Jonathon Wu from the Premium China Fund on Sky News

Below is a link  to an interesting interview with Jonathon Wu, Head of Distribution & Operations for the Premium China Fund,  on Sky News today.  We found it interesting and provides a bit of insight into what is happening in China and the broader region.

http://au.youtube.com/watch?v=AXNF5bDRxrA

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances.

It’s has been a while but we are back

Due to the current investment climate and the global financial crisis we have not been putting up any posts for a while but we are now in a position where we should be able begin making regualr posts again. 

Just as a reminder this site can only provide genreal advice in relation to investmetns and financial investments. 

Sorry for the absence and again, if you have questions please let us now.

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances.

Unemployment rises to 4.1 pct

The latest unemployment figures released today by the Australian Bureau of Statistics [ABS] hopefully shows that the economy might be finally slowing. 

The ABS has reported that unemployment has increased by 0.1% to 4.1% [seasonally adjusted] as at March 2008.   However, even though there was decrease in the seasonally adjusted rate, the trend estimate went the other direction, with a fall to 4.0% [down 0.1%].

The ABS also said part times job grew by approximately twice the number of full time jobs and the participation rate remained steady 65.2%.

Please see the attached summary for more details – abs-march-2008-unemployment-statistics 

To learn more about how the above infomration may inpact your financial strategy please contact Freedom Financial Planning on 03 9542 3200 or blog@freedomfinancialplanning.com.au

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances.

The Current State of the Australian Listed Property Trust Sector

A-REITs, formerly known as listed property trusts, have been hard hit of late, but it’s important to understand the recent changes to the sector that have influenced recent performance and why the experts are predicting good news for the future. Daryl Wilson, CFO and Director of Cromwell Group explains.A-REIT stands for Australian Real Estate Investment Trust, and is the new name for what was previously known as LPTs or Listed Property Trusts.  The re-branding is being undertaken by ASX in conjunction with the Property Council of Australia (PCA) to better align the name with those used in other jurisdictions, including the United States. 

So what else has changed in the A-REIT sector, apart from the name? 

Well, certainly the recent climate, and the accompanying major fall in A-REIT stocks, is not in line with historical behaviour at this point in the economic cycle.  In the past, the A-REIT sector has been a defensive haven in volatile times.  This time around, along with the broader financial services sector, it has been one of the hardest hit with the S&P/ASX 300 A-REIT index down 23% in the 12 months to 31 January 2008.  To understand the reasons for this, it is important to understand how the sector has changed in recent years.
 
Back in the good old days, A-REITs usually consisted of diversified portfolios of good quality Australian commercial or retail property.  They were managed by an external manager, who charged a fee for this service.  They tended to have reasonably low debt and gearing levels and dependable income streams from long term leases.  Over the past few years, there have been a number of changes to this model and many other revenue streams added to the traditional property income.  As a result of this, the current crop of A-REITS are a very diversified bunch indeed.  Some characteristics which have been introduced into the sector, or grown in nature in the past 10 years, are:

Higher gearing - the disquiet surrounding the A-REIT sector started back in December 2007, when the market became concerned about some A-REITs being caught with high gearing at a time when it became much more difficult to obtain debt funding, particularly in the US.  While there are some extreme examples, in recent years, it has become relatively common for gearing levels of some A-REITs to be 50% or higher. With the sub-prime crisis unfolding in the US in the later half of 2007, and having a flow-on global effect, those A-REITs with higher gearing levels have suffered.

Overseas investment – Many A-REITs have expanded overseas, and now derive a substantial portion, or even all of their income, from outside Australia.  While this has introduced more diversity into the sector, it has also introduced additional risks.  These include currency risk (both in relation to distributions flowing back to Australia and the original capital sent offshore to acquire the property assets), foreign property markets, legislative and management risks.  Property values in many overseas locations, including the United States and United Kingdom, are believed to have fallen in recent months, some by as much as 15-20%, which has had a significant impact on the value of those A-REITs which have offshore activities.

