The insidious side of low interest rates
June 05, 2016 | Robin Bowerman, Vanguard Investments Australia
Many investors might be worried about a low return environment - but something far worse than a sluggish economy may threaten your personal wealth.
Amid low interest rates and volatile market conditions, criminals using fake investment schemes are an increasing risk to investors hungry for higher returns, according to a major report "Targeting Scams" released this week by the Australian Competition and Consumer Commission (ACCC).
With many investors chasing the best yields they can get - particularly SMSFs in retirement, who are reliant on investment income - attractive, high yield opportunities can seem like a tempting avenue to get higher returns.
According to the ACCC, common ploys fraudsters use to entice investors include offering high-yields, quick returns, low up-front investments, low or no risk and inside information. Often, these scams are spruiked to the unwary by telemarketers cold-calling, use slick, scripted pitches to cover any and all angles available.
One of the many sobering statistics quoted in the ACCC report was that more than 40 per cent of the reported scams were inflicted on people over 55 years old. The total number of scams reported to the ACCC's Scamwatch website was 105,200 with total scam losses exceeding $229 million last year.
The ACCC said in reality the total will be higher as many scams go unreported.
The advice to anyone who thinks they are being targeted by such a call is simple: hang up the phone. If the person on the other end of the line can't answer a few simple questions around their organisation, like its financial services licence (AFSL) or credit licence (ACL) numbers, or their business address, then the conversation should end there.
An excellent resource for learning more about investment scams and appraising investment opportunities is ASIC's MoneySmart website. A first-line of defence with any offer is a simple check on the ASIC website that the company offering the product has an Australian financial services licence.
Illegal investment scams are at the extreme end of the spectrum, but investors should be suitably sceptical of anyone claiming to have the secret to high yields in a low-return environment. The ACCC report also warns of high-pressure sales techniques at "investment seminars" and urges investors not to sign up for anything at a seminar but rather take the time to consider and research what is being offered.
Years of investment data, such as that in the annual SPIVA scorecard, tell us that even highly-skilled and sophisticated money managers are rarely able to out-perform average market returns year-in and year-out, let alone guarantee astronomical returns.
Even if a financial product or its issuer is legitimate, any investment that promises outperformance of the market should be carefully analysed. It is likely that a high-yield product carries with it higher risk - not to mention high costs.
Although investors with a longer time horizon might be comfortable taking on a high amount of risk to ensure they have the potential to see higher returns on their investment, investors who rely on income should be wary of over-exposing their portfolio by chasing yield.
Because if something seems too good to be true, it almost certainly is.
Constant reminders about critical financial turning points
June 05, 2016 | Robin Bowerman, Vanguard Investments Australia
The federal Budget's heavy focus on superannuation will no doubt convince many fund members to think about the adequacy (or inadequacy) of their retirement savings.
And this month's cut in the official cash rate to a new record low is likely to encourage us to think about the size of our mortgage and whether we should be increasing repayments while rates are low.
The Reserve Bank's stats showing that the practice of "maxing out" to monthly credit card limits fell to an almost 14-year low in March may trigger a searching look at how we keep our own budgeting under control (or out of control).
Perhaps the stats, again from the Reserve Bank, indicating that ATM use slipped to near an all-time low in March may spur some of us to consider how we use cash machines. (In reality, the falling popularity of ATMs probably does not reflect so much a more cautious attitude to spending but a growing preference for plastic cards.)
We seem to receive constant reminders about critical aspects of our personal finances and the need to keep a close watch on them.
While we may like to think of ourselves as individuals, most of us deal with the same personal finance issues during our lives - although the details, of course, can differ greatly between individuals.
For instance, the majority of us face similar financial turning points (also sometimes tagged "life events" or "financial milestones").
Financial turning points include receiving our first pay, joining our first super fund, leaving our childhood home, getting married, signing the contract for our first mortgage and eventually retiring. Others have to cope with such less-fortunate financial turning points as losing a job, suffering a serious illness and coping with a divorce.
The decision to begin saving seriously to meet our long-term goals and the creation of our first financial plan must rank among the key financial milestones.
High on the list of ways to help prepare for many of the expected and unexpected turning points are careful budgeting, saving, investing, obtaining adequate insurance and seeking quality professional advice whenever necessary.
ASIC's personal finance website MoneySmart periodically updates a detailed feature, Life's events, which provides useful pointers about how to deal with a range of milestones. A central theme is the importance of budgeting. (See its budget calculator.)
Are you as ready as possible for your next financial turning point - whatever that may be?
Homeowners take advantage of record-low rates
April 28, 2016 | Robin Bowerman, Vanguard Investments Australia
Many home owners will no doubt treat the Reserve Bank's decision this month to leave the official cash interest rate at a record low as a continuing opportunity to further break the back of their mortgages.
As the central bank's statistics show, the official rate was 4.75 per cent at the beginning of November 2011 when the bank made the first of 10 cuts to bring the rate to just 2 per cent. And it has remained at that low for almost a year.
Low interest rates have, of course, been a two-edged sword for homebuyers.
On one hand, the long run of low rates has fuelled the strong rise in house prices, predominantly in Sydney and Melbourne. Yet on the other side, countless homeowners – particularly those who bought before prices took-off – are taking advantage of low rates by reducing their mortgages.
The Reserve Bank has been tracking this determination of homebuyers to accelerate their mortgage repayments and to build-up mortgage buffers while rates are low, as repeatedly noted in its half-yearly Financial Stability Review.
In its review published in September 2013, the bank commented that "anecdotal evidence" suggested that about half of homebuyers did not reduce their regular repayments despite the fall in rates. This was about two years after the sustained rate cutting had begun.
