Whatever... money management teenager style
May 12, 2015 | Robin Bowerman, Vanguard Investments Australia
Teenagers can be a worry - just ask any parent. But when it comes to understanding all things financial, today's teenagers have to deal with a much more complex and in many ways less tangible world.
Unusual indeed is the teenager today without a mobile phone - and the financial risks that come along with big data bills - while the world of online banking, debit and credit cards is just a login away.
That is before you get into the world of eftpos and the rapid convenience of paywave technology that makes it so, so easy to grab the extra bits and pieces you feel you need right then and there.
The paywave convenience may not just be a trap for teenagers but older folks generally should, with experience, have more awareness of what they can afford and know when they are perhaps living beyond their means.
Budgeting is a much underrated financial skill but teenagers in today's modern electronic world can be excused for not always connecting the dots.
At the risk of this becoming a grumpy old man column, back in my teenage years budgeting was not optional.
If you did not get to the bank before 3pm on Friday afternoon you couldn't drink beer on Saturday night. You also learnt that if you spent big on Friday night then you would not be drinking beer on Saturday night.
Such were the realities in a much simpler world.
The concept and impact of budgeting was a lot easier to understand when you just had to check how much cash was in your wallet to know how your budget was tracking.
Which is where the power of the old-fashioned paper bank statement can be put to good use - if you can get the teenager to open something as old-school as a letter.
But a new bank account - with new debit/credit card - plus motivation for a savings strategy did prompt the unsealing of a bank envelope in the Bowerman household recently.
Full credit to the bank involved because the statement layout showed in big letters not just the closing balance but also the amount of money that had gone into the account and the amount that had gone out.
The total amount that had gone out hit home and sparked a robust dinner table discussion.
Suddenly lunches with friends, coffees after school and so on were seen in a much more meaningful fiscal light.
Habits - allegedly - are about to change.
But the online world where teenagers are the first true native inhabitants can also be part of the solution as well as fuelling the problem.
Certainly you can get statements via email, online alerts about credit card payments can be sent, balances can be checked on the run as easily as a paywave.
But there are also an array of phone apps that help track expenditure and more importantly perhaps prompt good savings habits.
Most of these are commercial in one form or other but a recent visit to the ASIC MoneySmart website prompted the download of their recent Track My Spend app. While it may not win awards in the uber cool app design world, it gets plaudits for its functionality and is a simple, easy to use tool that lets teenagers and those a little further advanced in years to track spending over short periods like a week or further out on a fortnightly, monthly, annual or custom date range.
Best of all it is using the teenager tool of choice - the smartphone.
The corporate regulator's MoneySmart website is a resource that has been built up over many years and it comes with the credibility of being delivered out of the offices of the nation's corporate regulator as part of its effort to boost financial literacy.
There is a companion Track my Goals app to go along with the spend tracking tool that is also available free to download.
The MoneySmart site is a great resource not just for the apps mentioned but also for more detailed educational material and also investor alerts and warnings. All of which can help set up young investors - or those just young at heart - for investing success over the longer term.
Reinforcing benefits of total-return investing
May 12, 2015 | Robin Bowerman, Vanguard Investments Australia
The Reserve Bank's cutting of official interest rates to a record low of 2 per cent should reinforce to income-focused investors why the concept of total-return investing makes sense.
In short, total-return investing involves investing for both cash flow and capital appreciation.
And under a total-return approach, investors needing more income to finance their lifestyles than generated by their portfolios draw down against their portfolio's capital appreciation.
By taking a total-return approach, investors should be less tempted to chase yields by reducing exposure to high-quality fixed income and broad share portfolios to increase their allocation to higher-risk bonds and more concentrated high-yield share portfolios.
Unfortunately, not all investors would recognise the higher risks involved when moving away from carefully-constructed and diversified portfolios with asset allocations that reflect their personal tolerance to risk and their long-term goals.
Following the Reserve Bank's latest rate cut, it is worth revisiting a Vanguard research paper, Total return investing: An enduring solution for low yields, published in late 2012.
The paper points out that income-orientated investors have three fundamental choices when yields are historically low: spend less, reallocate their portfolio to higher-yielding investments or spend from total returns instead of income alone.
As the authors - Vanguard analysts Colleen Jaconetti, Francis Kinniry and Christopher Philips - say, "spending less is generally not a desirable option for most investors".
