NetActuary

Multiple Objectives-based Investing

We are starting quickly after the plum pudding to ensure 2014 is a very productive year.  The post retirement phase needs very different investment strategies to the wealth accumulation stage.  At the very least, there tends to be an income objective that is facilitated by growth asset versus a security objective that can be met with higher defensive asset allocations. Mass marketers of products like MySuper talk in terms of life cycling investments where they customise on a criteria like age.  This automatic approach is useful for low engagement members and those with modest financial literacy.  NetActuary provides analytic support to allow a far higher level of optimisation taking individual circumstances of retirement intentions, objectives, risk appetite, capacity to fund essential versus desired income etc into account.

We need to undertake risk mitigation without overly compromising returns.  An equities emphasis increases the probability that the desired level of income will last the required payment duration but at the cost of increased downside risk.  Cash (on the other hand) provides short term security but at a high cost down track.  So, in essence, our challenge is to help retirees find the optimal trade off.  This is going to require vastly more sophisticated analytical tools than those used by most advisers.  We need a change away from simplistic return targets and risk profiling to evaluating the danger of not achieving the retirees multiple objectives of income, lump sums and estate goals.  This objectives-based investing is also called “liability driven investing”.

There is now also a wider appreciation that major risk is not just the level of return achieved, but the sequence in which those returns fall.  The needs for capital cashing at times of depressed asset values can shorten the duration at which desired income is sustainable by many years.  The mass customisation solution is the “bucketing” approach.  This involves typically a cash bucket for three years’ pension payments together with a longer term growth bucket.  This is vastly too simplistic and too short.  The NetActuary tools evaluate the holistic private cashflow requirements in excess of anticipated Age Pension entitlements and all cashflows to cover this.  It takes into account dividends and structured capital releases from fixed term annuities.  A period of up to 10 years is needed to provide a decent duration in which to replenish cashflow resources in up markets, without the worry of having to access growth assets in down markets.

Enough of the generalisations and background information!  We need to focus on turning this into an action algorithm with dangers of not meeting objectives quantified.  Various items will be loaded onto the website soon.

The NetActuary Team

 

 

Ho Ho Ho!

Merry Christmas Everyone!  It has been a fun year with great progress on creating practical strategies for academic issues.  The time has now arrived to optimise the intake of plum pudding and the cost of new clothes.  From all of us here at NetActuary we wish you and your family a safe and merry Christmas – and may 2014 be awesome!

NetActuary will be operating throughout the Christmas and New Year period.  It’s a great time of the year down in Salamanca with the finish of the Sydney-Hobart Yacht Race and the “Taste of Tasmania” activities being only a few steps away!

 

The NetActuary Team

Mid Year Economic and Fiscal Outlook

Over the past few weeks - and from yesterday's MYEFO statement - it is fairly clear what the federal government superannuation changes are.  In summary, they are:

• The small business superannuation clearing house will be moved to the ATO from April 2014;
• The more flexible penalty options for SMSFs that breach superannuation laws will proceed;
• Off market transfers of listed securities prohabition, verification of SMSF bank accounts, making rollovers a designated service under Anti-Money Laundering will not proceed;
• We know that taxing superannuation pension earnings above $100,000 was seen as undeliverable;
• The Superannuation Guarantee rate will increase to 12% but with the 9.25% rate extended until 30 June, 2016;
• It is proposed that the Low Income Super Contribution of up to $500 for individuals earning less than $37,000 will be repealed with effect from 1 July, 2013;
• How account based pensions count for Centrelink's income test purposes will change to the deeming basis from 1 January, 2015.  There are grandfathering provisions for account base pensions that commenced before this date provided the recipient was in receipt of Centrelink income support at that date.

About the only area where the immediate future is unclear is how the Foreign Investment Fund rules being replaced with Foreign Accumulation Fund rules will affect overseas pension plans.  I hope we see similar rules to those that New Zealand have implemented.

The NetActuary Team

Market and Sequence Risk Control

 

NetActuary works in managing longevity risks with buffers, rebalancing, offsets, exporting etc.  This is now reasonably well known.  What I have tried to do here is to produce a summary of how we are assisting advisers with managing market/sequence risks for clients.  In very general terms, the six most important concepts are:

1. Liability Driven Investment Strategy – clients with a retirement lifestyle focus need greater emphasis on income security rather than on wealth creation.
    