Then in October last year, the bank observed that many homebuyers "continue to take advantage of lower interest rates to effectively pay down their mortgages faster than required".
The bank had noted the rapid build-up of mortgage offset accounts, which is a savings account attached to a mortgage. (Savings in these accounts are offset against the mortgage, thus reducing the mortgage interest paid – without tax consequences.)
And its latest Financial Stability Report, released in mid-April, reports that the savings held in mortgage offset accounts and redraw facilities as mortgage buffers had increased further over the past six months, reaching 17 per cent of outstanding mortgage balances.
The Reserve Bank calculates that more than two and a half years of scheduled repayments at current mortgage rates are held in offset accounts and redraw facilities. (The redraw feature enables borrowers to withdraw extra repayments.)
Astute homebuyers recognise that the making of extra repayments not only saves a large amount in interest over the term of their mortgage but provides a buffer against future rate rises.
ASIC's consumer website MoneySmart provides a useful calculator showing how much a homebuyer might save in mortgage interest by making even relatively modest additional repayments. Take a homebuyer with 30-year, capital-and-interest loan with a current 5 per cent interest rate.
Based on certain assumptions, MoneySmart calculates that by repaying $100 extra a month, this homebuyer will cut the term of loan from 30 years to 27 years and eight months while saving almost $43,000 in interest.
Treating SMSF related-party dealings with caution
April 28, 2016 | Robin Bowerman, Vanguard Investments Australia
Astute SMSF trustees who are contemplating a transaction with a related party - such as member, a member's family or a member's business entity - are likely to first consider gaining professional advice, perhaps from an SMSF specialist adviser.
Related-party transactions by SMSFs can involve complex superannuation and tax law with plenty of traps for the uninformed.
The reality is that if an SMSF trustee commits a series breach of superannuation law, there is an extremely strong chance that a related-party dealing is involved.
Up to 70 per cent of the most common reported contraventions in number and more than 80 per cent in value reported to the tax office as SMSF regulator over the 10 years to June 2015 appear to involve some sort of SMSF related-party dealings. (These percentages include a failure to separate SMSF assets from non-SMSF assets.)
In terms of value, reported contraventions include: providing prohibited loans or financial assistance to members (15 per cent); exceeding the in-house asset limit, which places a ceiling with exceptions on dealings with related parties (28.8 per cent); failing to separate superannuation assets (25 per cent); failing the sole-purpose test of superannuation to provide for members' retirement (4.5 per cent); failing to make investments on an arm's length, commercial basis (7.9 per cent); and acquiring unauthorised assets from related parties (2.4 per cent).
The remaining contraventions mainly involved operating standards and administrative matters.
It should be emphasised that that only about two per cent of SMSFs each financial year are the subject of reported contraventions by fund auditors to the tax office.
Other compliance issues may arise in certain circumstances when SMSF trustees borrow from a related party under a limited recourse borrowing arrangement (LRBA) to make investments for their funds.
The tax office released a practical compliance guideline this month setting out how SMSFs "may structure their LRBAs that are consistent with an arm's length dealing" from an income tax perspective. Its examples include an SMSF that has borrowed from a member's father, a related party to the fund, to buy a commercial property.
Again, the complexities here underline why SMSF trustees should consider taking specialist advice to ensure that a transaction involving a related party complies with superannuation and tax law.
Measuring the cost of being a performance chaser
April 15, 2016 | Robin Bowerman, Vanguard Investments Australia
Countless investors would be surprised to learn that their investment returns may be much lower than the managed funds holding their investments. And much of that lost performance is due to being performance chasers.
A Vanguard research paper analyses Morningstar data to show that Australian fund investors on average trailed the average return of 232 multi-sector funds by 4.13 per cent a year over the 10 years to December 2014.
Investor returns calculated by the researchers assume that the growth of a fund's total net assets for a given period is driven by market returns and investor cash flows in and out of a fund.
An unfortunate investment reality highlighted by Vanguard researchers is that cash flows into a managed fund tend to be attracted by, rather than precede, higher returns.
In other words, many investors take the view that yesterday's winners will also be tomorrow's winners. This is almost a sure formula for investors to lose money or at least substantially throw away returns as they switch between funds in pursuit of performance.
The researchers calculate that over the 10 years to December 2014, the average Australian investor trailed:
- Large Australian equity funds by 4.18 per cent a year. (Number of funds researched: 215, covering 88 per cent of assets under management in the category).
- Mid-small Australian equity funds by 4.37 per cent a year. (Number of funds researched: 47, covering 91 per cent of assets under management in the category).
- Large global equity funds by 4.79 per cent a year. (Number of funds researched: 100, covering 93 per cent of assets under management in the category).
- Mid-small global equity funds by 5.39 per cent a year. (Number of funds researched: 16, covering 96 per cent of assets under management in the category).
- Multi-sector funds by 4.13 per cent a year, as already discussed. (Number of funds researched: 232, covering 77 per cent of assets under management in the category).
In short, such performance-chasing behaviour - whether between managed funds or asset classes - can be highly damaging to an investor's efforts to create wealth. It's probably more damaging than many investors suspect.
We have not taken your or your clients' circumstances into account when preparing our website content so it may not be applicable to the particular situation you are considering. You should consider your and your clients' circumstances, as well as our Product Disclosure Statements (PDS), before making any investment decision or recommendation. You can access Vanguard's PDS at www.vanguard.com.au or by calling Vanguard Investments Australia Ltd. Past performance is not indicative of future performance.