Latest AXA Guide to Investment Markets

About every six months AXA Australia publish an interpretation of what has been happening in the local markets and economy in the context of the global economy. Of the many commentaries published by Australian product providers the AXA guide is one I feel is most written in plain, accessible language.

The latest AXA Guide to Investment Markets, dated June 2011 is titled “Understanding the ups and downs”.

Among the topics covered in the latest guide are:

  • Global debt
  • Surging commodity prices
  • “Two-speed” economy in Australia
  • Australian dollar
There’s one guarantee in economic interpretations – and that is that all the economists will disagree. No-one has a working crystal ball.
So read the AXA guide (and all others) for your interest but with caution – it’s not fact nor gospel.

How to reduce your tax

A desire to reduce tax is one of the key drivers many people list when they initially contact me for financial advice. So today I will share with you my perspective on how you can save tax.

First a word of caution

Only tax accountants and tax lawyers are legally allowed to provide you with specific tax advice. This article is an introduction to some key concepts of reducing your tax from a big picture planning perspective. And of course at the fringes there are some special cases. Start by understanding the key concepts before delving into the fringes.

Speak to your tax accountant for personal tax advice. And if you don’t have one – maybe you should get one as part of your financial team.

Key ways to reduce tax

Four key ways to reduce your tax are:

  1. Spend money in the production of taxable income
  2. Spend money where the Government wants you to
  3. Give money away charitably
  4. Park your money in a lower tax entity (e.g. superannuation, company, trust, partner’s name)

Note that the first three ways listed above involve you giving away or losing money as a way to reduce your tax.

Key concept: you don’t get everything back

A common misconception is that a $1 tax deduction saves you $1 in tax. That is not correct.

You don’t get everything back.

For an individual tax payer you get back the equivalent of your marginal tax rate. The majority of Australians have a marginal tax rate of 30% (excluding levies). So they get back only 30% of what they spend on deductible items.

An example

You give away $10 to charity. At the end of the financial year you claim the donation as a deduction and the tax on your income is reduced by $3 (what you ‘get back’ when your marginal tax rate is 30%).

Your net cash flow has however reduced by $7. That’s $7 less you could repay off your mortgage, invest or spend.

Spending money in the production of taxable income

Spending money in the production of taxable income is probably the primary source of higher tax deductions and thereby a reduction in your tax payable.

Conceptually you can split it into deductions related to active (personal exertion) income and those related to passive (investment) income.

Save tax on active income

As you may already be aware you can claim some expenses relate to your job, including these common categories:

  • Self-funded work-related education
  • Uniforms
  • Some travel
  • Some car expenses (not a full deduction as it is subject to some fringe benefits tax)
  • Retirement savings (i.e. before-tax contributions to superannuation often through ‘salary sacrifice’)

The Australian Taxation Office (ATO) publishes guides for specific industries and occupations. Check them out to see if there is a guide relevant to you and consult with your tax accountant.

One easy deduction you may not be aware of is that of your income protection insurance premiums. Most insurance is not tax deductible but income protection is because if you later need to claim then the benefit will be taxed as if it was your employment income.

Save tax on passive investment income

In general if your investments earn income each year you can claim a tax deduction for expenses related to those investments, including for:

  • Interest paid on money borrowed to invest
  • Expenses related to maintaining the investment

In Australia you can also use investment related expenses to reduce your taxable income from your job.

That aspect gets many people salivating so much that they overlook key financial principles.

  • If through investing your investment income is higher than your investment expenses you will actually increase your taxable income and pay more tax.
  • When your investment income is less than your investment expenses your investment is losing money.
  • Your net investment loss may reduce your tax payable on your wages income but you don’t get all of the loss back (remember). So you still have an after-tax net income loss.
  • When you’re making a net income loss on your investment you need to make it up in additional capital gain so that overall you get an acceptable return on investment.

Save tax on investment gains

When you sell your investment you realise your capital gain. In Australia the capital gain is included in your taxable income for the year.

You can reduce the tax payable on your capital gain through:

  • Holding the investment for over 12 months so that only half of your gain is taxable
  • Deducting capital expenses such as transaction costs and stamp duty
  • Offset prior realised capital losses

Tax rebates and offsets

The Government really wants you to:

  • Keep working and earning money
  • Raise future tax payers (so they earn more tax)
  • Look after yourself in retirement (so they spend less tax)

So the Government gives you an incentive to do that by rebating some tax to you for ‘expenses’ related to their goals. Current examples include:

  • Child care rebate
  • Education tax refund
  • Spouse superannuation contribution tax offset

Along the way there are other rebates that come and go depending on what behaviour the Government wants to incentivise at the time.

