07/2018 Self Managed Super Funds will be required to meet the new Event-Based reporting obligations. This is due to the new transfer balance cap measure and the event based reporting framework. From the 01/07/2017 there is a limit on the total amount you can transfer into pension phase inside your superannuation account. This amount is call the transfer balance cap, which starts at $1.6 million and will be index periodically in $100,000 increments. Your transfer balance cap must be reported to the ATO by the 01/07/2018 in relation to all pre-existing income streams.

From the 01/07/2018 all Self Managed Super Funds must report events that affect their member’s transfer’s balances. When you have to report depends on the size of your income stream. Timeframes for reporting are determined by the total superannuation balances of the SMSF's members:

  • where all members of the SMSF have a total superannuation balance of less than $1 million, the SMSF can report this information at the same time as when its annual return is due, or
  • SMSFs that have any members with a total superannuation balance of $1 million or more must report events affecting members’ transfer balances within 28 days after the end of the quarter in which the event occurs.

A SMSF is required to report earlier if a member has exceeded their transfer balance cap.

To ensure that you are reporting on time it is important that your administration services are up to date and using the latest software. It will no longer be good enough to lodge the information in May of the following year, some 9 months after the end of the financial year. Late lodgement will incur penalties and the need to provide a response to the ATO as to why the breach occurred.

We recommend that you take a look at your current administration services for your SMSF to ensure that they are sufficient to meet the new requirements. If you have any concerns contact Grow Your Wealth and we will be able to assist you.  

Bitcoin! Should you invest?

Bitcoin is everywhere in the media at present, the value of a Bitcoin has passed $10,000, Bitcoin has been around since 2009. So why all of the hype now?

This article will not explain how Bitcoin works there are plenty of You Tube clips for this, what I want to talk about is should you be investing in Bitcoin. Like all investments you need to weigh up the risk verse the rewards and determine if it suits your investment profile.  

So what is Bitcoin?

Basically it is currency used to buy goods and services generally over the internet, however, I expect in time you will be able to do so through a physical store using your phone. So it the same as having cash in your wallet or using your debit or credit card.

So owning Bitcoin is like having cash in the bank, except that there is no central body guaranteeing your money and no interest being paid on it. Bitcoin does have in place a decentralised ledger system to keep track of your money which provides security, the catch is that if it is stolen or lost there is no one to assist to recover your money.

As an investor if you want to hold cash, the current banking system is more secure and does provide interest. Bitcoin is not about cash as an investment it is about capital growth.

Why does Bitcoin go up in value?

Cash does not appreciate in value, it actually decreases due to inflation. Why is Bitcoin different? In simple terms there is limited supply and the supply is controlled by the makers of Bitcoin, new coins are created through the solving of mathematical equations. To increase supply the equations get easier but to reduce supply the equations are made harder. These equations are solved using super computers by what the call “Bitcoin Miners”.

So right now supply is short and demand is high so the price is moving higher. Will this continue? Depends on demand and demand will be driven by two factors:

1.       People need the currency to do on line transactions and therefore trade traditional cash for Bitcoin.

2.       Investors speculating on the price.

At present only a small percentage of people worldwide use Bitcoin on a regular bases to purchase goods. Which would leave me to believe the rest are investors speculating on the price going up.

Unlike most investments Bitcoin has no underlying value, it does nothing, is not protected by government legislation, it earns no income. There is no reason for the price to go up except that investors expect it to continue to go up. It reminds professional investors of the 17th Century Dutch Tulip & Bulb market bubble. Bitcoin is a highly speculative investment where you are just guessing where the price will go.

Warning

When big gains are made in this sort of investment you can be assured that most investors suffered big losses. It is basically gambling in something which has no rules. Keep in mind that in March 2017 the price was around $1000 per Bitcoin it is now at $10,000 per Bitcoin. This is a gain of 1000% in 8 months. For those looking to invest you may have missed the boat.

You also need to understand that this is a person to person system, to get Bitcoin your either mine it, sell something for it or pay cash for it. However you need to find someone who wants to sell their Bitcoin for cash or if you trying to get out you need to find someone who wants to pay cash for Bitcoin. For this you need a broker as such there are transaction fees.

The decentralised structure of the Bitcoin ledger system means that you cannot use walk into a bank and get your money back. If the price was to fall you may find that you simply cannot redeem you investment.

Is there a second GFC coming?

There is a lot of talk around at present of a second GFC event; this is mainly hype from the media who have no idea what caused the GFC. The key issue fueling these sorts of statements is the property market. Property has slumped over the past years, while household debt has gone through the roof (pun intended).

Australian household debt to GDP has increased 16 percentage points since the GFC. This increase has come at a time when interest rates are at an all-time low. A major rate raise could indeed see many Australian households go into debt stress and bankruptcy. However, we expect that the central banks will take a gradual approach to any interest rate increase. Therefore avoiding and sudden increase in bankruptcy.

The housing market has two major issues, interest rate increases and high under employment. Instead of a GFC type crash I expect we will instead see a long period of low growth in the property market.Recession is a real possibility for Australia. A recession is a significant decline in activity across the economy, being two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP). Although this has not technically happened, given the high under employment in Australia and high debt levels it would be fair to say we were already in recession like economy.

I expect that the Queensland State election due by May 2018 and the Federal election expected to be held in early 2019 will be the catalysis’s to pull us out of a recession or plunge us into one.

Separately Managed Accounts

Separately Managed Accounts (SMA’s) are the perfect way to get your share portfolio off to a great start. Investing is all about making the right decisions at the right time. When you first start investing the big mistakes most people make is lack professional advice and  diversification.

Diversification is the core or any successful investment strategy. Why? Diversification reduce risk, we all know it is risk verse reward. The higher the proposed reward or return then the high higher the risk you will be taking.

With the right diversification, you can still achieve the higher returns but with less risk.

A separately managed account is professionally managed like an individual portfolio with many key advantages:

  • The securities in the account are visible just as they would be if they had been purchased directly
  • The underlying securities are owned, not units in a fund.
  • As a result, you can manage the tax position.
  • SMA's offer one or more model portfolios to choose from so you are able to create a customised and diversified portfolio.
  • Consolidated reporting is provided online with complete and concise reports available at any time. All the paperwork and administration is taken care of by the SMA provider, reducing the administrative burden on investors.
  • Low minimum investment requirements and low brokerage costs allow effective diversification in a portfolio and allows for dollar cost averaging into direct shares.

Grow Your Wealth’s SMA has outperformed the benchmarks by 1.86% over the 6 months and 1.2% over the past 12 months. It provides great diversification and exposure to Australian Shares, International Share, Property, Fixed Interest and Cash.

The SMA allows you to start with small or large amount and is cost effective.

For more information go to  http://growyourwealth.com.au/praemium-sma or follow us on Face Book.

Make 19.5% per annum!

Do you want to know how to make 19.5% per annum  on going with no risk! Sounds great right, maybe it is a scam. Guarantee you it is not, it is a real return you can make but like everything you are required to make some sacrifice.

In this case I am talking about salary sacrifice into your superannuation. Superfunds are taxed at a rate of 15%. You as an individual employee have a sliding scale tax rate, the more you earn the more tax you pay.