Regarding any temptation to reallocate a portfolio to higher-yielding investments, Jaconetti, Kinniry and Philips write:
- Investors who shift some of their fixed-income portfolio into higher- dividend shares carry the risks of high volatility and potential for significant capital loss. "Clearly, for an investor who views fixed-income as not just providing yield but also diversification, dividend-paying stocks fall well short".
- High-yield bonds are both more highly correlated with the equity markets and more volatile than investment-grade bonds.
A critical role of quality bonds is to act as portfolio diversifier or ballast for a portfolio - not solely to produce income. This should not be overlooked in a very low interest environment.
Asset allocation through the ages
April 16, 2015 | Robin Bowerman, Vanguard Investments Australia
The majority of members of super funds have their retirement savings in the default or MySuper options. This is both a strength and weakness of the Australian superannuation system.
The weakness manifests itself because with mandatory contributions and default options there are low levels of member engagement with their retirement savings.
That is not to say that everyone in the default options is disengaged - a number certainly will have decided that the default option's asset allocation suits them just fine.
The interesting question is whether the asset allocation of a typical default fund suits members at any age.
Age is clearly a powerful filter for investment decision-making. Financial advisers are prone to say that if they had to build a financial plan based only on one piece of information that your age would be that critical data point.
So consider two super fund members. One is 25 years old and has started their first full-time job, the other has just celebrated their 64th birthday and is planning their life after full-time work about a year from now.
Both are invested in the same fund's default balanced option and therefore have exactly the same asset allocation for their super savings.
Yet our 25-year-old has an investment horizon that could feasibly stretch over 70 years. Our near retiree realistically has a time horizon in the 20-30 year range.
And along with their age difference is their ability to recover from severe market shocks like a global financial crisis. For the 25-year-old a GFC like event would barely show up as a blip on their fund's performance chart as they approach retirement in 50 years time. For the 64-year-old the consequences and impact of a GFC event on their retirement lifestyle could be much more immediate and dramatic as they enter the drawdown years.
Now each person can choose to move away from the default by opting for one of the other risk-based portfolios – typically ranging from conservative or stable to high growth – and align their asset allocation more closely with age and therefore risk profile.
But human nature being what it is most people do not do that.
A new generation of default options are emerging in the Australian market where the asset allocation is driven by the age of the member rather than targeting a certain level of risk for the portfolio investment mix.
So-called target-date or lifecycle funds are increasingly becoming the dominant choice for default portfolios in markets like the US 401(k) system which is comparable to our own defined contribution superannuation system.
Vanguard in the US is a major provider of 401(k) record-keeping and investment services and has seen the use of target-date funds rise from about 2% back in 2005 to about 40% in 2014 and forecasts that 63% of members in the 401(k) plans will be invested in them by 2019.
It must be said that the Australian system's starting point of investing in default funds taking a balanced portfolio approach was much better than the US system where a money market or cash fund was a common default.
A number of different methodologies have been developed for the target-date approach. Vanguard's approach is to segment investors into four distinct phases.
Phase 1 includes younger investors (under 40) where a higher allocation to equities – around 90 per cent - is used. Phase 2 sees the asset allocation move to a 50/50 split between growth and income investments for people aged 41-65 which is much more akin to current balanced defaults.
Phase 3 is when investors are in the early years of retirement and again the asset allocation to riskier assets is reduced, while phase 4 is when members are in the later stages of retirement although there remains a modest exposure to equities within the portfolio.
The target-date approach is simply providing an automatic approach to dialing down market risk as the member ages and recognising that capital preservation increases in importance as we get older and particularly after we have stopped full-time work.
Self-managed super fund trustees may question how relevant these types of default options are to them but the same challenges apply. The aim is avoid extreme asset allocation decisions – either too aggressive or overly conservative – and the impact of poor portfolio construction because of inadequate diversification.
Greying, working and contributing
April 16, 2015 | Robin Bowerman, Vanguard Investments Australia
The ageing of the population - as outlined in the latest intergenerational report - together with a growing trend to work past traditional retirement ages inevitably means more of us will want to contribute to super for longer.
Perhaps you are among the many choosing to extend their working lives into older ages by winding-down their working hours as employees or becoming owner/operators of small businesses.
Certainly, numerous people decide to keep working into their sixties and beyond for the satisfaction that work may give them. Then, of course, there are the financial benefits.
More years in the workforce provides an opportunity to save more for what will be a shorter and therefore less costly retirement. And obviously, there will be more money to meet day-to-day living expenses.
