CPD: Resolutions for a new year

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How do you encourage clients to build their investments in the year ahead?

As the end of the year rapidly approaches, clients will be planning for 2018. In this article, Centuria looks at ways to encourage clients to build their investments in the year ahead, whatever their longer-term goal.

Year end is a time for people to take stock and plan for the year ahead. This often involves a few resolutions for the coming year – researcher Neilson has found common new year resolutions to involve health, fitness and ‘spend less, save more’. Unfortunately, statistics – and lapsed gym memberships – suggest that many new year resolutions don’t last long into the new year. How can you help clients develop a regular investing focus in 2018?

Track the spend

Until they track their spend, many people don’t realise how much money is frittered away on discretionary items. Australians love their coffee and according to ASIC’s MoneySmart[1], spent $1.1 billion on coffee in 2012, a figure that has undoubtedly grown since then. On an individual basis, those who order a medium takeaway coffee each day spend approximately $1,642 a year on their habit…add a muffin or breakfast sandwich, and suddenly the annual spend exceeds $3,000.

The first step to regular investing is being able to identify spending that can be reduced or eliminated. Encourage clients to track spending for at least six months, whether using a notebook and pen, or an app such as ASIC’s TrackMySpend (available for Apple and Android, and free). This should enable them to identify essential and non-essential spending, and make decisions about where they can cut spending and free up money to save.

Manage a budget

A surprising number of people don’t have, or don’t stick to, a budget. A budget is a blueprint for your clients’ financial success, and will help them determine the appropriate balance between spending and investing. There are many programs and apps available for budgeting, or you may have a preferred format for clients to follow. There are five steps to a successful budgeting process:

  • Income from all sources – include wages, dividends, interest or rental income
  • Necessities – mortgage or rent payments, credit or loan repayments, utilities, car and transport expenses, insurances, education, food and clothing
  • Non-essential or ‘wanted’ items – buying coffee and lunch each day, eating out, entertainment, travel, luxury items, gym membership
  • A regular comparison between the spending tracker and the budget
  • Evaluation – strategies to increase and invest savings

Some budgeting apps recommend a system, such as ‘50/30/20’, which splits income across three major categories: 50% to necessities, 30% to non-essentials and 20% to savings and/or debt repayment.

Regular investing plans

A regular investing plan is an excellent way to build up a significant investment. Encouraging clients to commit to investing a specific amount each month not only encourages an investing mindset, but creates a nest egg outside of superannuation to meet medium to long-term financial goals.

While some people are very disciplined, for many, investing doesn’t come naturally…for every dollar in the bank, there are many ways to spend it! A regular investing plan, through which a regular sum is automatically deposited into a designated investing vehicle provides a range of benefits to your clients:

  • Quick and easy – most regular investing plans have direct debit system by which money is automatically transferred from a bank account to investment or savings account on a specific day each month.
  • Enforced investing – it can be tempting to skip a month in favour of a new pair of shoes, a mini-break or dinner at Heston’s latest restaurant, items not provided for in the budget. By automating investing, your client does not have to rely on their financial discipline to keep growing that nest egg.
  • Self first – it’s natural to pay creditors first; loan repayments, gas and electricity, credit card bills. A regular investing plan provides your clients with permission to pay themselves first and prioritise their financial future.
  • Growth – each month, there are two key advantages of a regular investing plan – while neither concept is new to advisers, it is worth reinforcing the benefits of compound interest and dollar cost averaging to clients.

Compound interest

Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t, pays it.’ Albert Einstein

Also described by Einstein as the ‘most powerful force in the universe’, compound interest is a concept that every investor needs to understand. The earlier they understand and harness its power, the better off they will be in the long term.

Compound interest means that that an investor receives interest not only on the initial investment, but also on the interest earned on the investment. The concept applies to any form of investment return. As Einstein claimed, it is a powerful force; when applied to an investment, the total return can grow exponentially over the longer term.

Example: $10,000 invested at an annual interest rate of 10%. Table one shows the impact of having the income paid out each year versus reinvesting the income and allowing the interest to compound. Note: as a simple example, this does not take into account any variance in the value of the underlying investment.

