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Are term deposits defensive?

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At first glance the answer may seem obvious, but is it? That depends on what an investor is looking to protect against. There is no doubt that term deposits offer capital stability and given the government deposit guarantee, are virtually risk-free. So, through the lens of protecting the capital value of one’s investment, they are undoubtedly defensive.

Should the question however be framed in the context of providing income, the answer is quite different. According to data from the Reserve Bank of Australia, over the past 10 years the average rate on a 1-year retail term deposit has more than halved from 3.70% to 1.80% at the end of June 2019. For a retiree seeking a stable income stream, term deposits have not been defensive.

In contrast, the dividend yield on the S&P ASX200 Index at 4.55% (before franking credits), is broadly in-line with the average yield over the past 10 years and near the middle of the 4.0-5.0% dividend yield range. In essence, over the past decade the interest derived from term deposits has been more unpredictable, and lower, than the dividends derived from a broadly diversified portfolio of Australian companies.

This does not imply that term deposits should be avoided. They may well be justified in a diversified portfolio. Careful consideration however needs to be given to the role they are intended to serve, and the possible unintended consequences of being defensive, particularly in the context of longevity risk.

Are Term Deposits Defensive?

By | Blog, Uncategorized

By Leon De Wet – Elston Portfolio Manager

At first glance the answer may seem obvious, but is it? That depends on what an investor is looking to protect against. There is no doubt that term deposits offer capital stability and given the government deposit guarantee, are virtually risk-free. So, through the lens of protecting the capital value of one’s investment, they are undoubtedly defensive.

Should the question however be framed in the context of providing income, the answer is quite different. According to data from the Reserve Bank of Australia, over the past 10 years the average rate on a 1-year retail term deposit has more than halved from 3.70% to 1.80% at the end of June 2019. For a retiree seeking a stable income stream, term deposits have not been defensive.

In contrast, the dividend yield on the S&P ASX200 Index at 4.55% (before franking credits), is broadly in-line with the average yield over the past 10 years and near the middle of the 4.0-5.0% dividend yield range. In essence, over the past decade the interest derived from term deposits has been more unpredictable, and lower, than the dividends derived from a broadly diversified portfolio of Australian companies.

This does not imply that term deposits should be avoided. They may well be justified in a diversified portfolio. Careful consideration however needs to be given to the role they are intended to serve, and the possible unintended consequences of being defensive, particularly in the context of longevity risk.

Are grocery shop owners off their trolley?

By | Blog, Uncategorized

With the rise of e-commerce, you might be tempted to think that the traditional grocery shop is on the way out. But is it? While certainly facing a competitive threat, bricks and mortar grocery stores also have a couple of important advantages over the pure online retailer.

  1. Margins – grocery retailing is fundamentally a low margin business making cost control critically important. Running an online business is however typically costlier, mainly due to increased distribution costs and depreciation of the capital investment needed in IT systems and logistics.
  2. Fractionalisation of costs – physical stores tend to incur a greater proportion of fixed costs, primarily due to the rents paid. This means that brick & mortar grocers can increase their profit by more from every additional dollar of revenue generated than online grocers which incur a greater proportion of variable costs.

To help overcome these challenges a pure online grocer can of course levy an annual subscription and/or add a delivery fee, but in doing so it is likely to eliminate a pool of potential customers. Given that the delivery economics however work best if drivers spend the bulk of their time bringing groceries into homes from trucks rather than driving kilometers between homes, the loss of potential customers is clearly something best avoided.

TPG Telecom – Game of Phones

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The stock in focus this month is TPG Telecom (TPM). One of the key sources of outperformance for investment managers is identifying and investing in companies exposed to positive long term thematics. In recent times, two broad investment thematics have been demographics and technological developments. One convergence of these themes is in the telecommunications industry, where the rise of the connected society and population growth have seen the demand for telecommunications, particularly data, increase dramatically. At the same time, the roll-out of the NBN has meant that the traditional dominant player in the market, Telstra, is under more pressure, as it needs to evolve its offering in the face of increasing competition.

5G is coming.

What has emerged is a battle for a place in the new landscape, with well-established telco providers including Telstra, Optus and Vodaphone competing with new emerging players, such as TPG and Vocus, while everyone is looking to deal with the market positioning of NBN Co in the fixed line space. A key weapon in this battle will be the emergence of 5G in the mobile space, not only in terms of how it can add to the current customer experience, but also as a potential NBN killer.

