Why gambling is better than trying to pick stocks

It is often thought that gambling is a bad financially but a good financial/investment plan is to buy certain stocks that have good prospects.

Before I get in any further, I just want to point out that I don't think gambling is a good investment strategy and should only ever be done with surplus money, money that can be lost.

So why could gambling be better than picking stocks?

Well, the concept between the 2 of them is the same. Identifying mispriced bets or stocks that provide good value for the risk they represent, and betting/buying that stock for gain.

However, the stock market, particularly in developed markets are very highly efficient. It is a completely free market mechanism where prices move with every trade and there is millions of market participants that are using all available information and buying and selling billions of dollars worth of stocks every day to determine fair price for that stock. Saying that you can pick stocks that have more upside potential than the market as a whole, with the same or lower risk is saying that you have more knowledge than all the participants combined.

With gambling on the other hand, the markets are more inefficient. The prices are set by the bookies and although do change, not every second of the day with every tiny bit of new information like how the stock market does. There is a much better chance of being able to identify inefficiencies within gambling markets.

That being said, bookmakers are very good and they consistently show very good abilities on setting prices.

So, should you gamble your way to retirement?

Absolutely not! 

No investment strategy should ever be based on trying to outsmart markets. It can't be done. There is no harm in having a flutter or trying to pick some stocks, but should always be done with surplus money and never the core of any wealth creation or investment strategy. The core investment strategy should be highly diversified to capture the return of each asset class and the makeup of the asset classes for your portfolio needs to right for your goals, objectives and risk tolerance.

Obviously this post is a bit tongue in cheek and even though picking individual stocks, albeit may under perform the market, will likely be a better strategy than gambling, however the point of the blog is to highlight that due to inefficiencies in gambling markets, it would be easier to find mispriced bets than it would be to successfully find inefficiencies in investment markets to be able to outperform the market.

What investment has the highest forecast returns for the next 10 years? You might be surprised.

Ok. Yea... I'll admit. That headline is a carrot to get readers in. But why can't I? Newspapers and Facebook posts use click bait all the time. And here you are reading, sucked in by some more click bait.

The first thing you need to do to have a successful investment experience over the next 10 years is to stop getting sucked in by the notion that someone out there can predict the future. I can tell you, if someone could, they aren't sitting on the computer writing blog posts, they'd be out on the beach somewhere, or on their yacht....sigh! But here we are, mere mortals unable to predict the future and needing to work.

Ok, so we aren't listening to predictions from people who don't know. What do we do then? Well, this is the tricky thing. Once someone isn't selling one particular product, they can't tell you want to do in a general sense, because everyone is different. Think of it like wanting to lose weight. Lite n' easy will tell you to buy lite n' easy. Terry Ferguson weight loss shakes will tell you to buy Terry Ferguson weight loss shakes, but a good nutritionist/dietitian will get to know you, your current body, health, goals etc etc and put together a diet plan which may involve a number of these products (but more likely just simple whole foods). The same is true in the finance world. If someone is saying 'this particular asset/investment product etc etc' is the best investment, then understand the motives behind it.

So, I will give you some insight on what I recommend to my clients. Firstly, I don't recommend direct residential real estate, even though it does seem to be a 'popular' investment choice. Why don't I? Well, for a number of reasons. A) it is extremely difficult to achieve diversification in property. Many people will end up with 1 or 2 properties which generally are of the same type/location etc. B) It is very difficult to slowly accumulate a position to property investment. C) You can't invest $20,000 increments. So it usually is 1 very large investment then maybe another one in a few years time. You take on a fair bit of market timing risk. D) They are often tedious and costly to hold: not only do you have rate's, insurance, water, agents fees but there is often repairs, maintenance etc. E) You can't exit your property position over a few financial years to minimise Capital Gains Tax.  Finally, I really do not believe they provide the long term returns many people expect they do. If they were such a good investment, would you expect Australia's most successful people to purchase suburbs and suburbs of residential real estate? They don't. They're busy getting rich in business.

So, what do I recommend. Quite simply, I recommend a highly diversified, low cost portfolio of passive managed funds. They can be Australian and International Shares, bonds, cash  etc and can be a mix of all these things. This gives my clients low cost portfolios that are simple and easy to administer and achieves them good long term after tax and fees returns.