The difference between deductions, rebates and offsets is the way the Government calculates what you ‘get back’.

The key is to stay aware of what is out there and then delve into the detail for those schemes that may apply to how you live your life. Your financial planner and tax accountant are a great help in keeping you aware.

Park your money in a lower tax entity

I believe tax management needs to be looked at broadly across the total tax you pay on all of your money.

In my opinion one of the best ways to reduce your overall tax payable is to reduce the tax rate that applies to the income you earn. Primarily you can achieve this by holding your money in different legal entities, since each class of legal entity can have a different tax rate. (Think of a legal entity as a big tank which can hold financial stuff.)

Examples of legal entities are:

  • You
  • Your partner
  • Superannuation trusts (commonly known as ‘super funds’)
  • Discretionary trusts
  • Companies (e.g. Pty Ltd and Ltd)

The tax rate for individuals such as you and your partner is based on a sliding scale related to your taxable income. The top marginal tax rate is 45% (excluding levies). As mentioned earlier the majority of Australians have a marginal tax rate of 30%.

Companies pay a top tax rate of 30%, whilst superannuation trusts pay a top tax rate of just 15%.

So the majority of Australians could reduce their total tax bill by investing through superannuation rather than in their own name. Your individual tax payable may not reduce but your total tax will reduce and therefore your net wealth will increase.

Another simple way to reduce tax is to hold your investments in the name of the partner with the lowest marginal tax rate. For example keep your cash savings in a bank account in their name. (Better still keep your cash savings in a mortgage offset account – but that is another article.)

High income earning Australians (those with a marginal tax rate above 30%) could reduce their tax by investing through entities such as companies and discretionary trusts. But the tax saved could be offset by the cost burden of establishing and maintain the entities. Plus there are other really important considerations, which you should first discuss with your advisers.

Putting it all together

As I said earlier I believe tax management needs to be looked at broadly across the total tax you pay on all of your money.

More importantly for most people tax reduction should not be your primary driver in selecting financial strategies. In my experience most people have much bigger financial fish to fry.

The ultimate purpose of managing your money is to ensure you have enough money for what you need when you need it.

Yes, reducing your overall tax will increase the money you have.

But there are some non-tax saving strategies, like repaying personal debt, that will increase your wealth and lifestyle faster, easier and more sustainably. Learn about those strategies too.

How much you should spend on your next house

The banks will tell you how much you can borrow. But how much should you really borrow? This article describes how to estimate the ideal maximum amount you should borrow and the true maximum affordable repayment. Follow this process so you can avoid over-extending yourself and find a harmony between lifestyle now and your future lifestyle.

These days I rarely read a non-fiction book cover-to-cover, instead I flick through to grab key ‘big ideas’ to evolve my thinking. In the past year one book I delightfully read in full was “Predictably Irrational” by behavioural economist Dan Ariely.

As I immersed myself in the insights there was one in particular, right at the very end that I read as a personal challenge. (page 285, 2009 revised edition, pbk)

Dan Ariely described how when he and his wife Sumi went to buy a house he asked some experts he knew “including a few finance professors from MIT and investment bankers” what seemed to him like a simple question.

It is a question you have probably considered too.

“How much should I spend on a house?”

Ariely describes how everyone told him the same thing – a way to calculate how much he could borrow based on his income and the interest rate. But that’s not the question he asked.

Ariely noted “when I tried to push for an answer, the experts told me that they had no way to help me figure out the ideal amount we should spend and borrow.”
(my emphasis)

Can you see why I read it as a challenge?

Well, I have the answer for you Mr Ariely (I hope one day I can call you Dan).

First, let me share Ariely’s behavioural conclusion from his experience:

“When we can’t figure out the right answer to the question facing us, we often figure out the answer to a slightly different question, and apply this answer to the original problem.”

Hopefully you can see the potential issues in that human decision making.

How much you should spend on your next house

The maximum price you should pay for your next house is the sum of:

  • Your saved deposit
  • Transaction costs
  • The maximum amount you should borrow

The maximum amount you should borrow is a function of:

  • the loan term
  • the average interest rate over the loan term
  • your maximum affordable regular repayment amount.