TPM’s recent purchase of 5G spectrum and entry into the mobile marketplace with what will be a very competitive offering, has been emblematic of the travails of share prices across the whole telco sector. Investor fears of a protracted and deep price war, combined with the impact of the NBN on fixed line margins have taken the sword to short term profitability.

However, it is important to take a longer-term perspective. The demand for fast and unlimited data is not going to reduce, and whatever the technology is that will deliver the connection that consumers and businesses require, providers of telecommunications will enjoy significant thematic tailwinds in the medium and long term, offering potential rewards for investors looking beyond the short term.

Why Operating Leverage Matters

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While positive on the global growth outlook, given financial and political challenges coupled with valuations at the upper end of historic trading ranges, investors should take the time to understand the cost structures of the companies they own.

Operating leverage, which is essentially the relationship between a company’s fixed and variable costs, can make a big difference to potential profit and cash flow. Fixed costs (eg. store rents, aircraft leases, loan repayments) are not dependent on the level of output/revenue, while variable costs (eg. commissions, freight, raw materials) change as the level of output/revenue changes.

The higher a company’s fixed costs compared to its variable costs, the higher its operating leverage, which means profits grow faster than sales. But because fixed costs must be paid even when output/revenue slows, profits and cash flows will also deteriorate much more quickly, making them susceptible to slowdowns in the business or economic cycle.

Operating leverage really is a double-edged sword. While economic conditions remain buoyant, companies with high fixed cost structures (eg. airlines, online businesses, utilities) can enjoy profit growth faster than revenue. However, in an economic downturn, companies with a greater variable cost structure can cut costs more quickly to better protect profits, as revenue declines.

New (tax) year, new opportunities – five changes worth considering

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It’s a new tax year – the arrival of the 2018/19 tax year brings with it many financial opportunities. Elston experts have focused on five of the best and explain how you can take advantage of them.

The arrival of the 2018/19 financial year has brought with it some potential new opportunities to consider:

1. Buying your first home?

From 1 July this year, eligible first home buyers can withdraw voluntary contributions made to their superannuation fund to purchase a first home under the First Home Super Saver Scheme (FHSSS). This applies to contributions made after 1 July 2017. The FHSSS allows eligible first home buyers to save their deposit in the concessionally taxed super environment.

2. Selling your home?

Eligible super members can make super contributions of up to $300,000 per person from the sale of their home after 1 July this year, if they are aged over 65. These contributions don’t count towards the contribution caps and can be made even if the member doesn’t meet the usual age, work and other contribution tests.

3. Eligible for a tax cut?

The tax cuts announced in this year’s Federal Budget have been legislated. The first tranche took effect on 1 July this year, providing savings of up to $530 (see table below). This extra cash could go towards paying off debt or making extra super contributions.

Source: Budget 2018-19 fact sheet, ‘Lower, fairer and simpler taxes’. The tax is calculated taking into account the low income tax offset, low and middle income tax offset and the Medicare levy (at 2 per cent).

4. Want a super deduction?

From 1 July 2017, most people (including employees for the first time) were eligible to claim personal super contributions as a tax deduction. This could reduce taxable income and give super savings a much needed boost.

5. Not likely to max out your super cap?

If super members make concessional (pre-tax) super contributions of less than the cap of $25,000 in 2018/19, they may be able to carry forward unused cap amounts, for use in a future financial year. This is worth keeping in mind, as it means members may be able to make ‘catch-up’ concessional contributions from 1 July 2019, if cashflow allows.

Need help?

At SB Wealth, we can help assess whether any of these opportunities suit you and your circumstances, and adjust your financial plans accordingly.

If you would like to discuss further, please don’t hesitate to call or email your adviser.

Franking Matters

By | Blog, Uncategorized

In a low rate environment, the income or cash flow that an investment provides is important, particularly if you rely on this income to fund your living expenses. While comparing options, you must of course consider their investment horizon and the associated capital risk of the underlying investments over this period. But equally, you must not forget the potential for that income to grow over time.

To illustrate the vastly different potential outcomes over the long term, consider the analysis below from AMP Capital, when contrasting the results in 2016 from having invested $100,000 in December 1979 in either:

i) a one-year term deposit or ii) the Australian share market.

The term deposit would still be worth $100,000 and paid roughly $2,450 in interest, while the shares would have grown to $1.12 million in value and paid $51,323 in dividends before franking credits.

Are you eligible for the franking credit rebate?

Given the dividend imputation system in Australia, which effectively allows companies to pass on a tax credit to their shareholders for tax already paid, the effective after-tax dividend income received by investors may in fact have been more than outlined above. This would certainly be the case for an SMSF investor in pension phase whose income is tax exempt, and as such can take full advantage of the franking credit rebate to supplement their income.