Example:

If you make over $37,000 per year you will pay tax plus Medicare levy at an average rate 34.5% on every dollar earned over $37,000. If you salary sacrificed $10,000 of your income which is tax at the 34.5% into your Superannuation fund, your tax saving will be $3,450. Inside of your super fund the $10,000 will be taxed at 15%, so you pay $1500 in tax. This is a saving of $1950 or a return of 19.5% on the initial $10,000 investment.

But wait there is more! Let’s say your income is $70,000 pa; your take home pay would be $55,700 pa. After the salary sacrifice of $10,000 your take home pay will drop to $48,900 pa. Which is only a difference of $130 per week!

The catch is that these funds will be locked away until you retire.  But the benefits are huge! It is a combination of the three main factors will allow you to create wealth, return on investment, reduction in tax and time.

Let compare the two investments of $10,000, one through salary sacrificing into super and another outside of super after paying income tax.

Investments outside of super after tax leaves you with $6550 to invest at 8% adjusted of tax on return, over 10 years. The expected value would be $84,000.

Investment inside of super after tax leaves you with $7500 to invest at 8% adjusted of tax on return, over 10 years. The expected value would be $102,500.

Results

·         Over 10 years you would have an extra $18,500 or 22%.

·         Over 15 Year you would have an extra $40,000 or 28%

·         Over 20 Year you would have an extra $75,000 or 33%.

Keep in mind this is just for investing in super as opposed to outside of super.

But let’s face the facts; you most likely would not have saved the money unless you did salary sacrifice. So in real terms you would have an extra $102,500 after 10 years or an extra $185,000 after 15 years or an extra $300,000 after 20 years.

What sort of difference would this make to your life! You could retire earlier or travel more when you retire. The point is at least you would have a choice, is your current strategy going to give you any choice?

For more information go to  www.growyourwealth.com.au or follow us on Face Book.

Budget 2017

Last year in December I noted the following in my Market Wrap 23/12/2016.

1.      The stock market will push its way back to 6000 points, so far it has hit a high of 5975, and we still have 7 months.

2.      Interest rates will move up, which we have already seen.

3.      Governments will announce infrastructure spending.

See for yourself http://growyourwealth.com.au/market-wrap1/2016/12/23/market-wrap-23-12-2016 .

The 2017 Budget in Australia was an infrastructure budget. This will bring employment and drive the economy. In times of recession, the Governments role is to stimulate the economy, which is what this budget is going to do.

What does this mean for debt, 10 years ago Australia had debt of $53 billion at present this figure is around $500 billion. Under this budget this is expected to increase further, case in point is Mr Morrison has raised the Australian debt ceiling to $600 billion.

The budget is forecast to hit surplus in 2020-2021 year, this is good news however it is still a long way between now and then and a lot will depend on the economy improving.

Let’s take a closer look to see who are the winners and losers.

The winners here are:

 Jobs- Infrastructure spending will create jobs. Keep in mind that for every dollar the government spends private enterprise will spend another $2 to $3. Unemployment is high in Australia, the way to solve this is to build and build, which is exactly what the government is doing. They are building infrastructure which will improve productivity long term. Nation building activities. I will take time before we see unemployment and under employment improving but at least it has started.

NDIS - The National Disability Scheme, will now be fully funded. This I am sure will be welcome news for the Disabled Australians. Allowing them to take control of their futures.

Self-Funded Retires – have over the past year had a number of restrictions placed on them in regards to increasing the money they have in superannuation. They now have the ability to make contributions to super from the proceeds of the sale of the family home. These contributions which are $300,000 per person are separate to the new non concessional caps limits and are not governed by the $1.6 million cap rule.

This measure is a big plus in my book, it is available to individuals between the age of 65-75 which is generally when retirees start looking to downsize and generally have issue in making further contributions to superannuation.

Age Pensioners - who recently lost the concessional cards will get it back. Once again unwinding a very unpopular change which happened last year. These pensioners were in the high income levels and the concessional card was all the benefit that they received. This will take effect on the 01/07/2017, so if you were one of the people who lost the card make sure you apply for it again.

Small Business – the big and long awaited news here is the tax cuts that they will receive. Now keep in mind that small business employs around 40% of Australians. This budget will move the goal posts so that now small businesses with a turnover of under $10 million will have its tax rate reduced to 27.5%.

This rate will start to drop in the 2025 year to 27% and then decrease each year by 1% finally reaching a rate of 25% in the 2027 tax year. Keep in mind that Australia has one of the highest company tax rates. A drop in this rate will make us more competitive on the world stage and attract more businesses to Australia.

The number of small businesses who can avail themselves of these lower rates will increase as the turnover limits are increased. In 2018 tax years they will include businesses with turnover below $25 million and in 2019 businesses with turnover of less than $50 million.

Best of all the rate of this financial years ending 30/06/2017 will be reduced from 28.5% to 27.5%. On top of this the current policy allowing small business an instant write off for assets costing less than $20,000 will continue. 

Finally, small businesses are no longer required to administer paid parental leave payments. This is a massive time consuming job for small business. Governments departments will now do this as they always should have.

Earlier budget measures which have been abandoned:

1.      Increasing the age of eligibility for Newstart and Sickness Allowance

2.      Cessation of the education entry payment

3.      Pharmaceutical benefits scheme – increase in thresholds

4.      Australian working life residence

5.      Youth Employment Strategy – revision of waiting periods for youth support

6.      Family payment reforms

7.      Increase to family tax benefit Part A.

The losers will be:

Unfortunately someone has to pay for the above expenditure, the government has been quite tricky here and although it appears that the big bad banks are going to foot the bill I can assure that it will be the average tax payer.

$6 Billion Bank Levy - Everyone who holds bank shares, has a loan with a bank or a deposit account, will pay this levy as the banks seek to claw back the $6.2 billion. This measure is just a money grab by the governments from our best performing companies. It is easy and popular to bash banks; however, we all use them and need them.

All of us have superannuation of which some of the funds are invested in the banks, we will be affected as this levy represents around 5% of their profit. This need to come from somewhere. Given bank yields are historically high you can guarantee that dividends will be cut. This will reduce the return on your superfund.

Next you can expect to see interest rates increase on loans, my guess is that this will start with commercial lending first, move into fixed rate loans, investments loans and finally owner occupied loans if needed.

For those holding cash or term deposits do not expect to see and rate rises unless the Reserve Bank makes them. However the banks may not pass them on.

That said keep in mind that the banks are backed by the government as such loss of capital from the banks collapsing is very unlikely. As such if dividend yields move back to historic rates of 5% this is still better then bank interest.

Everyone who pays Medicare Levy - from the 01/07/2019 the Medicare levy will increase from 2% to 2.5%. The funds are to assist with covering the costs of the NDIS, which is why the increase is delayed until the funds are needed in 2019.

This will sting all of us given the levy was only raise two year ago from 1.5% to 2.0%, the offset to this is the budget repair levy has been repealed however this only affected people making more than $180,000 pa.

On the bright side, the Medicare Levy low income thresholds have also been increased. These thresholds are the level of income you have to make before you pay any Medicare levy. The lower level which is when you start to pay has been increased to $21,655 for singles and for families to $36,541 plus $3,356 for each child.

Investment properties – If you own investment properties there are a number of changes which will affect you some in regards to holding residential property inside Superannuation and others investing in property outside of superannuation.

Travel deduction – the cost associated with travel to inspect your investment property is no longer an allowable deduction in your tax return as of 01/07/2017. It seems that too many people were writing off holidays as a property inspection trip.

