In this extract from Noel Whittaker’s new book, Retirement Made Simple, he says investing is complicated and shares the rules he has fine-tuned over the decades.
If you are investing for retirement, or are already retired, knowing something about investing is critical. Unless you are getting a lifetime pension from a previous employer, the only income you will have after you stop work will come from your investments or from welfare.
You may have had a range of investment experiences. Some of you will be highly successful investors. Some will – like many of my friends – use a financial adviser with whom you’ve had a satisfactory relationship for years. Some of you will have a chequered investment history with wins and losses, and may be confused about how to make retirement successful. Some of you may never have invested at all. And, sadly, some of you will have suffered serious losses due to a wide range of issues.
My goal is to explain the basics of investing and give you some simple rules that should stand you in good stead for the long haul.
But it’s not easy. The investment world is full of uncertainties, and investors are bombarded with a barrage of conflicting and often confusing information. In spite of all my years investing, advising and investigating investments, I also find investing difficult. The economy is constantly changing, laws are revised frequently, new products keep evolving, fraudsters continually think up new tricks, and surprises such as the 2008 global financial crisis (GFC) and 2020’s COVID-19 come along all too often.
To make matters worse, we are all victims of both inertia and our own personal biases. Many people I meet get really enthusiastic about starting an investment program, but they find the range of options so overwhelming that they haven’t a clue where to start, and consequently don’t even get around to dipping their toes in the water. It’s a natural reaction.
But understanding your own personal biases is critical if you are to be a successful investor. Just be aware that investing is an art, not a science – there are some fundamentals, which you ignore at your peril, but there are also many uncertainties, such as the future of interest rates, inflation, and the behaviour of both share markets and property markets. This uncertainty will always be with us, but a greater level of understanding will help you make better choices.
A good definition of investing would be: to allocate money for future use instead of spending it today. Naturally, you would hope that it would still be there when you needed it, and that it would have increased in value to compensate you for the loss of purchasing power over time.
The first fundamental is that every investment decision has advantages and disadvantages. If you put your money in the bank, while it should never fall in value, the income from it may be relatively small, and there are no tax concessions on the interest. If you put your money in superannuation, you move it to a low tax area, but the price of doing that is loss of access until you reach your preservation age. If you invest in shares, you enjoy the advantage of being able to sell part of your holding quickly, and the income may be tax free. However, its value could fall when the market does. If you invest in real estate, you face repairs, maintenance costs and vacancies, and have no ability to part-sell – but the advantage is that you would not expect to lose a huge chunk of your capital.
So the first fundamental principle is to make sure you understand the good points and the bad points of every investment decision you intend to make. Don’t invest until you understand them.
The next fundamental is that investments may produce income, or capital growth, or a combination of both. Some investments – such as vacant land or gold – produce no income at all. That is challenging because, while income is often predictable, capital growth is only fairly predictable over the long term; it is unpredictable in the short term.
You may think that’s stating the obvious, but the average investor does not understand it. If the share market – or the property market – is steaming along, that seems like a signal to the uninitiated to jump in and grab a share of the action. They don’t realise that the capital growth they are so excited about won’t happen forever, most of it has already happened. And, as we saw with COVID-19, a market that is booming in January could have crashed by March. This is why investors are always told that past returns from an investment may not be indicative of future returns.
So, here’s the dilemma. An investor will be looking for the best returns they can achieve within their risk profile, and these will usually come from ‘growth assets’, that is, from capital gains, typically from property or from shares. And while we could reasonably expect that a combined growth/income return from good property and share investments should average around 8 per cent a year long term, the short-term returns may be nothing like this. Hence, the principle is that if you are investing in assets such as property and shares, where the bulk of the returns are expected to come from capital growth, you should have a minimum seven-to 10-year time frame in mind. This will give you time to get through the inevitable bad periods. And don’t forget, if you’re a retiree aged 65, you have a good chance of another 30 years of investing ahead of you.
Over the long term, the best returns should come from growth assets such as property and shares.
I’m sure you know the only returns that count are the ones you receive after tax, but remember that all returns are not taxed in the same way. Furthermore, the tax depends on whose name the investment is in.
There’s more. Income is usually taxed at your marginal tax rate; rents and bank interest, for example, offer no tax concessions, so you pay full tax on these. But tax can be greatly reduced if the income is from franked dividends, which often applies to Australian shares. Capital gains are particularly attractive, because these are not taxed until you dispose of the asset, which could be many years after acquisition – and provided you have owned the asset for over a year, you get a 50 per cent discount on the tax payable.
If you think about the above, it will be obvious that the purpose of the investment should have a major influence on the type of investment you make. If you have sold your home and need to keep the money somewhere safe until the property you have contracted to buy off the plan is completed, the only option is a bank deposit. You can’t afford entry or exit costs, or the chance of your capital falling in value. It’s the same if you are contemplating a holiday in a year or so – the term is too short for anything but a bank deposit. But if you’re 50, and are building assets for a retirement in 15 years, you should look at growth assets to provide the returns you need.
The investment menu: cash, property, shares
Whenever I make a speech at a money seminar, I start by asking, “Are you confused by the vast range of options that appear to be available?” Most of the people in the audience have spent the day wandering from booth to booth, and the response is invariably an overwhelming “Yes.” I then remind them that, despite all the changes to the rules and the plethora of investment products available, there are still only three asset classes where the bulk of their funds can be invested: cash or fixed-interest securities, property and shares. And keep in mind that diversification – not having all your eggs in one basket – is a cornerstone of successful investing.
Once you understand the menu concept, you will appreciate why you have three major decisions when you are considering where to invest:
1. Asset allocation. What percentage of your total assets should you invest in each of the three asset classes – cash, property, and shares?
2. Investment vehicle. Do you invest in asset classes directly or do you use managed funds such as unit trusts, property syndicates, insurance bonds and friendly society bonds?
3. The best owner. In what name will each asset be held for ease of estate planning and to minimise tax?
All professional money managers and financial advisers focus on asset allocation – the term given to the way your investments are spread across asset classes. They usually look for a spread across Australian cash, Australian and international fixed-interest investments, Australian listed and unlisted property, and Australian and international shares. They may also look at putting some funds in alternative investments.
It is the percentage of assets in each category that determines the volatility of a portfolio, and ultimately its overall performance. In practice, most financial advisers regularly receive suggested asset allocation models from their research sources. These are different for each type of client and vary with the research analysts’ views of the market.
Remember, if your investment monies are in superannuation, you always have the simple option of letting your fund decide how much of your money should be invested across each asset class. The odds are that they will do a better job than you could, and a large superannuation fund will probably use all the investment vehicles.
- Every investment you make has advantages and disadvantages. Make sure you know what they are before you take action.
- Investments produce income, capital growth, or both.
- Capital growth is not something that is happening – it is something that has happened.
- Invest in growth assets such as property or shares with a seven-to-10-year time frame.
- Investment returns are not all taxed the same: the only returns that count are the ones you get to keep after tax.
- The purpose of the investment should influence the type of investment you make.
- When making an investment, consider in what name it should be held for maximum long-term tax effectiveness.
- Diversification is the cornerstone of successful investment. Don’t put all your eggs in one basket, or all your investments in one asset class.
Do you regard yourself as a successful investor? How did you learn the ropes or how are you going about learning?
Noel Whittaker is the author of the recently released Retirement Made Simple as well as several other books including Making Money Made Simple. You can buy Retirement Made Simple for $29.99 at noelwhittaker.com.au
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