Specialised asset classes - There are now many A-REITS which invest outside the traditional asset classes of shopping centres, commercial offices and industrial sheds.  Investors can gain exposure to retirement villages, hotels, pubs, storage facilities, child care centres and even vineyards via investment in one or more A-REITS.  Many of these A-REITs have performed very well in the last few years, as the values of these assets increased.  However, in the event that property valuations come under pressure, these specialised asset classes are expected to suffer more than the traditional property sectors.

 Stapled vehicles, with funds management or development businesses – Most of the larger A-REITS, and many smaller ones, no longer earn their income from just property investment.  Many have become what are termed ‘stapled’ structures, which simply means that one or more trusts are combined, or stapled, to a company.  This structure enables the ‘internalisation’ of management.  That is, instead of management fees being paid out to an external manager, they are retained within the A-REIT, less the costs of employing staff and managing the assets.  The advent of stapled structures has also led to a variety of other activities being introduced to stapled vehicles, including funds management and development activities.  These activities can be inherently more risky than passive property investment.

The impact on of recent events on A-REIT valuations

Valuations in recent times have been stretched for A-REITS.  This was caused by a combination of a bull market, with plenty of funds available for the A-REIT sector, coupled with higher property valuations and higher price earnings multiples being accepted for riskier transactional and development activities undertaken by A-REITS.  The impact of the factors outlined above coupled with the more widespread fall in markets generally and continuing interest rate rises have punished A-REIT valuations, in a lot of cases unfairly.

What is ahead for the sector?

The market is also wary of property valuations at the moment, with some concern property values in Australia will drop.  Cromwell’s view, along with that of many commentators, is that any valuation decreases will be skewed heavily towards the lower quality, non-traditional or riskier asset classes, with good quality portfolios suffering little, if any, fall in value.  This will also be assisted by underlying rents, which in many traditional property markets are still rising strongly.There is, in Cromwell’s view, some very good value emerging in the A-REIT sector.  The market is still shunning anything with offshore exposure, high gearing, or high reliance on development or transactional earnings, and rightly so.  However, there are still quite a few A-REITS which have good quality property assets, low gearing, and a high proportion of reliable, recurring income.  Many of these are at the small-medium end of the spectrum, and can be bought at yields close to, or in excess of, 10%pa.  As the broader market recovers, we expect those A-REITS which have these traditional defensive characteristics to be quickly and positively re-rated.In many ways, it’s back to the good old days, with a focus on strong earnings from quality property portfolios with low gearing.  Strong funds management businesses with a high proportion of recurring earnings will also be well regarded, as they have the potential to provide solid earnings growth.

Article prepared by Daryl Wilson, CFO and Director of Cromwell Group.

Sourced from www.asx.com.au on 13 March 2008.  This article appeared in the March 2008 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

About the Australian Securities Exchange [ASX]As one of the world’s top 10 listed exchange groups, measured by its market capitalisation, ASX group was created through the merger of the Australian Stock Exchange and the Sydney Futures Exchange.  ASX group operates under the brand, Australian Securities Exchange.  The Australian Securities Exchange spans the markets for corporate control, capital formation and price discovery and functions as an operator, supervisor, central counterparty clearer and payments system facilitator.  The diverse domestic and international customer base of the Australian Securities Exchange includes issuers of a variety of listed securities, corporates, investment banks, trading banks, fund managers, hedge funds, CTAs, proprietary and retail traders.

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances. 

The Australian S&P/ASX 200 Stock Market Index Explained

Regarded as Australia’s equity benchmark, the S&P/ASX 200 index gives investors insights into the strength of the market. But learning the history of the index and how it operates is important for any investor, not just those wanting to gain exposure to the index through investments.Recent financial market instability has brought increased attention to the performance of the world’s share markets. It’s not uncommon for the nightly news on TV to include footage of a bank’s dealing room or investors at a stock exchange somewhere watching the prices of their stocks on a large public display.

Most of us would be aware of the concept of an equity index as a gauge of share market performance. However very few people would have a more than superficial understanding of how an equity index is constructed and maintained, or how they might go about getting investment exposure to an equity index.

This article examines the local sharemarket benchmark index, the S&P/ASX 200, and some of the other indices in the S&P/ASX suite of indices. A brief history is given as well as an explanation of how the index is managed, where to find more information and how an investor could gain exposure to index returns.