Is it boring? Yea. I guess you could say that. There is no sexy sales talk of seeking high forecast return stocks with a bottom up quantitative analysis approach with a sector forecast overlay.

Why do I recommend what I do? Because it is quite simply the best thing for my clients and I don't care that it doesn't come with some slick sales pitch that no one really understands. It's boring, it's simple and it's the best thing you can do.

By investing like this are you going to get Gina Reinhardt, Frank Lowy, James Packer rich? Absolutely not. To get this sort of wealth, you need to start your own small business, grow it into a medium business then into a large business. This is not what I do. I help average people achieve better than average outcomes and have successful financial outcomes.

What are the tax benefits of insurance bonds? Really, what are they?

(This article was written a year or 2 ago and I've just recently updated it)

What's so good about insurance bonds?

I mean really? What is so good about them? Can someone please help me?

They often get wheeled out for high income earners that are too far away from preservation age to invest in superannuation or a good child savings tool because the income doesn't get added onto anyone's marginal tax rate. Noel Whittaker seems to love them and gives them a shout out regularly in his 'ask noel' column in the Brisbane Times. Here is the latest one (update: this article is quite old now and he's probably mentioned them since)

Anyway, what is it? An insurance bond is an investment product, like a normal managed fund but is taxed internally at the company tax rate - 30% instead of your marginal tax rate. This is good right? So many of us are on a tax rate higher than 30% - for example the 34.5% tax rate starts at an annual income of $37,000 - and most working people earn above that.

Well, they're not as good as they might appear on face value. First of all, you need to be invested for 10 years otherwise when you redeem, the profits are added back to your personal income (with a tax offset for the tax already paid inside the bond), so to get the benefits, you need to invest for a minimum of 10 years and on top of that, you can only invest up to 125% of the amount you contributed the year before. If you exceed that, the 10 years restarts.

So, if that is all ok, what's the problem then? Lower tax right? Yes. So if you are looking at an investment that is purely income (no capital growth) such as a cash investment or a fixed interest investment, then the income each year is going to taxed at a lower rate than what you would pay if invested in your name. But, if you take into account the additional administration fee of an insurance bond over the same investment in a normal managed fund, then for someone on the 34.5% marginal tax rate, then you're better off just with the additional tax of investing in your own name, someone on the 39% tax rate, it's line ball and on the 47% tax rate you are better off with the insurance bond (this varies a little bit depending on the actual income), but keep in mind that's for an income only investment in an insurance bond for 10 years. Is that what people on a marginal tax rate of 39%+ are doing? Investing in cash or fixed interest for 10+ years? I don't think so.

On to the growth - this is where it gets messy. I'd guess that a growth based investment is where a lot of the attraction of insurance bonds lie - after all, as I've mentioned, it's a 10 year play so people are probably going to take some investment risk.

When you own an investment such as property or shares, we know that you don't pay capital gains tax unless it is sold (or some other CGT event). The same is the case for assets held within an insurance bond - but that doesn't mean that if you hold an insurance bond for 10 years, that you can redeem and get away without there being any capital gains tax inside the bond. The insurance bond always keeps a provision for unrealised CGT when providing crediting rates to investors because they can't have people leaving a bond with an unrealised CGT liability inside the bond for the next guy to pick up. So, even though money might remain invested, the return you get is essentially after 30% capital gains tax on any growth.  This point is really important as I think this is where a lot of the misconception lies. You don't invest in an insurance bond, have the underlying assets rise in value over 10 years, then you get out without paying CGT. If the underlying assets have risen in value, but a CGT event hasn't occurred, the return you get is after a provision is made for paying the 30% tax on growth.

When you have an investment in your name, you pay capital gains tax at your marginal tax rate but providing it's been held for more than 12 months, you get a 50% CGT discount, so only half of the gain, so if you are on the top marginal tax rate - that's essentially a tax rate of 23.5% - better than an insurance bond.

So if  (for someone on the top marginal tax rate) capital gains are better in your own name, and income is better in a bond (marginally after taking into account the additional administration fee), is there really a benefit to holding an insurance bond for tax purposes?

Let's have a look at some performance figures - I've taken screen shots as websites update and I want there to be a comparison as at the same point in time (30 June 2018).