For definitions of the categories described in the formula below see my ‘Pay Yourself First (in practice)’ model I described in my recent article on better budgeting.

Maximum affordable loan repayment equals your net after-tax income, less allocations for:

  • Regular saving for your financial independence goal
  • Regular saving for pre-retirement essentials
  • Repayment commitments on other existing debts
  • Irregular expenses
  • Regular essential and comforts
  • Impulses and indulgences (presuming you’ll still want the occasional splurge)

Now you have estimated the ideal amount you should spend on repayments rather than some alternate rule-of-thumb like 30% of your income.

To estimate your maximum affordable loan amount you then plug that repayment amount into the free borrowing calculators provided by the lenders. Or you can do it yourself in a spread sheet using the present value (PV) function.

You can download an example calculation here.

Extra tips

By the way, don’t use what the lender says you can afford to repay each period. Their calculation ignores your need to save for eventual retirement and often assumes you can live a lifestyle equivalent to the Henderson Poverty Index (in Australia).

In completing the affordability calculation I recommend you:

  • Choose your loan term to match the amount of years until your financial independence goal. That way your debt will be repaid by ‘retirement’.
  • Add an extra 1% to the lender’s current interest rate to give you a buffer.

When you actually apply for the loan you can apply for the typical home loan term of 30 years and just plan to make extra repayments in line with your calculation. This technique also builds your buffer for if misfortune strikes.

In practice

Life is a balance between doing something that brings us immediate fulfilment and doing something else that is an investment in future fulfilment.

Exercise, healthy eating and study are often investments in future fulfilment.

If the type of home you really want to buy costs more than the above estimate you then need to make an informed trade off.

Are you willing to cut other elements of your current lifestyle? Or are you willing to cut your expectations of future lifestyle like holidays, car upgrades and retirement?

Please share your thoughts

What do you think of my recommended approach to this common dilemma? Please share your reflections in the comments below as I’d really like to know. (You can share under a pseudonym to protect your privacy.)

Job change checklist

Changing jobs is often an exciting time of life. It can also be a busy time. Following is a checklist of important items to promptly address to ensure you keep your financial well-being on track.

Changing jobs is often an exciting time of life. It can also be a busy time.

Following is a checklist of important items to promptly address to ensure you keep your financial well-being on track.

Cash Flow

  • If your pay date will change then consider resetting the automatic transfers that support your smart budgeting techniques
  • Revisit your budget to accommodate changes in remuneration. If you’re going to be paid more also see the wealth creation tips below.

Use free online calculators, like those from the ATO, to help you work out your new net (after-tax) pay.

Wealth Creation

All pay rises are terrific opportunities to accelerate your wealth creation. I suggest you put at least half of your pay rise towards a combination of the following:

  • Higher loan repayments.
  • Increased allocation to long term investment. For example you could boost your salary sacrifice to superannuation, which will soften the tax blow on your pay rise whilst making you wealthier.

Plan in advance and be ready to adjust your automatic transfers as soon as you start your new job.

Employer share plans

Do you have an employer share loan you need to repay upon leaving employment? If so, a common way to repay the loan is to sell some or all of the shares. If you don’t have a broker then read this article to discover how to sell shares without a broker.

Superannuation Fund

Don’t:

  • Blindly nominate your previous employer’s fund to receive contributions ‘just to keep things easy’. Your new employer may have a cracking deal on offer.
  • Blindly accept the default fund offered by your new employer. It may be a shocker compared to your old fund.
  • Blindly roll your old fund into your new employer’s fund. When you rollover you automatically lose your insurance cover. “So what?“, you ask. Well almost all Australians don’t have enough cover, so odds are you probably need to keep what you already have.

Do:

  • Promptly investigate what happens to your balance and linked insurance when you leave your employer. Do this before your last day in your old job.
    • Is the balance automatically rolled to a new ‘holding’ fund within a certain number of days?
    • Is some or all of the insurance automatically cancelled? If so, can you apply to have it continued? (If a continuation option is available you usually have around 30 or 45 days to apply.)
  • Complete a comparison of your new employer’s fund to your previous fund to ascertain which is better for you. I recommend you also consider some off-the-shelf funds in that comparison.

Employer Funded Insurance

One great thing about employer group insurance policies such as group salary continuance is that you probably didn’t need to disclose anything about your health to get it. So you can potentially be a basket case and still be covered.
The older you get the more likely that is.