History

Before April 2000, the All Ordinaries index was considered Australia’s institutional benchmark. The All Ordinaries index was launched in January 1980, to act as an indicator of the Australian equity market. As institutional investors grew increasingly sophisticated, there became a need to introduce a benchmark index that was complementary to the narrowly defined market capitalisation and liquidity requirements for equity portfolios. Hence, S&P, in partnership with ASX, developed the S&P/ASX 200.

The S&P/ASX 200, together with the entire S&P/ASX index series, was launched in April 2000. The S&P/ASX 200 covers approximately 80 per cent of the Australian equity market by capitalisation, and is regarded as Australia’s equity benchmark with over A$200 billion measured and managed according to the index.

The S&P/ASX 200

The S&P/ASX 200 measures the performance of the 200 largest index-eligible stocks listed on the ASX. Representative, liquid and tradable, the S&P/ASX 200 is widely considered Australia’s pre-eminent benchmark index and is used to measure portfolio performance for market practitioners, such as fund managers, institutional investment managers and professional advisers. Listed companies place immense significance on their membership in the S&P/ASX 200 index. Inclusion in the index generates significant institutional interest for constituents, and proliferates widespread media and buy/sell side analytical coverage.

A stock’s weight in an index is determined by the float-adjusted market capitalisation of the stock. The float adjustment removes controlling and strategic shareholdings from the market capitalisation calculation to ensure that only the portion of the company’s float that is truly available to investors is included in the index calculation. Holdings excluded from the market capitalisation calculation include government and government agencies, controlling and strategic shareholders/partners and other entities or individuals which hold more than 5 per cent (excluding insurance companies, securities companies and investment funds). Also, stocks in the index must have enough trading activity to meet certain liquidity thresholds to ensure that funds tracking the index can buy and sell index constituents relatively easily.

The index series

This index series offers investors exposure to a set of highly liquid and tradable indices whose total market capitalisation is large enough to approximate the market segment being benchmarked while keeping the number of stocks at a set minimum. This creates a highly cost-effective, easily replicable trading instrument that provides an appropriate barometer of the market’s performance. The fixed number of stocks also ensures minimum turnover as changes are made due to corporate activity or a reduction in a stock’s size or liquidity that makes it ineligible for inclusion.The benchmark S&P/ASX 200 is part of a suite of indices that represent the Australian market capitalisation hierarchy. Included in the hierarchy are the S&P/ASX 20, the S&P/ASX 50, and the S&P/ASX 100 and the S&P/ASX 300 representing the largest ASX listed 20, 50, 100 and 300 companies respectively.

The index suite also contains component indices such as the:

S&P/ASX Small Ordinaries which is comprised of companies included in the S&P/ASX 300, but not in the S&P/ASX 100 and is used as an institutional benchmark for small cap Australian equity portfolios. The All Ordinaries index which is considered the total market indicator for the Australian equity market. The index is comprised of the 500 largest securities listed on the ASX and the constituents are not screened for liquidity. It is the only index that is not float-adjusted. The S&P/ASX All Australian 50 and the S&P/ASX All Australian 200. Launched in June 2007, the S&P/ASX All Australian 50 and 200 are made up of ASX listed securities that have been defined as ‘domestic’ or ‘Australian’ for index purposes.

Industrials and Resources Indices With resource companies playing a significant role in the Australian economy there is a requirement to identify the performance of resources stocks and their relative distinction to other market segments. Consequently industrials and resource indices are available for the S&P/ASX 100, S&P/ASX 200, S&P/ASX 300, S&P/ASX MidCap 50 and S&P/ASX Small Ordinaries. Resources are defined as companies from the Energy sector and the Metals & Mining industry. The industrials indices are composed of everything else. The decision to split the Australian equity market between Resources and Industrials allows benchmark comparisons to be made against portfolios that are tailored to the respective broad sectors.

Gold and Metals & Mining Indices Launched in August 2006, these indices recognise the mining sector’s importance in the Australian equity market, and enhance the profile of the Gold and Metals & Mining industries within both the Australian and international markets. The S&P/ASX 300 Metals & Mining index is based on the S&P/ASX 300, and is comprised of companies that are classified in the Metals & Mining industry. The S&P/ASX All Ordinaries Gold index includes companies from the Gold sub-industry of the All Ordinaries index.