These performance figures show the after tax return for someone on the top marginal tax rate after taking into account capital gains tax if the investment is sold (top highlighted boxes) versus the return for the same investment in an insurance bond (bottom highlighted boxes).

Australia Shares Index 

International Shares Index (Hedged)

So, as you can see from the screenshots above is that someone on the top marginal tax rate would be marginally worse (0.07%) off after 10 years in the Australian shares index fund rather than in the insurance bond, and a bit better off (0.53%) in the international index fund (hedged) than in the insurance bond. Lets compromise and say a diversified fund (a mix of both) results in the insurance bond being no better or worse than someone who is on the top marginal tax rate throughout the entire time of owning the direct fund, and selling whilst also on the top marginal tax rate.

Lets hear some of the arguments for insurance bonds and my opinion on them.

• They're tax effective for high income earners - See above. Line ball at best for someone on the top marginal tax rate throughout ownership and selling the investment (even someone earning a high income and being in the top marginal tax rate could plan their exit from their investments after retiring and on a lower tax rate)
• You can switch which investment bond midway through without any taxation penalty - Yep - see above again - if the after tax return (after incurring CGT) is just as good for an normal investment as an insurance bond, you could also sell and buy a different investment if you owned it directly. You could also use the money for any other purpose too with the same net return as the equivalent insurance bond.
• If someone has a lower income year during the 10 year period, you can sell, pay tax on the earnings but get an 30% offset so you can get out during the 10 year period in that case with little or no additional tax. Yep - and if they owned the investment directly, they could sell in that same lower income year and their CGT on the investment would be much lower meaning their net return would actually be higher than the bond returns.
• The returns provided by bond provider are net of fees and they have a reduce admin fee for amounts invested above $500,000 (note: currently there is an offer for a discount for amounts above $50,000 for something like the next 3 years). So for a big investment, the bond's net returns would actually be a bit higher. I would argue that if someone is investing over $500,000 and is on the top marginal tax rate now and for the next 10 years, they're probably better off with their own investment entities - ie. within a family trust with a company as a beneficiary.
• They're great for estate planning as they can pass to the beneficiary without tax. So can any other investment (other than superannuation). You can't confuse superannuation death benefit taxes and a bond being tax free to beneficiaries as bonds are not part of your superannuation anyway.
• You can nominate a beneficiary and the money can stay out of an estate so someone can't make a claim on your estate - Yep. Good strategy. Uncommon, but worthwhile in these small cases. This is not a tax planning strategy though.
• By having the money invested in a bond, there is no earnings applied to anyone's income so won't affect any benefit (family tax benefit, super concessions etc) that is based on taxable income - This is also one of the few benefits (I actually don't hear this one but is one of the few actual good benefits). However, practically, unlikely to ever come into play. As we've said above - the returns are line ball for someone on the top marginal tax rate - and someone on top marginal tax rate isn't getting FTB or other government benefits. Someone on lower tax rates would get a higher net return if they invested directly, so the benefit of the increased centrelink/government benefit needs to overcome the lower net return in the bond. Realistically, there is unlikely to be instances where this happens. I can't see someone with say $100k investment, getting FTB, and investing in the bond will improve the FTB enough to justify the lower returns. But, it could happen, it would be rare though.
• They are good for investing for children because of the high tax rates for minors for unearned (investment) income - I haven't met many minors who have accumulated sufficient funds on their own for this to be an issue. This is about parents/grandparents giving them money. So, as I've said above, if there is better taxation outcomes by investing in their own name, at their marginal tax rate, then they can do this and just sell later and give the child, grandchild the money at that time. Alternatively, you can just invest in the childs name (yes they'll pay top marginal tax rate on the income) then if they sell after they reach 18, then they'll have adult tax rates on the CGT and more than likely pay very little CGT if they sell while still a student or are on a low marginal tax rate and wind up in a better position than if they achieved the poor after tax returns of the insurance bond. Just don't buy an actively managed fund that will keep turning over the portfolio and generating realised capital gains throughout the period of ownership.