 

 

The beauty of compound interest is that it allows investors to earn interest on interest – or investment returns on investment returns. This is what working capital really means!

There are three rules to get the most out of compound interest:

  • Reinvest any income from dividends, distributions or interest payments
  • Regularly add money to the investment – a savings plan is ideal
  • Invest over the long term.

Dollar cost averaging

While Albert Einstein did not have an opinion on dollar cost averaging, it still paints a compelling picture for regular savings.

Dollar cost averaging involves investing a regular sum of money into an investment – be it shares, an ETF, a managed fund, or an investment bond – whether prices are up or down.

Because of dollar cost averaging, investors using a regular savings plan automatically buy more units of the investment when prices are lower, and fewer when prices are higher, potentially achieving a lower average cost base. This means a greater number of units than if the total investment was made in a single transaction at an expensive entry point of the market.

Regular savings, and dollar cost averaging, can help investors to focus on long term savings goals and avoid them trying to time the market and make emotionally-driven decisions, something that often ends badly for investors.

Table two provides a simple dollar cost averaging example. If the $6,000 used in the example had been invested as a lump sum in January at a price of $1.05, the investor would have received a total of 5,714.28 units – through regular savings of $500 per month, the investor has nearly 200 more units purchased at an average price of $1.02.

 

 

Choosing a regular investing plan

Once your client has committed to regular investing, it’s time to determine the most appropriate investment strategy. Low interest rates, barely covering tax and inflation, make bank accounts attractive. Many managed investments have regular investing plans available, as do investment bonds…and the latter has five features that make them especially attractive to regular investors.

#1 An investing discipline

An investment bond can be used to develop an investing discipline. With an initial investment as low as $500, regular investments of up to a total of 125% of the initial investment, per year, can be made. It couldn’t be easier for your clients to start saving in 2018.

#2 A tax effective investment

An investment bond is a tax effective structure; tax is paid within the investment bond rather than personally by the investor. The maximum tax paid on the earnings and capital gains within an investment bond is 30%, although franking credits and tax deductions can reduce this effective tax rate.

There is no tax liability on maturation after 10 years, and no capital gains tax liability when switching between investment options. That’s an incentive for long term investing!

However, if necessary, the investment is accessible earlier; if redeemed within the first 10 years, the investor will pay tax on the assessable portion of growth as shown in table three.

 

 

#3 A long term view – and the power of compounding

Behavioural finance studies have shown that a tendency to make short term decisions on investments that have a longer-term time horizon often end badly for the investor. The power of compounding is best illustrated over the longer term. Figure one illustrates the power of compounding using an investment bond regular investment plan. Starting with an initial investment of $25,000 into the growth option of an investment bond, and making annual contributions of $5,000 or $10,000, results in a sizable investment pool at the end of the 10-year period.

 

 

This illustrative example does not purport to represent the actual return possible in any of Centuria Investment Bonds. An investment is subject to risk, the degree of which depends on the assets in which the bond invests. Assumptions: total returns of 7.5%, comprised of 4.0% income, 3.5% capital growth per annum, and a 21% tax rate in the bond.

#4 No annual tax reporting

No one likes paperwork and while the client’s money remains invested, the manager of the investment bond will pay tax on investment earnings; there is no requirement for your client to declare those earnings in their annual tax reporting.

#5 Investment choice

Centuria’s investment bonds offer a choice of investment options:

  • Australian shares
  • Balanced
  • Cash
  • Growth
  • Imputation
  • Property

Earnings are automatically reinvested in the bond and because investors have no capital gains tax liability, reinvestment dates do not need to be tracked for capital gains tax purposes. Investors can also switch between investment options without triggering personal capital gains tax.

When your clients tell you that investing is on the 2018 to do list, consider the advantages of investment bonds. For those clients who like to see modelling, Centuria has an Investment Returns Calculator that enables you to model a range of investment parameters across different bond portfolios. This provides a tangible incentive for clients to find that discretionary income and redeploy it from coffee and cocktails to a strategy that will meet their long-term investment objectives.

 

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[1] https://www.moneysmart.gov.au/managing-your-money/budgeting/spending/australian-spending-habits

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