Property Trusts and Financials X-Property Trusts In July 2002 two sector indices were introduced to the Australian market to reflect the importance of property trusts as a distinct sector for institutional investors in Australia. This was achieved by fragmenting the Financials sector into Property Trusts and Financials excluding Property Trusts.  Note: The S&P/ASX 200 Listed Property Trust index will become known as the S&P/ASX 200 A-REIT index from 5 March 2008. 

When are changes made to the S&P/ASX 200?

The S&P/ASX 200 index is ‘rebalanced’ quarterly. Rebalancing means reviewing index constituents to ensure adequate market capitalisation and liquidity is maintained. Rebalancing changes take effect on the third Friday of March, June, September and December. Between rebalancing dates, an index addition can be made if there is an index deletion. Deletions can occur between index rebalancing dates due to acquisitions, mergers and spin-offs or due to suspension or bankruptcies.

How can I find which companies are in the S&P/ASX 200?

A list of index constituents can be found on the S&P/ASX 200 section of the S&P website. Simply select Constituent List on this page to see which companies currently make up the S&P/ASX 200.

Sourced from www.asx.com.au on 13 March 2008  

About the Australian Securities Exchange [ASX] As one of the world’s top 10 listed exchange groups, measured by its market capitalisation, ASX group was created through the merger of the Australian Stock Exchange and the Sydney Futures Exchange.  ASX group operates under the brand, Australian Securities Exchange.  The Australian Securities Exchange spans the markets for corporate control, capital formation and price discovery and functions as an operator, supervisor, central counterparty clearer and payments system facilitator.  The diverse domestic and international customer base of the Australian Securities Exchange includes issuers of a variety of listed securities, corporates, investment banks, trading banks, fund managers, hedge funds, CTAs, proprietary and retail traders.

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances. 

ATO to beef up SMSF compliance

The Australian Tax Office (ATO) is set to spearhead several initiatives to address the burgeoning number of self-managed superannuation fund (SMFS) trustees who flout their legal obligations and the number of auditors who fail to report this.Speaking at the Self-Managed Super Fund Professionals Association of Australia National Conference in Brisbane today, the commissioner of taxation, Michael D’Ascenzo, acknowledged that the rapid increase in SMSFs in Australia had posed several major problems for the industry, which, if left unchecked, could seriously compromise Australians’ retirement savings.He said that many trustees, particularly the newer ones, did not fully understand their legal obligations and many auditors are not doing a good enough job at enforcing them.

“The issues highlight the fact that one of the main motivators for establishing these retirement savings vehicles – desire for flexibility and control over the investment of assets – is not always being matched by higher levels of accountability.”

D’Ascenzo pointed to a recent ATO survey that highlighted major gaps in new trustees’ knowledge, raising questions about their ability to meet their obligations.

He said common breaches included prohibited loans, the inclusion of non-allowable assets within funds, exceeding the cap on concessional contributions and illegal borrowing.

D’Ascenzo also acknowledged that even when breaches are detected, there is typically an unacceptable delay in rectifying them.

“[I]t is of concern that 25 per cent [of reported breaches] are only actioned after the ATO has followed up with the fund and 25 per cent still fail to rectify despite our contact.”

He said additional government funding has enabled the ATO to beef up its efforts to ensure SMSFs comply with the law and auditors meet their responsibilities.

These measures include carrying out an extra 6,600 reviews and audits of SMSFs this financial year and reviewing and auditing about 900 approved auditors, some of whom D’Ascenzo said fail to follow even basic auditing standards.

D’Ascenzo said the ATO had worked with industry experts to develop a SMSF start-up kit, which it will give to all new trustees, as well as a booklet entitled ‘How your self-managed super fund is regulated’, which it plans to release in the next few weeks.

He said the ATO would also implement special compliance checks to ensure trustees understand and meet their legal obligations and unveil a more user-friendly and practical website. According to US analysts, the Fed is poised to reduce official interest rates by another half-point when it meets on March 18.