The proviso is that if the investor is entitled to $5,000 or more of franking credits, they must have held the shares for at least 45 days (not counting days of purchase or sale, so in effect 47 days) to be eligible to receive the refund.

Residential property: can it fund your retirement?

By | Blog, Uncategorized

If your family is like many Australian families, when you get together for Christmas this year, you might find that the conversation turns to property. As a nation, we have a love affair with residential property, and booming capital city prices of late have done little to change this. We might feel good when the value of the family home goes up, but does this mean we should be relying on residential properties to fund our retirement?

There is no doubt that many people have done well by investing in the Sydney and Melbourne markets. However, capital growth does not pay the bills in retirement. It is income and cash flow that become important, when work income stops.

What does the data say?

Data provided by the Core Logic RP Data Home Value index shows that the average gross yield for capital city properties is just 3.25%. In Sydney, it is lower than the national average at 3.08%, and in Melbourne it is a paltry 2.9%.

This means that $1 million spent on a rental property in Melbourne would be expected to generate $29,000 a year. From this, investors would need to pay costs such as rates, insurances, agent’s fee, body corporate, maintenance and land taxes (depending on the state). This could easily account for $10,000 or more a year, meaning that the net yield is below 2%.

On this basis, a retiree looking to fund a comfortable lifestyle (considered to cost about $60,000 pa) would need to have over $3 million invested in property. By comparison, a $3 million investment in a diversified Australian share portfolio is expected to produce $152,700 of gross income (before any fees and charges).

Income is only part of the equation though. Surely recent capital growth in property would compensate for the low income? Residential property has performed well, although the exceptional rates of growth have been confined to small pockets of the country. Nationally, the average growth rate for the 12 months to 31 October was 6.6%.

While this is a very solid return, by comparison, the top 50 companies on the Australian Stock Exchange grew in value by 10.1%.

Is your money accessible?

While growth is good, retirees often need access to money in excess of their regular income needs. If all your money is tied up in a property, the entire property needs to be sold, as it’s not possible to sell off a bedroom. The sale of a property can also take some time and comes with significant costs. If a gain is made on the sale, there would also be capital gains tax to consider.

It pays to diversify

For many investors, a sensible investment in property can form part of a well-diversified strategy for creating wealth. But to focus only on this investment to the exclusion of all else is foolhardy. Investors need to ensure that they assess each investment on its true merits, rather than making emotional decisions.

 

Bitcoin – Bubble or a Brave New World?

By | Blog, Uncategorized

In recent times, we have seen the rise of so called ‘crypto-currencies’ such as Bitcoin and Ethereum, which have put themselves forward as alternatives to traditional stores of value and currencies. As these and other crypto-currencies gain in profile and popularity and are accepted as a form of payment, it is timely to look at the methodology behind these ‘assets’ and ask – are they a fad or something more?

What is Bitcoin and how does it work?

At its core, Bitcoin is a form of decentralized digital payment system. In a traditional payment system, a clearing house, such as a central bank or financial institution, contains a centralized ledger that tracks asset movement between individuals and institutions within the financial system. Before one individual can transact with another, the assets must effectively pass through this clearing institution. With a ‘distributed ledger’, the record is held and verified by many different institutions and parties throughout the system. This eliminates the need for a central registry to record and certify asset ownership before that ownership can transfer from one party to another and ultimately enables peer-to-peer transactions using a public record, called a ‘blockchain’.

Understanding the security issues

Using blockchain technology, every transaction is verified back to its source, so for example, if A wants to transfer bitcoin to B, the transaction is presented online and represented as a ‘block’. This block is then referred to every party in the network and then compared to the ledger. If the transaction is valid, it is approved and the block is added to the chain, with the bitcoin moving from A to B. In theory, this means that B can securely transact with A, confident that they are truly the possessor of the bitcoin, without having to go through a centralized third party, such as a bank.

Another positive worth mentioning is that because of the distributed nature of the ledger, if one node gets hacked or destroyed, the rest of the nodes still contain the accurate ledger. Of course, this is only true to the extent that the network is isolated. There have been issues with security when bitcoin and other crypto-currencies have interacted with a traditional monetary system, such as exchanges.

Despite this potential weakness, these exchanges have been vital when it comes to increasing the popularity of cyber currencies. However, the vast majority of transactions remain speculative in nature, where traders are buying bitcoin in the hope of selling them at a higher price, rather than using them as a store of value. The value of bitcoin has been extremely volatile, and there’s still a long way to go before they can be considered a traditional asset.