2. The Trade Off – having a higher level of equities in the portfolio increases the anticipated retirement income that is sustainable, but at the cost of also increasing the possibility of a disastrous outcome.
   
   
3. Be a Smooth, Cool Character – constructing the retirement plan on smoothed equity returns over 5 or 10 years will allow some of the year to year volatility to be ignored but still leaves a significant problem that needs to be dealt with.
   
   
4. Wrong Place, Wrong Time – sequence risk control is essential with careful liquidity management from a portfolio that has structured capital release independent of equity values from something like a fixed term indexed annuity.
   
   
5. Now that is Surprising! – just as a TTR strategy needs all drawdown levels to be evaluated, the optimal market/sequence risk control outcome needs the trade off between higher returns and lower, more certain returns to be evaluated.
   
   
6. Don’t Operate without an X-ray – dealing with risk (in other words stochastic concepts) can only be properly evaluated with appropriate tools that turn academic concepts into implementable, practical plans.

Is the above still as clear as mud?  If you have a few minutes spare sometime, give Brian a call on (03) 6223 2320 and he can elaborate and discuss various aspects of this important topic.

The NetActuary Team

 

Careful Depreciation

One of the tasks we get asked to do often at NetActuary is an analysis of a potential property investment, transfer between structures or disposal.  You know one can tell the quality of the data input and assumptions in a glance - by how the depreciation has been filled in.  So, this blog tackles how to be careful with these deductions.  They are important and contribute significantly to the overall rate of return.

There are three types of depreciation found with a rental property.

1. Borrowing expenses;

2. Amount of decline in value of depreciating assets; and

3. Capital works deductions.

If borrowing expenses are more than $100, they are spread over 5 years (or the term of the loan if less).  Less than $100 are fully deducted immediately.  Expenses include loan establishment fees, title search fees, cost of preparing and filing mortgage documents, stamp duty charged on the mortgage etc.  The deduction for the first year is apportioned according to the number of days in the year that one had the loan over 1,826 days (i.e. 5 years taking the leap year into account).  The next year is worked out by the diminished value of the expense multiplied by 365 (or 366) and divided by (1,826 - days in first year etc).

The normal depreciating asset deduction can be worked out by either the prime cost or diminishing value method.  The formula for assets purchased on or after 10th May, 2006 is:

          base value  x         days held      x              200%            

                                     365 (or 366)           asset effective life

The base value is purchase price in the first year or adjusted opening value in subsequent years.  The prime cost method simply apportions the purchase cost over the asset's effective life.  For most depreciating assets, one can choose to work out the effective life oneself or use those determined by the Commissioner of Taxation listed in the Guide to Depreciating Assets.  Immediate deductions may be available on goods costing $300 or less.   A low value pool can be set up for goods which cost less than $1,000 after GST.  Depreciation here is 37.5% of the opening balance and 18.75% on acquisitions during the year.  A balancing adjustment amount is worked out on disposal of the item to be included in the assessable income or to be claimed as a deduction.  In a low value pool the closing balance also has to be adjusted for loss on disposal.

Capital works deductions are spread over a period of 40 years since 15th September, 1987.  There are different rates for earlier constructions.  The deduction is only available when the construction is complete.  Examples of capital works include: a building or an extension (room, patio, garage, pergola etc); alterations such as removing or adding an internal wall; structural improvements such as sealed driveway, retaining wall or fence.  If you are an owner-builder, your labour and expertise don't form part of the capital works.

Besides determining whether an expense is plant and equipment versus capital improvements, it could also be a repair and maintenance expense.  Anything that extends the functional life or changes the orginal character is capital expenditure amortised over 40 years.  Repairs and maintenancy is simply to prevent or fix existing deterioration e.g. servicing equipment, fixing a part of existing equipment or building.  These costs can be 100% deducted in the year in which they occur.

To claim the maximum possible in the depreciation expense items is going to take multiple tax depreciation schedules and careful record keeping.  This is an area in which SMSF property investors probably need to be more diligent.

The NetActuary Team