Sourced from www.moneymanagement.com.au on 13 March 2008  

 www.moneymanagement.com.au is part of an online venture of the Financial Services publishing arm of Reed Business Information (RBI), which is owned by the global Reed Elsevier publishing group. www.moneymanagement.com.au draws news and content from existing print titles within the Financial Services group, which include:  

 • Money Management Newspaper
• Super Review Magazine www.superreview.com.au
• Financial Planning Magazine www.moneymanagement.com.au
• The blue book Directory 

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances. 

RBA Lifts Interest Rates Again

As expected today the Reserve Bank of Australia raised official interest rates by 0.25% to 7.25%, effective 5 March 2008.  Please see the attached RBA media release that explains their decision.

RBA Media Release – 2008 March Rate Rise 

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances.

Simple Steps to Assist in Locating Your Lost Superannuation Benefits!

Superannuation is a way of putting money aside now and saving for the future. And for most of us who are employed in Australia it’s compulsory for employers to put money away on our behalf. [9% of your per tax wages, providing your earn more than $450 per month]

In December 2007, the Government announced there was $12 billion of unclaimed or lost superannuation money registered in the Australian Tax Office’s (ATO) Lost Members Register.

Your details are added to the Lost Members Register once a superannuation fund receives two pieces of unclaimed or returned mail; therefore, if you have moved house or jobs it may be possible you have more superannuation funds than you realise!

How do I find out if I have any lost superannuation benefits? 

If you would like Freedom Financial Planning to help you find out if some of this money belongs to you then just complete the Authorisation to Collect Information Form and return it to us at PO BOX 118, Mt Waverley, VIC 3149.

Alternatively, should you wish to investigate this yourself:

1. Write down all of your past employers since 1992 (the year compulsory super was introduced)

2. Look for any old superannuation paperwork you may have, and identify which employer contributed to which fund

3. If you cannot account for all of your employer contributions, confirm with your old employers to which fund they may have paid your super contributions

Otherwise:

·          Contact the ATO Lost Member Register on 13 10 20

·          Visit the ATO’s SuperSeeker website and follow the instructions to search the thier database.

Prior to making any phone calls or searching any websites, make sure you have your Tax File Number (TFN) at hand!

What are your options if you find any old superannuation funds?

Any old superannuation fund that you locate can be either:

·          Rolled over / consolidated into your current superannuation fund

·          Left where it is, but please make sure you contact the fund and update your details so the fund can send you your annual statements

Some of the advantages of consolidating your super funds may include:

·          Avoiding duplication of the account fees

·          Easier control over how you invest your super assets

·          A single statement for all your super assets

·          Easier to manage and keep track of your super assets

IMPORTANT: Prior to rolling over ANY superannuation fund:

·          Contact the fund administers to confirm any penalties and/or other fees that the superannuation fund may levy to transfer your benefit to another fund

·          Contact the fund administers to confirm whether you have any insurance benefits that will be cancelled upon transferring your benefit to another fund. It pays to find out what insurance is linked to your fund and determine whether you need to retain this insurance before you transfer you asset and unknowingly cancel an insurance policy

Can I transfer my superananution benefits to Freedom Financial Planning?

Yes! Freedom Financial Planning can assist you with all matters relating to your superannuation and longer term retirement planning needs.  Simply contact us on either 03 9542 3200 or blog@freeodmfinancialplanning.com.au to arrange an appointment with a licensed financial adviser who can assist you in reaching your goals and achieve financial freedom!

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances. 

Wealth Creation Strategies Part 5: Direct investments v’s managed funds

Direct investments relate to investments that have been made directly to the market. These types of investments include the purchase of direct shares on the Australian stock exchange, listed property trusts, Government notes, bonds, direct property and debentures.  These types of investments are available for direct purchase to individual investors such as you, however, there are some considerations in making direct purchases.There is a lack of diversification in investing in one type of stock.

For instance, purchasing one particular share does not give appropriate exposure to various sectors of the market, let alone diversification between sectors within the share market. A substantial cash outlay is required if appropriate diversification is to be obtained via investing directly.Investing directly in the market can be of benefit for experienced investors with large sums of money, special interests, ambitions of self-management and special opportunities.

It would however be more advisable that direct investments, primarily shares, be used to add value to a portfolio of investments predominantly made up of managed funds.