So, to sum up insurance bonds a bit:

1. They are more expensive for the exact same funds, so straight off the bat you are actually going to get worse gross returns before you even factor in tax.
2. As a bond pays CGT at 30% with no discount, the investment needs to pay a fairly reasonable amount of income (relative to growth) for it to even be close. 
3. You have to keep them for 10 years before you can redeem them and enjoy those 'supposed' tax benefits.
4. You can only invest 125% of the value of investments you made the previous year, so if you invested $10,000 last year, you can only invest $12,500 this year. If you only end up doing $5,000 this year, then you can only do $6,250 next year. So you can't be flexible with your investing. If you miss a year - that's it. No more unless you will restart your 10 year.

So with these negatives and with the outcomes being, lets call it 'line ball' even when calculating on the top marginal tax rate, why do it? In reality, it is very uncommon for both members of a couple to be on the top marginal tax rate throughout the whole time and then sell prior to retirement (granted, not everyone is in a long term relationship).

There would be some very obscure circumstances where it may be warranted for a complex asset protection or estate planning scenario, but I honestly believe it is an oversold product to make people think they are getting some great fancy outcomes but in reality, it isn't.

NOTE ON RETURNS: Vanguard providing after tax returns is based on complicated calculations and assumptions and actual net returns may vary very slightly. Also, the comparison with the Genlife insurance bond returns is using their index portfolios which is now managed by Blackrock, not by Vanguard, however they were previously managed by Vanguard (so part of those longer term returns are from when Vanguard were managing it) and they're both index funds, so they both track the index almost identically.

Tax inside superannuation! Can you minimise it and can it make a big difference

Superannuation funds pay 15% tax on earnings and similar to how individuals receive a 50% discount on capital gains, superannuation funds receive a 33% discount on capital gains, so they effectively pay 10% capital gains tax. It is important to also understand that once you start a pension with your superannuation, no tax is payable at all on any earnings.

We know that as individuals, it is best not to keep incurring capital gains tax buy continuously selling and buying assets as handing over big cheques to the ATO isn't great for your wealth. But what is happening inside your superannuation fund? Most people would be completely unaware of the ongoing realisation of capital gains tax inside pooled superannuation funds, which are typically how industry funds work. There is investment trading going on, other people rolling money in and out of the fund etc which is hindrance on returns.

Let take a look at Sunsuper, one of Queenslands largest superannuation funds. Their 5 year return on their balanced fund returned 9.0%* and the same balanced fund inside pension (i.e so it paid no tax) was 10.0%. So effectively the tax that is being paid within the fund on the income and all the capital gains being realised cost investors 1.0% per annum. If you think that doesn't seem like much, let me just demonstrate the power of compounding interest and the fact that superannuation is a long term investment. Lets say a 30 year old has $100,000 in superannuation and their net contributions each year is $10,000 (so effectively someone earning about $120,000) and that increases each year by 3% and we compare the difference between getting an 8% per annum return and 1.0% less (ie 7%).
The difference is over $375,000!

But, there is tax on superannuation earnings and it isn't completely avoidable, but it is possible to minimise this to maximise your net returns?

Vanguard is a major index fund manager both globally and in Australia and they release after tax returns. An index fund manager just buys the index so they aren't trying to continually buy and sell to outperform which results in a much more efficient portfolio. They publish both the after tax returns on distributions only (i.e the after tax returns after you pay tax on the income only) and after tax returns if you fully redeem (i.e the after tax returns if you sell the investment and incur the capital gains tax). Their 7 year gross of tax return (i.e the equivalent of the sunsuper pension returns) on the Vanguard High Growth Fund# was 11.43%, however the after tax return on the distributions is 11.48%.

What? Is that a typo? How did it go up? Well the cost of tax on the income is very small, then when you add in a refund of franking credits, the after tax return on distributions is actually higher than the published gross returns of the fund (as they don't include the franking credits in the gross return.

So, instead of losing 1.0% per annum return to tax like the Sunsuper returns, you gain 0.05% return by investing in a superannuation where you control the capital gains tax and not at the mercy of the transactions of thousands/millions of other members and also constant buying and selling trying to outperform.  Then you might say, but at some point you will have to pay the capital gains tax? Well, no. When you invest your superannuation in a wrap or investor directed superannuation fund, you are able to transfer the assets to pension without selling them, because it isn't selling the asset and isn't a change in beneficial ownership or trustee, so it isn't a capital gains tax event. Then once it is in pension, it is all tax free so you can sell down without any capital gains tax.