Depreciation will now only be able to be claimed on plant and equipment which you incurred actual expenditure. As such if you purchase a property with the assets already there you will not be able to claim the depreciation expense. This is a catch for those buya second hand house.

Finally those looking to buy investment property through a Self-Managed Super Fund, your limited recourse borrowing loan will be included as part of your superannuation balance. This may affect your ability to make non concessional contributions. If the value of your superannuation balance added to the value of the limited recourse loan is greater than $1.6 million you will not be able to make non-concessional contributions.

Government Benefits – there are a number of changes making it harder to access government benefits including:

Longer waiting periods depending on personal assets. This is the extension to the Liquid Asset Waiting Period (LAWP).

·         There will also be changes to the Newstart Activity tests for over 55’s. From 20/09/2018 the following changes will come in:

o   If you are aged between 55-59 you will only be able to meet your half of your participation requirements through volunteering.

o   If you are aged 60 – age pension age you will have an activity requirement of 10 hours per fortnight.

Residency requirements will change on the 01/07/2018, you must meet one of thefollowing:

o   15 years continuous Australian Residence

o   10 years continuous Australian Residence with 5 of these during your working life.

o   10 years continuous Australian Residence without having received an activity tested income support payment for a cumulative 5 year period.

There will be reform to working age pensions as follows:

o   From 20/03/2020 Newstart and Sickness allowance will be changed to Jobseeker Payment at the same rate.

o   Widow Allowance will close to new entrants as at 01/01/2018 and cease on the 01/01/2022.

o   Bereavement Allowance will cease as of the 20/03/2020.

o   Wife Pension will transfer to Age, Carer or Jobseeker payments as at 20/03/2020.

o   Partner Allowance will cease on the 01/01/2022

o   Widow B Pension will convert to Age Pension on 20/03/2020.

Housing Affordability

First home buyer measure will have no effect on property prices and I expect there will be little take up on this. This measure allows first home buyers to put up to $30,000 in their super fund through salary sacrifice; they will later be allowed to take these funds out to purchase a property.

I am not sure what the government is trying to achieve here. In the budget they took some measures to discourage investors in the property sector. They also brought measures to force foreign owners to rent their investment properties in Australia out or face a $10,000 levy. The idea being that this will free up property for sale.

The issue with property is jobs and income, properties now and over 5 times the average income making them unaffordable unless prices drop or wages increase. On top of this are the high levels of unemployment, regardless what they do until unemployment reduces property will be out of the reach of many.

If you would like to find out more how the budget affects you call Grow Your Wealth on 07 4771 4577 or email at admin@growyourwealth.com.au  

For more information go towww.growyourwealth.com.au or follow us on Face Book.

Shares Vs Property

One of the most common mistakes investors make is choosing a side, shares or property.

Why choose when you can have both, simply invest through listed property trusts. This allows you to diversify into different property sectors such as industrial, retail, residential and commercial property.

The facts are both make a solid return, statically over the long term shares have performed marginally better then property, however, if you take closer look at the investment cycle, at different times property will outperform shares and vice versa.

Keep in mind when investing in property you can invest in direct property (rental property) or you can invest in listed property trust through shares. The below comparison looks at investing in direct property vs shares.

The key between choosing between the two investments is determined by the following factors:

1.      Cash Flow – Investment in property will require regular cash from your other income to cover expenses. Shares do not; in fact they will give you more income.

2.      Volatility – the price of a share will be more volatile than direct property.

3.      Borrowing – it is easier to borrow to buy a property then it is to buy shares. Also you may be subject to margin calls on borrowing for shares.

4.      Diversification – generally property investors lack diversification as such carry more risk. Shares easily allow you to cheaply invest in different sectors such as banks, materials, retail, consumer staple, IT and Health Care.

5.      Entry and Exit fees –property has high entry and exit costs. The cost to invest in shares is cheap in comparison. This allows you to be more agile with your investing.

The key to any good investment strategy is sustainability. You achieve this through good diversification of your investments assets. A mixture of shares, property and cash generally provides the best result. The key is to increase and decrease weightings depending on what economic cycle we are in. Holding property through listed property trusts such as Stockland and Westfield allows you to increase and decrease your exposure quickly and cheaply.

As mentioned in my pervious article “Is time on your side” investing is an ongoing process, to get the best results you need to continue to make changes to suit the economic climate. 

 

If you need help contact Grow Your Wealth for a free initial meeting. Costs nothing but your time.

Is time on your Side!

Every day millions of Australians take the time to exercise, whether in the Gym, cycling, running and walking the dog. Why is it we make the time to stay fit and healthy so we can live longer, but do not make the time to ensure we can afford to?

How much time do you spend each day, week or month on your finances? Would it surprise you to now that only 30% of people will seek out professional financial advice in their life time? Your finances are an important part of your life; you need to spend time regularly to ensure that they are looked after.

Wealth is not about how much you earn but more about how much you spend. It is what you do with your money that counts.  The most common mistakes I see people make when it comes to investing:

1.      They approach it as if it is a one off event. I call this the “set and forget” approach.

2.      The main focus is to reduce their tax. Negative gearing approach.

3.      The trend follower, no strategy. I want what they have.

Investing is about strategy, you must have a plan and like all plans it must be reviewed, compared and adjusted along the way. This takes time, time you must spend to ensure a successful financial situation.

Successful people know this, they do this every day in and out, it is why they are successful.

Meanwhile the set and forget investor missed the opportunity to take profits, the negative geared investors profits went mostly to the bank in the form of interest and the trend follow ended up with the hot potato. By the time most of us hear about the new hot investment the profits are gone.      

So today, do yourself a favour, take a look at your superannuation and ask yourself the following questions:

1.      How is my money invested, is that strategy right for me?

2.      Do I have enough to retire on?

3.      What can I do to save more money and tax at the same time?

If you need help contact Grow Your Wealth for a free initial meeting. Costs nothing but your time.

Tax and your investments !

Most people spend far too much time worrying about tax. Even worse some investors base their investment decision on the tax benefits that they will receive.  A sure fire way to lose money. 

Tax is always something you should consider, but if you focus your efforts on making money and growing your assets you’ll pay some tax along the way and you’ll do fine in the end.  You should take the sensible and legal steps available to reduce your tax, but don’t be obsessed by it.

Tax considerations should almost never influence your selection of investments.  Take the popular forestry investments. You purchased a tax deductible investment in trees and claimed the tax deduction. When the trees are fully grown and harvest 10 years later you pay the tax. Unless of course the company goes broke in the meantime (Great Southern Plantations) in which case you lose all of your money.

Taxation should, have an influence on how you hold your investments: 

1.       in one name

2.       in joint names,

3.       in a trust

4.       in a company

5.       in a superannuation fund

The two main taxes which affect your investments are income tax and capital gains tax.

Income tax

Individual income tax rates range from 0% (for people with income under $18,200) to 49% for anyone whose taxable income is over $180,000.  “Taxable income” is the income on which you actually pay tax, after all of your deductions.  Be aware that the tax thresholds can change from one year to the next.

Income from your investments is part of your taxable income.  Interest income, for example, is simply added to your taxable income and subject to tax.  Dividend income often comes with franking credits attached, as discussed in an earlier chapter.