Keeping that cover is therefore a golden opportunity.

Group insurance policies often have continuation options that allow you to retain cover under a personally owned policy without medical underwriting. However you have to apply quickly – usually within 30 or 45 days of leaving your employer.

In my experience it helps to contact HR before your last day. They’ll usually refer you to the adviser appointed to the group policy who will then guide you through the process.

Call your adviser

If you have previously worked with a financial planner then a job change is one of those moments you should proactively contact them. Changes in income can trigger tweaking of your strategy. Also job changes sometimes occur as a result of the natural evolution of what you want in life. Your financial well-being strategy needs to evolve with you.

Your financial planner will be able to guide you through all of the above and alert you to anything else you should think of.

How to sell shares without a broker

Over the last 20 years there have been plenty of share floats that have brought everyday Australians into the world of share ownership. One day, perhaps upon retirement, you may decide that you want to sell these shares to fund your lifestyle. This article reveals how to sell your shares without a broker.

Over the last 20 years there have been plenty of share floats that have brought everyday Australians into the world of share ownership. For example:

  • Privatisation of Government assets like Commonwealth Bank, CSL and Telstra.
  • Also large companies like AMP have demutualised and listed on the stock exchange and in the process issued shares to policy holders.

One day, perhaps upon retirement, you may decide that you want to sell these shares to fund your lifestyle. But, how do you sell your shares when you don’t have a broker?

(Technically you can’t directly trade on the Australian Stock Exchange – you have to use an authorised broker. By ‘without a broker’ I mean without the old-school method of talking to a human.)

Online share trading facilities

In our modern world the first idea that may spring to your mind is to establish an account with one of the many online share trading providers.  Certainly that will work. But if you only want to conduct one or two trades it is a lot of effort.

Plus in setting up an account most online providers also establish a new, linked cash account for settling the trades. Again for one or two trades it is an extra account that’ll probably be more hassle than benefit.

Further, if you have some shares in your name, some in your partner’s name and even some in joint names you also may need a separate trading account for each ownership type.

One off trading facilities

If you just want to sell shares and not buy then a one off guest or visitor trade is what you need.

With a visitor trade you can sell the shares and receive a cheque posted to you, which you deposit into an existing account of your choice. No need to establish a new bank account.

Both of the big Australian online share brokers E*Trade and Commsec offer one off trading services. E*Trade refer to it as a Visitor Trade and CommSec refer to it as a One Off trade. You can download the forms from their website.

Paperwork

Yes it still involves a bit of paperwork and you still have to prove your identity by submitting certified copies of your ID. But it does avoid the extra paperwork of closing an account at the end.

TIP: If you already are a customer of CBA and have therefore proven your identity you can avoid that part of the process if you use the Commsec one off trade facility.

Cost

One off trades usually cost more than the standard per-trade fee from each broker. But it is still as low as $50 with E*Trade or $66 with Commsec (depending on size). See their websites for specific details to decide which is cheapest for your trade.

Market price only

One disadvantage of a one off visitor trade compared to establishing the online account is that your shares will be sold at the market price at the time your form is processed. You don’t get to dictate the sale price.

If you want to be able to time the sale of your shares and nominate the sale price you will need to establish the online account or go through the traditional human brokers (remember those?).

Issuer sponsored shares only

You can only use the one off trade facilities if your shares are what is known as “issuer sponsored” rather than “broker sponsored”.

The Commsec form describes how to tell the difference:

  1. Find your share holding statement.
  2. Look for the Shareholder Reference Number (SRN), which it is a 10 digit number.
  3. If your SRN starts with  the letter “I” then your shares are issuer sponsored.
  4. If your SRN starts with the letter “X” then your shares are broker sponsored.

Broker sponsored shares

If your shares are already broker sponsored then just contact that broking company and ask them about the process and cost to sell the shares. You’ll be able to find the broker’s name and contact details on your share holding statement.

If you don’t fancy them or their fees then you can establish an account with one of the online share brokers and transfer your shares to them as your new nominated broker. Then you sell your shares using the normal online trading facility.

Better budgeting

For many people the word “budget” conjures feelings of restriction. (Just like the word “diet”.) However a good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted. In this article I reveal a better budgeting technique using the model “Pay Yourself First (in practice)”

Cue Skyhooks tune…

Budget…is not a…dirty word! Budget…is not a…dirty word!