Is there a future for cyber currency?

Notwithstanding its various shortfalls, there are a number of situations where some form of cyber currency and transactions using blockchain technology may have application. Payments in third world countries where there is a lack of a robust banking system and a dearth of cash available is one such application. In the not too distant future, cyber currencies may also provide a viable alternative for people looking for a more instantaneous international transfer of assets, compared to the current slow and expensive international payment system.

While the development and progress of these cyber currencies is interesting from a financial and technological point of view, it is still early days. There is more than a hint of a bubble around them, particularly with some of the newer ‘initial coin offerings’. This is probably best summed up by a recent new cyber currency to be offered to investors – UET, which stands for ‘Useless Ethereum Token’. On their website they state, “Is this a joke, is this a scam? No, it is real and 100% transparent – you are literally giving your money to someone on the internet and getting completely useless tokens in return!”. UET raised over $US5,000 in its first 12 hours. While this may not be a large amount on money, this kind of behavior may suggest that it is a bubble after all.

 

Retirement Planning? A Tailored Financial Plan is The Key to Success

By | Blog, Uncategorized

For most Australians, the definition of retirement means different things to different people. Whereas previously to retire meant a departure from paid employment, nowadays lifestyle factors affect our work-life cycle and, for some, retirement has morphed into a combination of semi retirement, career change, lifestyle change and travel.  Whichever is the best fit for your individual circumstances, targeted retirement planning is mandatory to ensure you are able to comfortably accommodate your goals and aspirations.

A recent media release from the Australian Bureau of Statistics (March 2016) announced Australians are intending to work longer than ever before. In the survey conducted in 2014-15, 71 per cent of persons intended to retire at the age of 65 years or over, up from 66 per cent in last survey result of 2012-13 and 48 per cent in 2004-05. For those in the labour force who intended to retire, the most common factor influencing their decision was financial security.

Planning for Retirement

At Elston, we understand that financial security begins with a customised financial plan. We work with our clients to develop the right long term structure so they’re not forced to sell assets at a loss at retirement. We encourage clients to structure their wealth so they have the flexibility to work as much or as little as they like, while improving their long-term capital preservation and sustaining their living requirements for retirement.

Navigating the different options available can be challenging. How do you generate a passive income stream? Where should you invest? What are the latest changes to taxation and other regulations relating to superannuation? Our advisers offer up-to-date advice on a range of retirement planning solutions in alignment with your individual circumstances, assets and liabilities; your short and long term financial goals; and your ideal retirement plan. Some of these options include:

Self Managed Super Funds (SMSFs)

A self-managed super fund (SMSF) provides greater flexibility and control over your investments and financial future. With many Australians unsure where their superannuation is invested in traditional industry and retail funds, and many delivering average, or below average performance, the benefits of an SMSF make it an attractive component of a long term retirement plan.

SMSFs are proving to be a solid investment vehicle, with the Australian Taxation Office touting them as a viable way of saving for retirement. Indeed, an SMSF must be run for the sole purpose of providing retirement benefits for the members or their dependants. The difference between an SMSF and other types of funds is that the members of an SMSF are usually also the trustees. This means the members of the SMSF run it for their own benefit and are responsible for complying with the super and tax laws.

Superannuation Funds

With traditional super funds professional, licensed trustees are responsible for managing the fund and bear the compliance risks. While some allow control over the mix and risk level of your super investments, generally you are unable to select specific assets your super will be invested in.

If an SMSF isn’t a good fit for your current financial situation, there are many options available for leveraging and maxmising your traditional superannuation fund.  Additionally, you can make your own contributions, organise a salary sacrifice arrangement, or take advantage of eligible government superannuation co-contributions.

The right advice – the right plan

Everyone has unique goals, limitations and assets; and accessing the right financial advice is as important to your retirement plan as the structure you use. An experienced financial planner will use a ‘big picture’ approach, taking the time to discuss your personal circumstances and identify your goals, before matching you with a plan designed to actualise your retirement goals by harnessing your financial potential.

Control your wealth – control your future

Retirement dreams are never a one-size-fits-all ideology, and retirement planning is never a one-size-fits-all financial solution. Whether you dream of caravanning around Australia, spending more time with the grandchildren, cruising the world, or taking on part-time or hobby income streams, you need the financial security to embrace your dreams with confidence.

To control your wealth is to control your future. Whether it’s building wealth through an investment strategy, or tapping into the benefits of an SMSF, Elston can help you achieve financial security with a customised retirement plan.