Companies face a flat income tax rate of 30%. Franked dividends received by companies are subject to no tax.  This is because tax at the company rate has already been paid by the company which delivers the dividend.

Superannuation funds pay 15% income tax.  Note, however, that the screwy definition of income includes the contributions received, as well as income from any investments held by the fund.  (Except that non concessional contributions are not subject to tax.  These are discussed in a later chapter devoted to superannuation.)  Also remember that super funds receive excess franking credits as cash refunds.

Account based pension funds pay nil income tax.  These funds also receive excess franking credits as cash refunds.

The differences among these tax rates can have a big effect on how you hold your investments.  These tax issues, combined with the other issues of asset protection and control (discussed in a later chapter) should be considered carefully when you decide exactly how you organise your investment structures.

Capital Gains Tax

The first thing to understand about capital gains tax (CGT) is that it only arises when you choose to sell an asset.  If you buy shares and hold them forever, CGT doesn’t arise.  It’s under your control. 

CGT is payable when you make a gain on the sale of a capital asset.  If you buy a parcel of shares for $10,000 and sell those same shares for $15,000, a gain of $5,000 arises.  In the worst case, this can be treated as just more income, in which case it is taxed at your marginal rate.

Capital gains on assets held more than one year are taxed more gently.  Half of your gain is excluded; so on the same transaction as above, you would ignore half of the gain and just add $2,500 to your taxable income.  The other way of looking at it is that the maximum tax rate on long-term capital gains is half of 49% = 24.5%.

Companies are not allowed to use the discount method.  They can use the indexed method, but the indexation of all assets is frozen at the value as at September 1999 and of course doesn’t apply to any asset acquired after that date.

Trusts simply pass through all of the characteristics of a gain:  if it's a short term gain, you should distribute the gain to a beneficiary which either has an offsetting capital loss available or which will suffer the lowest tax liability on the gain.  If the trust distributes a long term gain, the beneficiary can exclude part of the gain as if it had realised the gain directly.

Super funds can exclude one third of the capital gain, another way of looking at it is that the Superfund pays tax on capital gains at a rate of 10%. As Superfunds pay tax at a rate of 15% if you deduct one third or 5% you have a tax rate on capital gains of 10%. Account Based pension funds pay no tax on capital gains.

When an individual is dealing with capital gains be careful of Bracket Creep.  Remember that realised capital gains can push you into a higher tax bracket.  If your other taxable income is just less than $87,000, for example, you're still on the 32.5% marginal rate.  If you realise a long-term $20,000 gain one year, you exclude half the gain and add the other half ($10,000) to your taxable income, bringing it up to $97,000.  In this case the tax applicable to the extra $10,000 would be 37% plus the 2% Medicare levy, or $3,900.

All of these tax rules have an effect on where you place your investments and can have significant effects on how and when you sell certain assets.  Please be careful, however, not to make too much out of the tax effects:  if you pick assets which produce good income and good capital gains, you’ll do well.  You will also pay some tax, but in the end the good results produced by your investments will overwhelm the tax damage.

Inherited shares

The tax treatment of inherited shares depends on when they were originally bought.

Shares bought before 20 September 1985--No tax is payable when you take possession of the shares.  Your cost base is the value of the shares on the day your benefactor died.   

Shares bought on or after 20 September 1985--For these shares, you inherit your benefactor's cost base.  It's exactly the same as if you personally had bought the shares on that date at that price.

Franked Dividends - How Do They Work?

This chapter will save you money, investors make mistakes all of the time due to lack of knowledge. Once you understand dividend imputation, you’ll be miles ahead.

Life before dividend imputation

Paul Keating introduced changes to the taxation of dividend income which have had extraordinarily positive effects on Australian companies, investors, and the Australian economy as a whole.

Before dividend imputation, Companies made whatever profit they made.  Then they paid company tax.  Out of their after tax income, they paid dividends.  These were then taxed, again, as income to shareholders.  Here's what happened back in the bad old 1970s when the company tax rate was 46% and the top personal rate was 65%:

Of every $100 in company profit, more than $81 could go as tax!  Companies therefore had little incentive to make profits.  Instead, many simply borrowed massive amounts of money so that their interest expense ate up any profit they made.  They used the money to buy lots of assets and hoped that these assets would appreciate and that shareholders would benefit through a growing share price. 

In 1985, then-Treasurer Keating introduced the dividend imputation system, which took effect in 1987.  Under this system, companies can pass credits for company tax payments through to their shareholders.  These franking credits are attached to dividends paid.

The tax changes from 2000 and 2001 made imputation even more attractive, by making excess franking credits (meaning those beyond the amount necessary to reduce your tax to zero) refundable in cash.

So how does it work?

A company pays tax at the company rate of 30%.  For every $100 of income, it has $70 left over after tax.

Example 1

Individual

The company in this example pays all of its after-tax income in dividends, and your proportional share of these dividends happens to be $70.

You would receive a $70 cash dividend with a $30 franking credit attached to it. 

Assuming you’re on the top marginal tax rate, you go through the following steps to work out the tax treatment of your dividend.

 

1.  You add your cash dividend and the franking credit to calculate your “grossed up” income.  This is $70 + $30 = $100.

2.  You apply your marginal tax rate of 48.5% to this amount.  Your notional tax payable is 48.5% ´ $100 = $48.50.

3.  You then subtract the franking credit of $30.  Your tax payable is therefore $48.50 - $30.00 = $18.50.

Note on the above example if you margin rate is low then 30% you will receive a refund of the excess franking credits.

As an example, if you’re on the 19% marginal tax rate, you would receive the $70 dividend totally tax free.  In addition, you would have the $11.00 tax credit left over.  This amount would reduce the tax you pay on any other income you may have by $11.00.  If you don’t owe that much tax, you’ll receive any amount left over as a cash refund.  This means that the $70 dividend is actually worth $81.00 in real cash in your pocket.  Excellent!

Brilliant dividends v. dumb taxable interest

The other way to look at it is to compare dividend income to interest income.

Suppose that same person, on the 19% marginal tax rate, received $70 as dumb interest income.  This would be subject to 19% tax ($13.30) so the total benefit to the investor would be only $56.70.

To this person:

·         A franked $70 dividend is worth $81.00.

·         Interest income of $70 is worth $56.70

 Example 2

 Super Fund

The company in this example pays all of its after-tax income in dividends, and your super funds proportional share of these dividends happens to be $70.

The super fund would receive a $70 cash dividend with a $30 franking credit attached to it. 

As a super fund only pays tax at a rate of 15% it will receive a refund on the excess franking credit.

 

1.  You add your cash dividend and the franking credit to calculate your “grossed up” income.  This is $70 + $30 = $100.

2.  You apply your marginal tax rate of 15% to this amount.  Your notional tax payable is 15% ´ $100 = $15.00.

3.  You then subtract the franking credit of $30.  Your tax payable is therefore $15.00 - $30.00 = -$15.00 or a refund of $15.00. 

If you have started a pension in your super fund and you are over age 60 then you will receive the full $30 in franking credits back as a refund from the ATO. Pension income on people over age 60 is tax free.

What could be nicer than paying no tax on dividend income? Getting a tax refund from the ATO!

A fully franked dividend is worth 1.4285 times as much as the same amount of interest income.      