Australia's changing demographics means more people will need to understand the rules about contributing to super beyond 65 and about whether their personal super contributions are deductible.
As simply explained in the Australian Superannuation Handbook, published by Thomson Reuters, a super fund can accept:
Compulsory contributions from an employer regardless of an employee's age.
- Personal and salary-sacrificed contributions from members up to 74 years of age. (Beyond 65 years, members must have paid work for at least 40 hours over 30 consecutive days during a financial year. This is known as the "work test".)
- A key question for someone who is winding-down their working life by operating a small business in their own name is whether their personal contributions are deductible.
Superannuation commentator Trish Power has written a valuable article - Who can make tax-deductible contributions? - in the latest issue of online investment newsletter Cuffelinks. (Power publishes the SuperGuide online newsletter.)
As Power explains, a person can usually claim a deduction for personal contributions up to the concessional contributions cap if they are self-employed or an employee who earns less than 10 per cent of their assessable income (salary-sacrificed super and reportable fringe benefits) as an employee.
A plan to extend your working life can be made more attractive if your super contributions are deductible.
An investor's personal trainer
March 12, 2015 | Robin Bowerman, Vanguard Investments Australia
What value do you expect a financial adviser to add to your investment success? If you expect an adviser to create an investment portfolio that will consistently outperform the markets, you are likely to face disappointment.
It is a reality that an adviser will almost inevitably struggle to add value for a client through market-timing and selection of securities - particularly after costs and taxes are taken into account. This mirrors the difficulty faced by the majority of actively-managed funds despite their experience and resources.
Fortunately, skilled financial advisers can potentially contribute significantly to their clients' investment long-term success in ways that have nothing to do with market-beating performance.
For the past 14 years, Vanguard's Investment Strategy Group in the US has studied what it terms "Adviser's Alpha". This is defined as the value that advisers can add through their wealth management and financial planning skills - guiding their clients in such areas as asset allocation, cost and tax efficiency, and portfolio rebalancing - and as behavioural coaches.
In other words, skilful advisers can add considerable value by using the best wealth-management practices together with personally encouraging their clients to adopt disciplined, long-term approaches to investing.
Vanguard just has released a new Australian edition of this classic investment research, using local data in an endeavour to quantify the direct value or "alpha" an adviser may add through such services.
The authors of the Australian report - including Francis Kinniry, a principal of Vanguard's Investment Strategy Group, conservatively estimate that "Adviser's Alpha" may add about three per cent, at least, to a client's net returns. Much, of course, will depend on an investor's circumstances.
For many investors, the best investment and wealth management strategies described in the report are likely to provide an annual benefit - such as from reducing investment costs and taxes. Nevertheless, the most significant value-adding opportunities would tend to occur intermittently and often during times of market duress or euphoria, according to the report.
During market duress or euphoria, advisers can act to urge their clients not to abandon carefully-prepared and appropriate long-term strategies in response to widespread market fear or greed.
Vanguard's report outlines six ways that adviser's can potentially add value that have no relationship to attempts to outperform any benchmarks:
- Asset allocation. As Smart Investing has discussed many times, research has long shown that asset allocation is the primary determinant of a portfolio's return viability and long-term performance. Advisers can guide clients on the creation of portfolios designed to maximise their potential returns within their personal tolerance to risk.
- Behavioural coaching. With a strong personal relationship with a client, an adviser is in an excellent position to encourage a disciplined, long-term approach to investing as opposed to getting caught up with the prevailing emotions and "noise" of the markets.
- Cost-effective investing. By encouraging clients to invest in low-cost managed funds such as traditional index funds and Exchange Traded Funds (ETFS), advisers can add considerable value. The report uses Australian data to support this point.
- Rebalancing. Through periodic rebalancing of a portfolio, an adviser can ensure that a client's asset allocation remains consistent with the risk/return characteristics of their target or long-term portfolio.
- Tax efficiency. Advisers can create strategies to ensure that their clients make the most of tax-advantaged savings opportunities over the long term from acquisition to disposal.
- Total-return versus income investing. Particularly at a time of historically low yields from balanced and fixed-income portfolios, advisers can explain to clients the benefits of focusing on their total returns from a diversified portfolio - that is income plus capital appreciation.
Advisers can alert clients to the added risks of moving away from well-thought-out investment plan in an effort to maintain their yields.
Significantly, this Adviser's Alpha research should reinforce the qualities that investors should look for when choosing a financial adviser as well as reinforcing the fundamentals of sound investment practice.
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