It is important to point out though that although the Vanguard fund is net of their fees, you will need to pay administration fees on a wrap, investor directed (or even SMSF) superannuation fund if you want to invest like this, however most of Precision Wealth Management clients pay very attractive administration fees as everything is rebated back to the client. Generally our clients pay about 0.20% - .0.05% administration fee (depending on the size of the account) so really, the net returns would have been about about 11.28% - 11.43% per annum, compared with Sunsuper's net returns of 9.0% on their superannuation. You saw the difference above of 1% per annum, I don't think I need to show you the difference 2%+ can make over the long term.

Industry funds don't like financial advisers and don't like it when they recommend people move their superannuation to another provider and they have put a lot of marketing into convincing you it is a bad move as financial advisers charge fees. But, perhaps, just perhaps, financial advisers fees actually add a lot of value to clients both with financial benefits and also peace of mind, and also perhaps, the industry fund product offerings aren't actually that great.

*All returns are 5 year returns to 31 August 2015.

#I am using the Vanguard High Growth fund as it has 90% growth assets and 10% defensive assets and the Sunsuper balanced fund has 81% growth assets and 19% defensive assets - if you call 'diversified strategies' defensive assets. I'm not sure. So even though the name suggests they aren't a similar fund in terms of allocation to growth and defensive assets, the asset allocation says they are.

Should under 40's salary sacrifice to superannuation?

It's a question that I'm often asked off the cuff by younger people, "Should I be contributing extra to superannuation?"

The question comes about because they want to set themselves up for retirement and they know starting early is the key to that. There is basically one major pro and one major con - the pro is tax savings and the con is that it is locked up for a long time. That con however could also be seen as a pro, as it can be a method of 'forced savings' similar to a mortgage.

There is never an answer that fits everyone, hence this being just general advice, but lets have a look at it to help you make the decision.

There is 2 types of contributions you can make:

Non concessional - a contribution to superannuation using after tax money. ie. money you have already paid income tax on and is in your bank account. A non concessional contribution incurs no contribution tax on entry to superannuation as you've already paid income tax on it.

Concessional - this refers to contributions your employer makes as well as salary sacrifice contributions or a contribution that a self employed person makes which they claim a tax deduction for. It is essentially contributions made using pre tax money. Money in which income tax hasn't been paid yet. Concessional contributions incur 15% tax on entry to superannuation.

For most people under 40, they probably shouldn't be making any non concessional contributions, unless they are a low income earner and can access the government co contribution. In which case, they should only be making up to $1,000. For details on the thresholds for this, you can visit the ATO Website here. For some lucky few who have managed to accumulate significant wealth prior to the age of 40, they may start looking to make some larger non concessional contributions but this would definitely be in very rare circumstances.

For someone making extra concessional contribution (above the employer contributions), such as requesting your employer to salary sacrifice contributions, the benefit may just be worthwhile. The tax savings on salary sacrificing to superannuation depends on your marginal tax rate. If you are on the top marginal tax rate (and earning less than $300,000), you will save 34% in tax after taking into account the 15% tax on superannuation. It essentially means that by giving up $1 of after tax income (money in the bank) you would have $1.67 in superannuation. 67% more money just by having it in superannuation and if you are on the top marginal tax rate, you probably have reasonable cash flow to afford to give up a few $.

As you earn less, the savings become less, and the less likely that you have surplus cash flow lying around but that definitely doesn't mean people on lower marginal tax rates shouldn't salary sacrifice.

Looking at the maths, however, doesn't really answer the questions - there is other factors at play. For anyone under the age of 40, their preservation age currently 60, and we'd probably be kidding ourselves if we didn't think it will be more like 65 by the time we get there. So, what do you do?

Well, as I said earlier, there is no right or wrong answer but what I will say is that I talk to people all the time about their finances, it's what I do, and I'm yet to meet a person that has said "I really regret putting away that extra money into superannuation" but I do meet people all the time who aren't adequately prepared financially for retirement and I also meet plenty of younger people (myself included) that spends money on things that they could probably do without.

For most people (earning between $37,000 and $80,000) they are on the 34.5% marginal tax rate. Why don't you think about requesting salary sacrificing say $50/week. It'll mean you'll have $32.75/week less in you bank account. Maybe increase it over time? Your future self will thank you for it.