If you work through the math, you’ll find that this multiple applies regardless of your marginal tax rate.  In all cases, a franked dividend is worth 42.85% more than an equal amount of taxable interest income.  This even works if you’re on a 0% marginal rate.  Because the franking credit is refunded to you in cash, you receive a full $100--42.85% more than the $70 nominal dividend. 

This multiple depends only on the corporate tax rate, so if that changes from 30% you'll have to adjust the multiple. 

Can you lose your franking credits?

Prior to the 2000/2001 tax year, it was possible to accumulate enough franking credits that some would be wasted, in the sense that once you had reduced your tax liability to zero, and credits had no further value. 

Since 2000/2001 excess franking credits are refundable, this topic can be put to rest forever.  Franking credits are good, in all cases:  they reduce your tax bill and they can produce cash refunds, no matter who you are or what your tax rate is.

There is one very rare situation in which franking credits can be lost. 

If your shares are held in a trust, and that trust makes a net loss during a particular year and therefore has no distributions to make to beneficiaries, then franking credits received by the trust during that year can be lost. 

This is a most unusual situation which normally won't arise if you simply hold assets in a trust which does not carry on a business which could produce negative net income.  It would also be possible to trigger this problem within a trust if you were to have high levels of borrowing within the trust, so that the interest expense overwhelms the income and delivers a net loss.  Realised capital losses would not trigger this particular problem, only operating losses. 

Super Changes - they will affect you.

These changes are expected to become effective from 1 July 2017. The changes will affect us all; the largest affect will be on those who are retiring in the next 10 year.

The legislation has passed through parliament giving members and super funds some certainty over the treatment of their super – at least in the short term.

The new measures include:

  • Low Income Super Tax Offset (or LISTO) to provide a tax refund of up to $500 a year if you earn less than $37,000. 
  • A $1.6m transfer balance cap to limit how much you can transfer from your super account into a tax free pension account. 
  • Changes to before-tax super contributions that can be taxed concession ally – annual cap reduced to $25,000;
  • Cap for high income earners reduced from $300,000to $250,000 at which level you will pay additional tax. 
  • The ability to make ‘catch up’ concessional contributions if you have a super balance below $500,000. However these changes will not start until 01/07/2018.

In addition to the above the government has also previously changes the non-concessional contributions rules.

In the 2016 budget the government proposed a $500,000 lifetime non-concessional cap. To replace the $180,000 per year or $540,000 in a three years period non-concessional cap.

This will now be replaced by a new measure to reduce the existing annual non-concessional contributions cap from $180,000 per year to $100,000 per year. Individuals aged under 65 will continue to be able to ‘bring forward’ three years’ worth of non-concessional contributions in recognition of the fact that such contributions are often made in lump sums.

In addition individuals with a superannuation balance of more than $1.6 million will no longer be eligible to make non-concessional (after tax) contributions from 1 July 2017. This limit will be tied and indexed to the transfer balance cap.

These measures mean that with their annual concessional contributions, Australians will be able to contribute $125,000 each year and, if taking advantage of the non-concessional ‘bring forward’, up to $325,000 in any one year until such time as they reach $1.6 million.

Individuals aged 65 to 74 who satisfy the work test will still be able to make additional contributions to superannuation. This will encourage individuals to remain engaged with the workforce which is of benefit to the economy more generally.

If you would like more information on how this will directly affect your personal situation give us a call on 07 47714577 for a free initial meeting.

Direct investment or managed funds? Which one is best?

This is another debate which will rage forever. With more fuel being put on the fire now that Exchange Traded Funds (ETF’S) are now available. ETF’s are managed funds listed on the stock exchange so they trade like a share.

Rather than arguing that you will do better in one or the other, I would simply urge you to match the structure of your investments to your needs

Direct shares are a more active investment, whereas Managed Funds are more passive investments. 

If you look at it in comparison to a football game, the direct share investor want to know who scored who assisted and who the most valuable player was. A managed fund investor wants to know if his team won or lost.

Managed funds and ETFs have practical advantages for some investors.  They may be of use to you if you wish to:

1.  Invest in overseas shares or other special asset classes

2.  Let someone else make all the investment decisions

3.  Make small regular investments

4.  Exploit arbitrage opportunities between managed funds and listed investment companies

For all but the largest investors, managed funds are the only practical way of investing in overseas assets.  While you can buy and sell overseas shares from Australia, it’s inconvenient and expensive. 

Inside of a Managed Fund the fund manager makes all the decisions about investment selection, timing, and allocation to various markets and sectors. 

I don’t think this approach produces the best results; it is my experience the more effort you put in the better the result. However, a surprisingly large number of people feel more comfortable investing through managed funds then being directly responsible for the investments themselves.

Managed funds are more suitable for following type of investors:

·         small initial investments as they provide better diversification

·         you wish to make a regular monthly investment of as little as $100,

·         less input required by the investor fund manager make all of the decisions

·         looking for cost effective international investment exposure

Exchange traded funds (ETF’s) and Listed Investment Companies (LIC) are similar to managed funds in that they carry on no business other than buying, holding, and selling shares in other companies.  Unlike managed funds, however, both shares trade on the share market so you can buy or sell conveniently at any time and how they are priced.

When you buy or sell units in a managed fund, you do the transaction at a price very close to the value of the fund's assets.  For example, if a trust has assets of $100m and it has 100m units, then it has net assets per unit of $1.00.  If you want to buy units you'll pay about $1.005, and if you want to sell you'll receive about $0.995.  This difference is called the "spread" and it's designed to shift the cost of trading in and out onto those investors who come and go.  This is fair, because otherwise the transaction costs would be borne by the long term investors.

ETF and LIC shares, on the other hand, are subject to the whims of the market.  An LIC with net assets of $1.00 per share might trade on the market for 90c or for $1.10.  Waves of enthusiasm and despair pass regularly through the market, and quality LIC shares regularly swing back and forth between trading at a premium (a price above asset backing) and at a discount (a price below asset backing).

As many fund managers offer the same product as a managed fund or a ETF or LIC the difference in the way these price allows at time for you to move between the managed fund and the listed version for a profit while still having the same investment exposure and risk associated with the investment.

You will however need to have a good broker to advise you when the time is right.

Investment Vehicles: listed investments

Investment Vehicles: listed investments

There are two main ways to invest:

Listed securities or listed investments--any share or unit which trades on the stock exchange.  These are described in this chapter.

Managed funds or unit trusts--two names for the same thing:  a fund in which investors’ money is combined and managed as a single pool.  These are described in the next chapter.

 The main categories of listed investments are these:

 ·         ordinary shares

·         Exchange Traded Funds (ETF’s)

·         Convertible Preference Shares

·         reset preference shares

·         property trust units

·         income securities

·         stapled securities

·         debt securities

·         warrants

·         options

Ordinary shares--The people who own the ordinary shares own the company.  The ownership of a company might be divided into say 100,000,000 ordinary shares.  (In this case we’d say the company has 100 million issued shares.)

If you own 100 shares, you own one-millionth of the company.  If you own a million shares, you own 1% of the company.

Suppose this company makes a profit of $200m after tax.  If it sets aside $100m to spend on growth, there will be $100m available to pay as dividends.  This works out to $1 per share.  As all ordinary shares are exactly the same, each is entitled to the same $1 dividend.  If you own 100 shares, you’ll receive $100.

Most companies pay franked dividends, which are discussed in a later chapter devoted entirely to this important topic.