Once on live TV I was challenged to come up with a better word for a budget. The interviewer felt the word was too creepy.

The reality, as you can probably guess is that it has nothing to do with the word but the meaning we associate with it.

In fact the origin of the word “budget” is in the leather case or wallet that bureaucrats used to carry their financial plans.

Of course the problem is that for many people budget conjures feelings of restriction. (Just like the word “diet”.)

A good budget should be the exact opposite. It should facilitate you having enough money for the things that really matter so you need not feel restricted.

You achieve this this by following the wealth principle I call “saving for the significant and minimising the insignificant.”

Pay Yourself First (in practice)

It’s likely you’ve heard of the principle to pay yourself first.

Back when I was a graduate engineer I thought this principle meant to put a certain percentage of my income away for wealth creation. Then I wondered “what next? How do I manage the remainder?”

Now that I’ve had the benefit of working with lots of people on their cash flow I’ve created this model to help you create an effective budget that sets aside money for the significant things in your life plan.

(Download a PDF version of the model here)

Top-down or bottom-up?

To follow the principle of pay yourself first ideally you work from the top as you allocate your income into pots of savings.

However, if you find that you never have any savings and in fact spend more than you earn the top-down approach won’t feel possible – because it’s not yet. To extricate your butt from the spending fire first you need to get control. You do that by starting at categories 5 and 6 and working upwards as you increase your control.

In short if you are in stages 1 or 2 in the Six Stages of Wealth Creation you would start at the bottom and work upwards to improve your cash flow management. Everyone else can take the planning approach and go top-down.

Your pots of money

1. Financial Independence

The first pot you allocate is how much you need to regularly invest so you accumulate enough net wealth to “retire” – or make work optional – when and how you want it.

In addition you include the additional regular loan repayment s you need to make to ensure you are free of personal (non-investment) debt by your financial independence target date.

2. Pre-retirement Essentials

The second allocation is to all the big things you want and need to do, buy or experience between now and the point you achieve financial independence.

For example: car upgrades, major home maintenance, family holidays, replacing major household items, parental leave. (The list goes on.)

In my experience many people find these items either blow their savings or are funded by debt. Why borrow and pay interest on predictable expenses when instead you could be earning interest? Earning interest in advance actually reduces the true cost of the items and the amount you need to save.

3. Irregular Expenses

In this pot I include all expenses you pay at least every year but less frequently than monthly.

For example: clothing, utilities, insurance, gifts, parties, subscriptions.

Again from my experience it is often the irregular expenses that end up blowing the savings of otherwise consistent savers. The problem for them is that whilst they are saving, usually by automated pay deductions, they are not saving enough. Month-to-month they may have savings but not year-to-year.

Often when clients actually separate their irregular from their regular expenses they are shocked by how high a proportion are irregular expenses. That observation alone is an insight into why they may be spending too much.

The expenses may be out of sight but they should not be out of budget.

4. Existing regular commitments

This category is the allocation for repaying all of your existing debts as per the current minimum required repayment.

For many people this is the first line item they put in when working out their budget.

The reason loan repayments is item 4 is that when you take a planning approach you first allocate items 1 through 3 to work out how much you can afford to borrow.

The way many people actually work out how much to borrow is a combination of:

  • What the lender says they will lend them
  • Their income less the regular spending that comes to their mind (i.e. untracked)

5. Regular Essentials & Comforts

All the regular items you spend at least every month.

When you take the planning approach you get to this point and discover how much you can afford to spend on comforts. And some things you thought were essentials get re-categorised.

It’s at this point many people start prioritising between lifestyle now and future significant goals.

  • Which is more important to me?
  • If I don’t save up for that future goal, but still want it how will I create the money to afford it? (e.g. I’ll only be able to afford X if I get a promotion – so I’d better start investing in professional development.)

6. Impulses and Indulgences

The final category is a little allocation for spontaneity.

How much to allocate to each pot

If everyone were identical in situation and value-system then we could define a nice neat package of percentages to allocate to each pot.

But we’re not.

To create a budget that is meaningful and motivating to you it needs to relate to your goals for your money.

That’s not as hard as it may sound. You already know what you want – it’s in your head, you probably think about it regularly. Just get it out of your head and onto paper and then put a number and time frame next to it.

Automatic wealth creation

Once implemented good budgeting should also be as automatic as possible. That’s the next step of smart cash flow management.

If you’re interested in how to put this all into place talk to me about Cash Flow Coaching.