Note: it is important to remain under your concessional contribution cap of $30,000 per annum for those under the age of 50. This includes what you employer contributes for you. This is general advice only and does not take into account your personal circumstances. We recommend you seek professional personal advice.

Author: Glenn Hilber is the Senior Financial Adviser for Precision Wealth Management. He can be contacted on 1300 200 012 or enquiries@precisionwm.com.au

The biggest investment crash ever

Every time the RBA cuts interest rates, the news will run a little segment on how this is great for borrowers and bad for retirees as their income on their cash investments has reduced.

The goal for a retiree would be to invest to ensure they have adequate income to live on for their entire retirement. If a retiree with $1,000,000 in the late 80's (they would have been considered a very wealthy retiree at that time) had invested in cash, they would have been enjoying income of about $140,000 per annum at the start of their retirement. By 2008 that would have been down to about $50,000 per annum and now they would be struggling to get $30,000 per annum. A fall of over 75% in income!!

Is that not the biggest crash ever? To have your income fall by 75% in a period where living expenses have more than doubled.

Not to mention, inflation has halved the real value of your capital over that time.

And cash is meant to be the safe investment, and shares are the risky investment, right?

If that retiree had invested their full retirement savings in the ASX 200 at the time and just left it there, living off the dividends each year, their retirement savings would be about $10M today and they would have income of about $500,000 per annum. HALF A MILLION $ PER ANNUM! As opposed to the guy who took the safe option now receiving $30,000.

Sure the first few years they would have received less income but I'm sure anyone looking at these numbers would choose less income for a few years.

Retirees really need to change their thinking when it comes to investing in retirement. They really need to invest less of their savings into the risky cash and allocate a large portion of their wealth to the safe shares.

QSuper have changed their default investments to the lifetime investments options. This now means anyone over 58 (who hasn't made an election) now has between 50 - 75% of their retirement savings in CASH!!! A 58 year old could have 40 years of investing ahead of them. The example above, back to the late 80's, is less than 30 years. I think you get my drift on what I think of this.

In other news, the government has already come out ahead of the budget to announce the Age Pension asset test will be tightening. I've been saying this for a long time. And expect to see the principle residence included in some way at some point in the future. What does this mean? Simply, if you want a comfortable retirement, you need to take control and plan to be completely self funded. The Age Pension will be only for those people on very limited income in retirement.

If you would like to discuss your retirement plans and investments with an independently owned and licensed, fee for service, financial planner, contact me on 1300 200 012 or www.precisionwm.com.au

Should we invest based on managed fund star ratings

There is a big industry out there to review all the managed funds available and give them star ratings to try help people choose the right fund that will 'do well' but the problem is, they really have no idea. They are like the fortune telling/horoscope industry, the only difference is there is billions of dollars at play and people base fairly large financial decisions on them.

The data shows that people follow the star ratings - just look at the following graph. It shows cumulative cash flows of 4 and 5 star funds are positive (meaning more people added money to these funds than withdrew month) and negative for 1, 2 and 3 star funds (meaning there is more withdrawals than additions to these funds).

Data provided by Morningstar and adapted by Vanguard

But, how do you the star ratings actually perform? Surely it must be a reasonably decent guide?

The following graph shows the performance (relative to their benchmark) of the different star rating funds for the 36 months following their star rating.

Data provided by Morningstar and adapted by Vanguard

The graph shows that after funds have been awarded their higher star ratings, which is generally based on past performance, they then demonstrate the most under performance. Quite a classic case of a statistical term - mean reversion.

I'll note at this point that on aggregate, all funds collectively under perform the index and that is a fact of life, the index has no costs in it but there will always be costs involved when investing. The collective under performance is usually around the 1% mark which is roughly the average cost of actively managed funds.

So what do we do? Go through and pick the lowest star rating funds? They should under perform the least?

No!

We simply ignore the star ratings and take a passive approach to investing. Don't try pick the top or bottom fund of the year before. Simply have low cost exposure to the asset classes that are appropriate for you. Don't take speculative risks and remain diversified. Over the long term, you will end up with a successful investing experience which results in greater lifestyle outcomes, as that is really what it is all about.

We all want greater lifestyle outcomes and that's what I'll award 5 stars to!