Exchange Traded Products -- Exchange-traded products (ETPs) is the family name for the group of products comprising exchange-traded funds (ETFs) managed funds (MF) and structured products (SPs). They are financial products traded on an exchange that invest in or give exposure to securities (shares) or other assets such as commodities.

Most ETPs generally seek to track the performance of a specified index or benchmark (such as the S&P/ASX 200 index) or a currency such as the USD or a commodity such as gold. Single asset products that track the performance of a specific security, bond or debenture are also available.

Convertible and/or preference shares--These are different classes of shares which have different rights from those attaching to ordinary shares.  Convertible shares, for example, might pay you a fixed rate of return for a number of years before converting to ordinary shares.  Preference shares receive some sort of preferential treatment.  They may have a target dividend which must be paid in full before ordinary shareholders receive any dividends. 

Sometimes these special classes of shares can be quite good.  Your broker should be able to help you figure out whether any of these would suit your portfolio.

Reset preference shares-- Generally companies issue resets at a face value of $100.  They promise to pay dividends either at a set rate (such as $6.00 per share per year) or at a floating rate (such as 2% above the 90-day bank bill rate).  These terms are set for a fixed period, usually five to seven years.  At the end of that period the company has the right to re-set the terms of the offer.  Some resets pay franked dividends while others pay unfranked dividends.

Property trust units--Owning units is analogous to owning shares, but slightly different.  A property trust owns various property assets and makes its money by collecting rent and by buying and selling properties.  A trust pays distributions rather than dividends, and a trust must normally distribute all of its income every year.

A property trust might be divided into 100,000,000 units.  As a unit holder, you’re entitled to your proportional share of the profit.  If you own 10,000 units and the profit works out to 50c per unit, you’ll be paid $5,000.

Because the trusts themselves do not pay tax, they do not have any franking credits to pass on.  However, the trusts are able to pass on certain deductions and allowances, so distributions from property trusts usually have certain tax advantages.  These vary significantly from one trust to the next.

The main forms of tax-advantaged income from property trusts are tax free income and tax deferred income.  Tax-free income is just that:  because of the depreciation and other allowances available to the trust, part of your income may come to you as fully tax free.

Tax deferred income is income in respect of which you pay no tax when you receive it.  It does, however, affect your cost base.  Here's how it works.  Suppose you bought property trust units at $1.00 each.  You received tax-deferred distributions of 10c per unit, paying no tax on that income in the year or years in which you received it.  You then sold your units at $1.10.  When it comes to calculating your capital gain, you reduce your cost base by the 10c, so the gain is $1.10 - 90c = 20c.  This is under your control, as you don't realize the capital gain until you sell your holding.

Income securities--These appeared in the late 1990s and are disappearing fast, although they may still be relevant to your portfolio from time to time.  Issued by major companies, income securities generally have a face value of $100 and pay interest at a floating rate linked to some market rate, such as 1.5% above the 90-day bank bill rate. 

Stapled securities-- Each unit you buy on the market comprises a combination of two or more of the following:  a share in a company, a unit in a trust, and/or a debt security.  These cannot be separated (hence they're "stapled").  Such investments pay both dividend income from the company part and trust distributions from the other part.  Those which incorporate a debt security produce interest income also.

Debt securities--Some companies choose to borrow money directly from the market rather than from a bank.  They do this by issuing debt securities, some of which trade on the share market. 

On maturity the company will either redeem them for their issue price, or the holder may elect to convert each note into an ordinary share. 

Warrants--Warrants are a bit more complicated and come in many varieties.  In general terms, warrants give you alternative ways to benefit from owning shares you otherwise like enough to own directly.  Most warrants give you the right to make a sort of down payment, allowing you to control a number of shares in a particular company without paying the full price for those shares up front.  This can be glorious when the share price goes up, but doubly painful if the underlying share price goes down.  Warrants are discussed in greater detail in a later chapter.

A good advisor will be able to assist you to select warrants which can be suitable for your particular purposes, but make sure you understand them fully before you buy.

Options--In their simplest form, options give you the right to buy or sell a particular share at a fixed price for a specified period of time.  These can be used for speculative purposes or as sensible tools to enhance and protect your portfolio.  You can easily manage your portfolio without ever using options, but if you have a good advisor you can benefit from the careful use of options.

The Mechanics of Buying and Selling

You buy and sell all of these listed securities through a stock broker.  You can trade “at market” which means you’re willing to buy or sell at the current price, which might be up or down by a few cents from the price quoted at any given moment.  Telling your broker to buy or sell at market means to get the deal done at the best price available right now. 

Alternatively, you can place a limit order to buy or sell a share at a particular price.  If you do this, there’s no guarantee your order will be filled.

At any given moment, the price is determined by what buyers are willing to pay and sellers are willing to accept. There is no guarantee these orders will ever be filled.  They will be filled only when there are sellers willing to sell at the price buyers are willing to pay.

Orders are filled in chronological order:  the first order placed at that price will be filled first.  This is a fair and democratic system.  It doesn’t matter if your order is big or small:  if you placed it first, it will be filled first.  All the other orders at that price will be filled in the order in which they were placed.

Finally, note that the share prices you see in the papers are the prices at which the last trades of the previous day were completed.  They do not mean that you can buy or sell at that price today.

Settlement

When you complete a buy or a sell, your account must be settled within two business days.  If you’ve bought shares, you’ll need to pay your broker by the third business day after the purchase.  If you’ve sold, payment will be made to you on the second day. 

CHESS

CHESS stands for “Clearing House Electronic Sub register System.”  Your broker will encourage you to sign up for a CHESS account. 

CHESS is just a way of keeping track of your share holdings.  It replaced the slow, cumbersome, and error-prone system of issuing share certificates.  Under the CHESS system, your shareholding is reflected by a holder statement rather than a certificate.  This is analogous to having a bank account (evidenced by a statement) rather than cash under your bed:  it’s much safer and much smarter!

Participation in CHESS costs you nothing, and gives your broker no particular rights beyond those he already has.  It does, however, enable your broker to do a far better job for you.  It’s much easier to identify your share holdings and settle your trades, which can save you a lot of time and trouble.

At any moment, your broker can print for you a complete list of your CHESS holdings.  CHESS itself sends you a holder statement for each of the shares you hold, so you have paper evidence of your holdings separate from the advice you receive from your broker.

CHESS also assists with the little things, such as changing your address.  If all of your share holdings are on CHESS, you can change your postal address for all companies with one letter to your broker.  Without CHESS, you’ll have to write a separate letter to every single company in which you own shares.

If for some reason you get cross with your broker and want to switch, moving your CHESS account to another broker is quick, easy, and painless.  You do it all with your new broker, so you don’t even have to speak to the old one if you don’t want to.

The alternative to CHESS is issuer sponsorship, which means you have a separate relationship with each company in which you own shares.  Your broker doesn’t know what you have, or even if he does, you’ll have to deliver your holder statements to him before you can sell anything. 

Even then, your broker will have to verify your holdings.  This takes time and makes it impossible to trade quickly if an irresistible opportunity presents itself.  Non-CHESS clients are a nuisance for brokers and unlikely to get snappy service.  Having your holdings on CHESS is one of the basic steps toward ensuring you get good service from your broker (there's a whole chapter about this later) and I promise it’s worth real money to you to be a favored client rather than a nuisance.

