This article appeared in the January 2014 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Nerida Cole, Dixon Advisory
After a year of strong performance on the domestic share market, here are five steps towards getting the most out of your investments in 2014.
1. Review your investment approach and financial goals
With the S&P/ASX 200 Index returning 17.4 per cent in the year to 1 December 2013, many people's expectations regarding the performance of their portfolio have been exceeded. But there's the risk of falling into the complacency trap. By taking a structured approach to reviewing and assessing investment and financial goals, smart investors may be able to enhance their situation in 2014 without increasing their risk.
Consider these matters when evaluating performance of the past year and adjusting your portfolio:
- Where was the outcome better than expected?
- Where was the outcome not as good as expected?
- Using critical analysis, why did these outcomes occur?
Also answer the following: did interest-rate reductions provide some relief on expenses? Were tax liabilities higher than expected? Is your cash reserve higher or lower than at the start of the year? If the performance of your portfolio was above expectations, was this the result of your considered patience after three to four years of poor returns?
2. Consider your income and expenditure for 2014
If you want to do at least as well or even better with your finances in 2014, it's important to understand the likelihood of changes to your income and cash flow, as well as your expenditure.
When assessing your income and cash flow, how would you rate your income from employment? Also, do you expect a tough year and cutbacks on bonuses or potentially a redundancy? If you do, it's critical to shore up your cash reserves and be very cautious about taking on new investment opportunities or debt.
Changed business and economic conditions that affect dividends can also affect cash flow. The outlook for yield on cash and fixed-income investments is low for 2014, which will affect all investors, particularly self-funded retirees, because legislated minimum pension payments have returned to pre-GFC levels.
On the other side of the equation, analysing your expenditure requirements is more than simply listing your estimated annual expenses.
Consider the analysis you performed for 2013 and ask yourself:
- Did you have any cash-flow difficulties that required shifting cash out of savings accounts, the unplanned sale of investments or having to borrow funds to meet expenditure needs?
- What are your commitments for 2014 and when do they fall? An annual budget can sometimes hide the fact that a large number of payments may fall in one period, such as before the end of the financial year.
- What are the big-ticket items such as school fees, renovations and holidays?
- As a home-owner, have you benefited from interest-rate reductions over the past year, enabling you to pay off the loan quicker with the same repayments? Those who have borrowed for investment may discover they have moved into a positively geared arrangement and may benefit from reviewing this from a tax perspective. If you have a home loan, ideally this is set up with an offset account and only the minimum loan repayments actually go towards the loan, with all surplus payments going into the offset account.
3. Match your expenditure liabilities with your cash flow and allocation of assets
Structuring your cash flow, investments and assets to match your upcoming liabilities and expenditure reduces risk and improves investment outcomes. Matching expenditure liabilities will minimise transaction costs and enable sensible and efficient use of cash flow because it allows you to understand what is driving deficits and surpluses.
Self-funded retirees and those in the important stage of approaching retirement also need to consider this to help reduce the effect of sequencing risk. This is the risk that adverse returns close to retirement, when capital balances are at their largest, can wipe out decades of savings. This is just as important for wealth builders who have a limited investment horizon, be it education costs, early retirement or a new home.
When considering the allocation of assets, also look at your potential to tolerate volatile returns and capital loss that can arise from a variety of investments and changes in global economic conditions.
4. Consider the effect of changes to investments, financial markets and global conditions
Traditional approaches to assessing tolerance to risk can be limiting when only an investor's capacity to withstand market volatility is considered. However, smart investors will take a dynamic approach and overlay a timeline of their cash-flow and liquidity needs and also ask another key question - how much capital can I afford to lose?
Your portfolio's asset allocation is the predominant driver of your exposure to risk. As your personal situation and investment conditions are constantly changing, it's important to review your asset allocation regularly.
While investing in Australian and international shares offers the potential for long-term capital growth and regular dividend income, it comes with high levels of volatility.
Defensive assets such as cash and fixed interest have lower levels of volatility and generally a lower risk of capital loss. However, investors need to understand what they are actually invested in because some so-called defensive investments may have higher levels of risk than their name implies.
5. Consider your tax position
There are many issues to consider when looking at your tax situation, including:
- Was the tax outcome for the 2012-13 financial year what you expected?
- Did you pay more or less tax than you anticipated? What about your spouse?
- Have you lost the tax benefit of negative gearing due to low interest costs?
Getting a better outcome here can be the lowest-risk way to improve your after-tax return, and with six months of the 2013-14 financial year to go, there may be time to make adjustments that can help you.
Where you have access to other entities such as superannuation, trusts or companies, a more tax-effective outcome may be possible by directing future savings into one of these, depending on legal and tax advice from a professional experienced in these areas.
Superannuation is generally considered the most tax-effective structure in Australia. Earnings inside super are taxed at a maximum of 15 per cent and generally 10 per cent for capital gains, with these tax rates dropping to zero when a member moves to the pension phase.
However, this needs to be weighed up against the restrictions on accessing capital, which is generally not available until preservation age (between 55 and 60). Investors closer to retirement who are looking at reduced tax effectiveness from negative gearing strategies may want to consider moving surplus cash from investment loan offset accounts into super.
But extreme caution should be taken regarding contribution limits, which can create significant issues, and restrictions on accessing funds. If your spouse is a low-income earner, he or she may be able to hold cash reserves and other income-producing assets with lower levels of tax.
Before restructuring the ownership of your assets, you and your tax adviser will need to consider what tax costs would apply. Some investors may be carrying a few underperforming stocks or losses carried forward from previous years, which may offset some capital-gains costs.
About the author
Nerida Cole is Managing Director, Financial Advisory, Dixon Advisory.
Find a stockbroker provides a snapshot of several financial advisory groups that advise on shares and other investment matters.
© Copyright 2015 ASX Limited ABN 98 008 624 691. All rights reserved 2015.