Advantages of managed funds:

Cost efficiency

The cost associated with investing in managed funds is relatively cheaper than investing directly. For instance, investing in the share market, most stockbrokers will charge between 1.5% and 2.5% for every transaction made (i.e. Buy, sell, switch). Total direct property costs to buy, sell, hold or manage will, if properly accounted for, easily exceed total unit trust costs. Managed funds will generally have an entry or exit fee on products.

Diversification

With managed funds, it requires a small amount of money (as little as $1,000) to gain some exposure to the various sectors of the market and dozens of individual stocks. Investing directly requires large sums of money to gain a wide variety of exposure.

Professional management

Investors in managed funds have professionals working on their behalf making the appropriate investment decisions. The investor does not need to have a detailed knowledge of the investment markets, property and tenant problems, rights issues etc.

Liquidity

Funds can be accessed from unit trust funds generally within 5-10 days after making a request. Access to capital in direct investments, particularly property, can be very difficult, costly and time consuming. Managed funds have a major advantage over direct property investments, in that you don’t have to sell the whole investment to access some capital – it is virtually impossible to sell one room of an investment property.

Types of managed funds:

There are several asset classes and managed funds can be used as a means to invest in any one (or a combination) of these assets. The types of managed funds include:

Capital guaranteed

This type of fund guarantees the capital you have invested will not fall in value. Depending on the fund this may or may not apply to the total balance (total balance includes interest credited to date). The long-term return of these funds is influenced by the fact these funds generally hold the majority of their funds in cash and fixed interest with a smaller portion in growth assets and performance is expected to lay at a point between cash and capital stable investments.

Cash and fixed interest

These funds usually invest in securities (i.e. bills and bonds) issued by financial institutions including banks, Government and semi-Government authorities. Cash funds are suitable for short-term liquidity requirements and emergency needs while fixed interest funds lend themselves well to a source of regular interest income.

Capital stable funds

The majority of funds within a capital stable fund are invested via cash and fixed interest while a smaller proportion is usually held in shares and property to stimulate growth within the fund. Even though these funds typically share a similar asset allocation to capital guaranteed funds they usually out-perform them based on the fact they do not incur the cost of the guarantee.

Balanced funds

A balanced fund, as the name suggests, invests across the entire spectrum of asset classes (usually weighted towards growth assets) with the aim of reducing risk while maximising long-term return through the use of diversification. The investor must be aware these funds are generally subject to a higher level of volatility than the above types of funds yet long-term performance is expected to be higher.

Sector specific funds

These funds will generally invest in only one asset class except for holding some cash to meet liquidity requirements. They are used to access growth assets directly without having exposure to other asset classes within the fund. As these funds allow an investor to be ‘over-weight’ in an asset class there is the potential to achieve a higher level of return and in-turn, experience a higher level of volatility.

For assistance in helping you create your own wealth creation strategy to help you realise your goals and achieve financial freedom contact us today by either telephone 03 9542 3200 or email blog@freedomfinancialplanning.com.au  

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances.

Wealth Creation Strategies: Part 4 – Growing Wealth With Gearing

Gearing simply means borrowing money to invest.  Gearing may be used with existing savings to accelerate the process of wealth creation by allowing an investor to make a larger investment than would otherwise be possible.  The borrowed money can be invested in a number of ways, including direct shares, property and managed investments.

Negative gearing occurs when the interest payable on borrowed funds exceeds the net income received from the investment.  The investor must have surplus income over and above their day-to-day living expenses to meet the shortfall. Gearing can be an effective strategy if the after tax capital gain return of the geared investment exceeds the after tax costs of funding the investment. The leverage effect of gearing is illustrated below:

From the above graph, it can be shown that, with a geared strategy, any capital gains made on the investment are magnified compared to a non-geared strategy. However, the opposite is also true, capital losses are also magnified when using a geared rather than a non-geared strategy. This is the predominant risk associated with gearing.

The risks of gearing

The risks associated with negative gearing make it unsuitable for some investors. It is essential to carefully consider these risks and to seek investment and taxation advice before proceeding with this strategy.  The specific risks associated with negative gearing include: 

Timing mismatch.  It is important not to rely solely on investment income to meet interest payments, as investment income may be irregular and the interest payment may be due before the income is received from the investment.  In particular, negative gearing reduces your cash flow because the investment income does not cover interest costs, which may result in a reduction in both cash flow and the ability to service the interest costs.