Once in a while you do have a good reason to trade shares quickly.  If you have a CHESS account with your broker, you can buy shares and then turn around and sell right away if you want to.  If you don’t have a CHESS account, you’ll either have to pay an extra fee so your broker can request your holder number from the share registry, or you'll have to wait three to eight weeks after you buy, because your broker won’t accept a sell order until you have your issuer-sponsored holder statement.

Conclusion:  sign up for CHESS right away.  To do otherwise is to cause yourself endless aggravation and ensure that your broker moves you right down to the bottom of the list as far as service is concerned.

Changes to Super

Proposed Superannuation changes.

You may be aware that the government has proposed to make a number of changes to your superannuation and how it will be taxed. Please keep in mind:

1.       This is your money, you’re earned it and you pay tax on it.

2.       Your superannuation will replace the age pension,

Age Pension

The proposed changes set out in the 2014 Federal Budget are to increase the age pension age. If you were born in 1966 or later you will not be eligible to receive the age pension until you are age 70.

Here are the core changes which will affect most people in the 2016 May Budget:

  • $1.6 million cap on the total amount of super that can be transferred into a tax-free retirement account.
  • Reducing the annual cap on concessional contributions to $25,000 and allowing catch up contributions of unused caps over 5 years for balances of $500,000 or less.
  • A $500,000 lifetime cap will to be applied to after-tax concessions on super to reduce the capacity for super to be used for wealth accumulation effective immediately and backdated to 2007.
  • Increase in super contributions tax to 30% on income above a threshold of salary of $250,000 per annum.
  • Permit personal deductions for contributions up to $25,000 a year for anyone under 75 which will help self-employed and retirees continue to build their retirement savings.

How these changes will affect you.

For most people these changes will affect the amount of money you will be able to accumulate in your superannuation fund. The amount of money you accumulate will affect the quality of life you will have in retirement.

If you were born in 1966 or after you will not be eligible for the age pension until age 70, as such you will need to relay on your superannuation if you wish to retire at age 60.

1.       The cap of $1.6 million in tax free pension will not affect most people. For a couple the combined total is $3.2 million. This is more than generous and would provide a great retirement for the vast majority of people. Any remaining funds would be left in a low tax environment of 15%.

2.       Reducing the concessional cap to $25,000 is where the problems start. The facts are that most people do not start saving seriously for retirement until there late forties or early fifties. This is no big surprise, before this people are raising a family and paying of a home, any spare cash goes pretty quickly. This cap will limit the over fifties from boosting they superannuation once the nest is empty.

3.       Limiting the lifetime non concessional cap to $500,000, when coupled with the reduction in the concessional cap again workers planning for retirement are limited on how much money they can get into superannuation at a time when it will be needed. Typically this money would come from the sale of a business or other investments such as investment properties or shares.  It does not make sense to put these investments inside of super to early just in case you need the money.

4.       Increasing the tax on superannuation for salary earners over $250,000 to 30% will not have a big impact across broader Australia. It is currently $300,000 before you receive this increase in tax, I suspect that this drop will catch a few more in the net and is simply attacking the richer people.

5.       Allowing personal contribution of $25,000 for people up to age 75, who wants to be working or needing a tax deduction at age 75? It does however clearly show that the government intends for us to all work longer.

Summary

When looking at retirement for Australians, what is clear is that the government is working hard to ensure that you work longer. Making it harder to get money into superannuation and raising the age pension age.  Based on the average wage if you start working at age 20 and salary sacrifice $25,000 per year into superannuation you will have the $1.6 million tax free pension at age 60.

However this is not a practical solution given the high cost of living in Australia, in our young years we raise families and buy homes, in our later years we build a nest egg to retire on so we can travel and relax and watch our families grow.

If these changes are introduced we will all need to review how we are going fund our retirement, the young need to ensure that they have a solid saving plan in place and get it started now. The rest of us need to take more interest in our superannuation and speak to a financial planner now.

The cost of not acting, is working until the age of 70.

Negative Bond Yields

Bonds are safe investments, there is little risk of losing your capital and in time of high volatility investors will move into bonds to reduce loss of capital even though they know that they will give up the possibility of growth and in some cases will even accept that they will have a negative return, hence Negative Yield Bonds.

Buts fist let’s look at what a bond is, basically as bond is a promise to pay you back the original investment plus interest over a time period.  A bond has two yields:

1.       Current yield – this is the amount you will receive each year or the coupon rate.

2.       Yield to Maturity – this takes into account the income received and any gain or loss basedion buying  the bond either under face value or above face value.

For example;

You invest $10,000 in a 2 year bond at an interest rate of 2% (Current Yield); over the term of the bond you receive $200 per year interest, total $400. At expiry you get back your face value being $10,000.

All is good with the investment.

The Bonds market value (the amount it can be sold for before maturity)  however will change when interest rates change, for example if you invest as per the above example, but interest rates move up to say 4% during the 2 year time frame then the market value of your bond will reduce to $5,000.

Why? Because if you want to exit the bond before the maturity and potential buyers can receive a 4% yield elsewhere so you will need to reduce your price to sell. This is when the yield to maturity will change. In the above example after a year you would have received $200 interest and $500 back in capital. Your yield to maturity would be negative $300 or -30%.

In time of extreme uncertainty investors can go knowingly into bonds which will lose them money. A good example is the Brexit, which just happened. Investors were so keen to move into safety they are prepared to pay more than the face value of the bond.

So if we take our above example investors may pay $10,500 for the same bond. They will still receive the 2% return each year but only on the face value of $10,000.

So after holding the bond for 2 years they would receive $400 in interest and $10,000 back for the face value total $10,400. Therefore losing $100 incurring a loss of 9.5% for the period.

Why would someone invest in something which they knew would lose them money?

There are three main reasons:

1.       Large managed funds have a mandate that a proportion of their fund must be invested in bonds. When volatility is high causing negative yields they have no choice but to invest the funds.

2.       Investors are concerned about exchange rate risk, as such instead of holding cash in their currency may look to hold an international bond.

3.       Investors are so irrational that they feel that this is the best way to protect their money and accept the loss assuming it will be less than if they maintained their current investments.

Bonds are not without risk, as such all investors need to look carefully into what it is they are investing in and ensure that the Yield to Maturity  is positive and not just focus on the current yield.

It might surprise you to know that in Germany around 40% of bonds on offer have negative yields.

Inflation - can send you broke!

Inflation has always been with us

The steady increase in the prices of most goods never ceases.  Governments in most of the advanced democracies have taken admirable steps to reduce inflation to a low level, but they all accept that there will always be some price growth.  The Reserve Bank of Australia targets 2-3% inflation, but does not try to achieve zero price growth.

The RBA and the world's other central banks have all recognized that while it's important to keep inflation low, it's more important to make sure that there's always at least some inflation as modern economies have come to depend on a bit of inflation to keep everything moving. 

In deflationary times (in which prices are generally decreasing) economies grind to a halt.  If you expect that cars, refrigerators, and building materials will be cheaper next year, you're more likely to delay purchases of all of these things.  As soon as a few people hold this belief, their behavior causes it to come true:  people stop buying; prices drop; people expect prices to drop farther, and deflation takes hold. 

 You need to inflation proof your income from your investments. The best way to do this is through investing in companies which will continue to grow their dividends over time. Cash is safe but over time due to inflation it will quickly disappear and your standard of living will fall.  

