'Brexit': What's next for investors?
July 05, 2016 | Robin Bowerman, Vanguard Investments Australia
The votes have been cast and counted, and the people of the United Kingdom (UK) have chosen to exit the European Union (EU).
We expect this vote to have significant impact on the global economy, but it will take considerable time before the effects of 'Brexit' are fully felt in Australia. The most immediate ramification is likely to be political change in the UK, given the bitterness of the referendum campaigns. However, the referendum is not itself a binding decision but will need to be incorporated into an act of the British parliament. Under the terms of the Lisbon Treaty, the UK will then give formal notice to the EU, after which a two-year (extendible) negotiation will be held to decide on the actual terms and conditions of the exit.
Market volatility and investor uncertainty:
In the weeks leading up to the vote, speculation caused increased market volatility, especially for assets denominated in British pounds. Some studies suggested that Brexit could cause the pound to weaken further against the Australian dollar and other currencies, perhaps by up to 20%. (As at 22 June, the pound was trading at about A$1.96, down from A$2.20 last August, according to XE.com.) This might suggest that Australian investors should avoid allocating their assets to the UK. But of course, by now, some of this effect is already priced in by the markets.
We also need to bear in mind that Brexit will have global effects, so merely moving out of UK assets might not achieve the desired result. While the short-term impact of the vote is likely to disrupt the markets, it's less clear how significant this will be for a long-term Australian investor holding a well-diversified global portfolio.
The UK economy:
One important dimension of Brexit is how it will affect the UK economy and, by extension, the incomes of UK citizens. There's a range of estimates on how the UK economy will be affected; some are positive but the majority are negative.
Post-Brexit, the UK will lose its automatic right to the favourable trade terms that EU membership bestows. This might discourage inward flows of direct investment by overseas firms – for example, Australian companies wanting to establish a UK base to access the broader European market. There could also be a negative impact from restrictions on the number of EU citizens coming to work in Britain, something that has boosted the UK economy and tax revenues in recent years.
The argument that Brexit will increase British GDP assumes that trade with Australia and other non-EU countries could increase (even though such trading opportunities already exist under current regulations). The anti-EU camp also argued that removing excessive EU regulation could allow higher growth. But the UK is already one of the least regulated economies in the EU. What's more, many of the existing EU regulations that have applied to UK businesses were initiated or supported by the UK government. In some cases, the British government has introduced rules over and above those that apply elsewhere in the EU.
Finally, on immigration, it will still be possible for EU citizens to work in the UK post-Brexit, but the choice of who works in Britain will now likely be in the hands of the UK government. So this could be better (from the British perspective, at least) than unrestricted access to workers of all types.
Costs of doing business:
Brexit will probably mean higher costs for investors. The ability to 'passport' financial services has allowed Vanguard and other asset managers whose European operations are based in Britain to distribute funds into the EU cheaply and efficiently. In the absence of these passporting arrangements, asset managers might need to set up additional offices in continental Europe, and it's likely that the cost of doing this would be passed on to the end investor.
The alternative argument is that the cost of investing in the United Kingdom could fall due to a removal of regulatory costs imposed by the European Union. Overall, the net effect is still probably to increase costs, but this is another area where the impact is not clear-cut.
Taking all these factors together, the pros and cons of Brexit for Australian investors will be affected by a wide range of factors. As ever, the best approach is to be clear on your goals, to take a long-term view and ensure that your portfolio is well diversified.
Planning for political shocks
July 05, 2016 | Robin Bowerman, Vanguard Investments Australia
Political shocks by their nature provoke strong reactions from investment markets.
Uncertainty, courtesy of political or regulatory risk, feeds market volatility as investors - professional and individual - try to decode the meaning of the changing environment and how to value assets accordingly.
Because the outcome was unexpected the Brexit vote sent shockwaves through global markets with the ongoing political leadership instability in the UK providing daily - if not hourly - instalments to feed the global media interest.
A strong tone that has punctuated public commentary this year has been one of upheaval: voters are unhappy with the status quo - whether that's in the US, Britain or any number of developed nations.
As Vanguard's global chief economist Joe Davis said recently: "What we saw recently [in the UK] is just confirmation of some longer term trends, some of them economic in nature, which I think are leading to some change across the world in the political arena."
By comparison our own federal election process appears almost reassuringly normal - despite the closeness of the result bringing its own form of uncertainty.
Investors will have no shortage of geo-political issues to occupy their attention in the coming months, if not years.
When you look forward the US presidential campaign will provide stiff competition to Brexit developments for investor attention though the second half of the year.
And we should expect some bumps and surprises as the unparalleled process of the UK exiting the EU is negotiated.
Now that we have got over the initial shock factor of the Brexit vote three lessons for investors have stood out.
The first is the overriding value of having a written financial plan.
At times of market stress and/or crisis when the market drama and sense of urgency is clamouring for your attention and driving a strong sense of needing to do something….
Being able to pull out your personal financial plan, refer to the goals that have been captured in calmer times and check whether you are on track can be a powerful antidote to the sense of market turmoil.
The second is the need to be globally diversified. As Vanguard's chief economist in Europe, Peter Westaway, says investors who were overly concentrated on UK assets probably had the most regret in the immediate fallout from the vote.
"We also need to bear in mind that Brexit will have global effects, so merely moving out of UK assets might not achieve the desired result,"Westaway says. "While the short-term impact of the vote is likely to disrupt the markets, it's less clear how significant this will be for a long-term Australian investor holding a well-diversified global portfolio," Westaway says.
The third is the value of taking a long-term perspective. A week out from the vote and markets have settled somewhat but clearly the uncertainly level will be high potentially for several years so we should expect other bumps and setbacks to impact markets.
The good news is that since the result of the vote became public, investors largely seem to have stayed on course.
Trading volumes for Vanguard ETFs were significantly higher on Friday 24 June, the day the Brexit votes were counted and results filtered through to media, but the data showed more buying activity than selling. By Monday ETF trading volumes were back to within normal ranges.
And now, as our attention has turned back to political developments at home, it looks as though we will have possibly a week or two of uncertainty as we await a final result of the Federal election outcome.
The final outcome of the Federal election and what our new government might look like is clearly important but it is worth remembering that while political shocks can affect markets, they shouldn't drive your long-term investment plan.
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.
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