Fluctuations in interest rates.  If the income from investments does not change, but interest rates on borrowed funds increase, then you will incur additional costs that will need to be covered from other sources.

Reduction in capital value.  Although there are potential wealth creation benefits to be gained from gearing, these benefits are achieved at the expense of higher risk.  The following table illustrates that although gearing has the potential to increase capital gains in a rising market, it can also compound a capital loss in a falling market.

Suitability of Gearing

Gearing is best suited to people who have a high risk tolerant attitude to investment, a high level of disposable income and are prepared to hold their investments for at least five to seven years.   The potential benefits of negative gearing include: 

Potential for increased capital gains and diversification.  Gearing increases the size of an investor’s portfolio by allowing them to purchase additional investments with borrowed funds.  Capital gains in excess of the after tax cost of funding the geared investment are added to the portfolio’s overall return.  By increasing the number of securities in an investor’s portfolio, the volatility of the overall investment portfolio may be reduced due to greater diversification.

Taxation.  Under current legislation, interest payments on money borrowed to invest in income producing investments, together with ongoing expenses, can normally be claimed against your taxable income.  Investors on high marginal tax rates will receive a higher tax deduction and investors on lower marginal tax rates can potentially make greater use of imputation credits and will incur a lower capital gains tax liability when they sell their investment.

Gearing Options

Lending Facility	Pro’s	Con’s
Geared share fundMay be suitable for Self Managed Super Funds	·          No risk of margin calls·          Investor does not have to borrow (leverage is obtained via institutional borrowings)·          Escalated returns and risk as the investments are internally geared·          The funds are usually actively managed with the objective of neutral gearing.·          Simple paperwork – no need to complete borrowing applications	·          Greater volatility (relative to regular non-geared equity funds) due to the gearing within the fund·          No obvious visible tax deduction to the client, although leverage benefit is received by the client
Home equity loan	·          Limited restrictions on what you can invest in·          Funding available determined by equity in your home·          No margin calls·          Lower cost of finance than margin lending	·          If the investments fall in value, your home could be at risk if you cannot otherwise repay the loan·          Paperwork (and some Government and legal costs) may apply to the loan
Margin lending	·          Security of shares or managed investments required·          Relatively broad range of investment choice	·          If the value of the investment falls, you may be asked to invest more money ·          Some restrictions on what you can invest into
Instalment warrantsMay be suitable for Self Managed Super Funds	·          Leveraged exposure to individual or basket of underlying securities·          Boosted yields via higher levels of dividend and franking credits	·          Generally higher interest and borrowing fees relative to other options·          Must hold instalment warrant at term expiring to own the shares outright·          Administration and time to manage
Structured products/protected equity loanThese comments are general in nature as product features vary significantly	·          Guaranteed not to lose money if the investment falls in value and it is held until maturity·          No margin calls·          Able to borrow up to 100% of the money being invested	·          The interest rate is substantially higher to pay for the guarantee·          Only a portion of the interest expenses may be deductible due to the capital nature of the protection·          Strict restrictions on investment options and rules governing the extend of the protection·          Very high break even point to cover high finance costs, usually in the vicinity of 5% pa after tax capital growth

Click here [MLC - Margin Lending] for a general guide to the pro’s and con’s of margin lending produced by MLC Limited.   MLC is the wealth management division of the Nationial AUstralia Bank (NAB). MLC provides investment, superannuation and insurance solutions and supports the provision of quality financial advice which helps people achieve and protect their lifestyle and financial goals.

For assistance in helping you create your own wealth creation strategy to help you realise your goals and achieve financial freedom contact us today by either telephone 03 9542 3200 or email blog@freedomfinancialplanning.com.au  

WARNING: The information contained on this website is provided in good faith. While the contents are obtained from various sources that are deemed reliable, it is not guaranteed as accurate or complete and should not be relied upon as such. It is recommended that you seek independent, professional advice before implementing any of the suggestions to ensure that it is appropriate to your needs and circumstances. 

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