If you want to retire with $50,000 annual income (in today’s dollars) this nominal amount will have to increase a bit each year to keep up with the cost of the things you buy. 

Investing in cash

From 1990 until 2016 the average cash rate was 4.9%; we will use 5% for this example.

Some people think that all they have to do is accumulate $1,000,000 and put it on deposit to produce a $50,000 annual income.

If you did this, you would indeed get around $50,000 income the first year.  But after a few years, the purchasing power of that income would diminish dramatically.  With inflation running at just 3%, the purchasing power of $50,000 income will be reduced by 26% in just ten years.  Your $50,000 would be worth only about $37,000.  That would make a real difference to your lifestyle!  After 20 years, the value would be reduced by 45%, to about $27,500.

Look at it this way. On a $100,000 deposit paying 5% you would receive $5,000 annual income.  The Tax Office regards all $5,000 as taxable income.  If you’re on a tax rate of 32% (40% tax plus 2% Medicare levy), here’s what happens to the income from your $100,000 term deposit:

Annual interest income:                               +$5,000

Less:  tax at 32%                                            -$1,600

Less:  inflation cost                                        -$3,000

Real annual return to you:                                $400

This means that the real return to someone on the 30% tax rate is about 0.4% per annum.

This doesn’t mean you should never use term deposits.  If, for example, you have a bill to pay between three months and two years in the future, a term deposit can make sense, as it will guarantee that you have the cash required when it comes due.  

With only very rare exceptions, however, term deposits should never be one of your main investment vehicles.

Your dividends grow faster than inflation

Listed companies are always working to become more productive and more profitable.  This constantly increasing profitability allows companies to increase their dividends. 

The key point:  dividend income from a sensible, reasonably diversified portfolio grows faster than inflation.   This doesn’t mean that every company’s dividend increases every year.  Some years are good for banking and insurance company profits (and dividends), for example, while other years will be better for resources or technology companies.

Once your portfolio produces enough income to meet your living expenses, you can expect to feel a little bit better off year after year.

If you pick companies whose earnings and dividends grow strongly, you can be miles ahead of inflation.  Over the twenty six years from 1990 to 2016, for example, the Consumer Price Index (CPI) increased by about 85%.  This means that a collection of goods and services a typical person would buy for $100 in 1990 would have cost about $185 in 2016

Let’s look at the dividends from some major companies over the same period:

                                             Estimated

                                                                        1990                2016

Company                                        div/share    div/share        change

BHP Ltd                                                           36.5c               $1.09                   +194%

National Australia Bank Ltd                           51.0c               $1.98                   +288%

Rio Tinto Limited                                            58.0c               $2.96                   +410%

CSL Limited                                                    10.0c               $1.71                  +1600%

Westpac Banking Corp. Ltd                            52.5c               $1.88                   +258%

Woolworths Limited                                       12.0c               $1.16                   +866%

If you invested $100,000 into the above shares, your income would have started at $8244 p.a. and grew 326% to $35,162 p.a. Not only has your income maintained pace with inflation it has grown close to four times more than inflation.

Yes you are now better off than before. Starting to see why cash is not as safe as you think. On top of this the original $100,000 is now worth $556,000, that is right is has grown 456% in capital value over this time.

The owner of this portfolio has gone from being comfortable to being extremely well funded.  From experience, however, I can tell you which topic most clients in this situation would bring up most often will be about the company which failed!  The important point is this:  good portfolios, even great portfolios, always have a few stocks which will turn out to be dogs.  You deal with this by selecting stocks as carefully as you can and by learning to let the dogs go.

If you were to select a diversified portfolio of ten companies right now, all of which have a positive outlook, the likely outcome after ten years is this:

Winners:  one or two will have rocketed ahead, with both fast dividend growth and fast share price growth.  You’ll wish you had put all of your money in these. 

 Steady performers:  five to seven will deliver dividends which grow much faster than inflation.

 Dogs:  one or two will lag behind, with declining dividends and share prices.

 All you’re trying to do (and all you can expect from a good advisor) is to pick one or two extra winners or avoid one or two dogs.  This is all it takes to boost your results dramatically.

 Core Message

 Inflation makes life more expensive, if your income is not keeping you then you are getting poorer each day. A well-managed portfolio can ensure not only that you do not fall behind but that you also beat inflation.

Income over Price

The first mistake most investors make is obsessing over the share prices. The second mistake is thinking that the daily price movement of their shares reflects the underlying value of the share.

The growth in your share price will not be linier, as there are many factors which affect the daily share price. The sooner you stop focusing on price the sooner you will a successful investor.

The price means nothing, by itself

 The price of a share is driven by many factors including:

 1.      the dividend paid on the shares

2.      expectations about future dividends

3.      perceptions of the stability of the company’s earnings

4.      a premium or discount based on the mood of the market

5.      the market's assessment of the quality of a company's board and management

 Let’s consider each of these factors:

 Dividends

You invest for income and compare this against the risk you are taking. Whether or not this is reasonable depends mainly on how much you would receive for your money elsewhere. We use the cash rate to measure the risk free income; the share price value reflects the premium required by the investor to take the risk on that investment. When the risk high the dividend amount needs to be high and vice versa.

The share price will fluctuate depending on the dividend, if the dividend being paid is higher than the risk applied to the share, then investor will look to invest and push the price up until it gets back to fair value for the associated risk.

For example, banks will normally have a dividend yield of 5%, if the bank trading at $20 and paying a dividend of 10% then investors will pay more for the bank up until the price increase to a level, in this example $40, where the yield will be back to 5%.

 Expectations

If people expect future dividends to be higher, they’re willing to pay more for the shares which will deliver these dividends.  This clearly would push the price higher.  A gloomier outlook would pull the price lower.  At any given time there will be investors who expect the outlook to improve and those who expect it to deteriorate. The market price reflects the net view of all different investors.

Earnings Stability

This refers to the market’s perception of the reliability of a company’s earnings.  Such companies as Woolworths and Telstra are regarded as having high quality earnings, because people will keep on buying goods and services from these companies pretty much regardless of what happens in the economy at large. 

Equally well managed companies such as Qantas have less reliable earnings.  In a slow economy, business people may travel less, and everyone can defer or skip an overseas holiday.  In a pinch, people can get by without Qantas far more easily than they can get by without Woolies or Telstra. 

Market Mood

When markets are running hot, investors seem to like every share.  They’re often willing to pay too much.  In gloomy times, some people can’t envision a recovery, so they’re willing to sell their shares for far too little.  For this reason, shares are sometimes too expensive and sometimes too cheap.  In the long run, prices are pulled back in line with the dividends a company pays.

 Board and Management

The market places more trust in the management of some companies than others.  A company which produces steady, predictable results with few nasty surprises will be more highly regarded than an accident-prone company whose board members engage in public brawls.  Even a company with a long successful history will see its share price fall if the market loses faith in the board. 

A change in board member can bring uncertainty and cause markets to look for a lower price or alternatively be seen as a positive and push the price up depending on who have been changed.

You don’t have to trade

 I’ve mentioned this many times throughout this book, but it’s so important I’ll say it again.  Most investors do best by buying good shares and then leaving them alone.

 There are opportunities to make money from trading, but these are for people who are willing to treat their portfolios as a full-time job.  Most people have neither the time nor the information to do this effectively.