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Greetings!
Welcome to the latest edition of The Financial Fortnight That Was. In this edition we look at franking credits, provide a summary of the movements in markets over the past fortnight and look at our golden rules of investing. We hope that you find the material informative and relevant. As always, if you have any comments or suggestions for future editions please do not hesitate to be in contact.
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A Quote for Consideration
"It's bad enough that you have to take market risk. Only a fool takes on the additional risk of doing yet more damage by failing to diversify properly with his or her nest egg. Avoid the problem--buy a well-run index fund and own the whole market."
William Bernstein
The Four Pillars of Investing
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Financial Topic Demystified
Franking Credits
A unique element of the Australian taxation system is the imputation system used to determine the payment of tax on company dividends. Some research coming out of Australia suggests that franking credits paid to investors under the imputation system are not being priced into the value of shares and are in effect a bonus to Australian investors - The value of dividend imputation tax credits in Australia, Journal of Financial Economics, Damien Cannavan, Frank Finn and Stephen Gray, July 2004, Vol. 73, No. 1: 167-197 So what are franking credits and how do they impact on the returns of investors?
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The dividend imputation system was introduced to Australia in 1987. The basics of the system are that if an Australian company pays tax on its income and then pays a dividend to shareholders from post-tax sources it can choose to pass on a franking credit to these shareholders to acknowledge that some tax has already been paid on the dividend. The best way to explain is through an example.
Company XYZ earns $1 of profit for tax purposes and pays the company tax rate of 30% on that profit - i.e. $0.30. It records this $0.30 in a franking account as a record of the amount paid to the Australian Tax Office. When the company pays a dividend, it may attach a franking credit from the franking account in proportion to the tax rate. In this case for every $0.70 of dividend paid in cash may have a $0.30 franking credit attached. This is called a franked dividend.
On completion of their individual tax return, the share holder reports the $0.70 of dividend and claims the $0.30 franking credit. The result of this is that the tax office will see this as a $1 increase in assessable income to the shareholder but at the same time reduce their tax liability by $0.30.
The impact on the assessable tax payable by the share holder will depend on their marginal tax rate as follows:
Marginal Tax Rate |
Tax Consequence |
Effective Return on a $0.70 dividend |
0% |
$0.30 tax offset |
$1.00 |
15% |
$0.15 tax offset |
$0.85 |
30% |
No net effect |
$0.70 |
40% |
$0.10 extra tax payable |
$0.60 |
45% |
$0.15 extra tax payable |
$0.55 | The franking tax offset will cover, or partly cover, the tax payable on the dividends. If the tax offset is more than the tax payable on the dividends, the excess tax offset will be applied to cover, or partly cover, any tax payable on other taxable income received. If any excess tax offset amount is left over after that, the Tax Office will refund that amount to the share holder.
Only Australian residents are eligible to claim the franking credit.
As you can see, the big "winners" are those on a 0% marginal tax rate.
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How do we apply this?
At present, we apply this research by having an extra weighting to Australian shares within the growth allocation of our recommended investment portfolios. Please see our Investment Portfolio Basics web page for more details.
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Fascinating Financial Fact
Does money buy happiness? - The Easterlin Paradox
Richard Easterlin in 1974 published a paper "Does Economic Growth Improve the Human Lot? Some Empirical Evidence". In the paper he found that contrary to expectation, happiness at a national level does not increase with wealth once basic needs are met. More recently researchers from the University of Pennsylvania's Wharton School of Business have released a study showing a "clear positive link" between wealth and "subjective well-being" based on global surveys.
The new study has sparked a debate amongst "happiness economists" which really seems to boil down to how you measure happiness. We'll leave it up to you as to which side of the debate you favour.
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On the Lighter Side
"Money can't buy you happiness but it does bring you a more pleasant form of misery." Spike Milligan. |
Market News
Market Indices
Since our previous edition, Australian and global sharemarkets have both experienced negative movements. The S&P ASX200 Index has fallen 4.66% from the 16th to the 30th of May. It is now down 9.43% from the same time last year and down 10.81% for the calendar year (2008) so far. The MSCI World - ex Australia, a measure of the global market, has fallen 1.81% over the same period. The index is down 10.45% from the same time last year and down 5.95% for the calendar year so far.
Emerging markets have also experienced negative movement with the MSCI Emerging Markets Index falling 2.83% since the 16th of May. It is up 16.68% from the same time last year but down 3.66% for the calendar year so far.
Property trusts have also fallen since the 16th of May with the S&P ASX 200 A-Reit Index (formerly known as the Property Trust Index) falling by 5.19%. The index is down 33.36% from the same time last year and also down 23.61% for the calendar year so far.. The S&P/Citigroup Global Real Estate Investment Trust (REIT) Index, a measure of the global property market, has fallen 3.19% over the same period. It is down 20.20% from the same time last year and down 2.17% for the calendar year so far.
Exchange Rates
As of 4pm the 30th of May, the value of the Australian dollar has risen against major benchmarks for the fortnight. It has risen against the US Dollar since the 16th of May being up 1.16% at .9559. It is up 16.74% from the same time last year and up 8.43% for the calendar year so far. Since May16th the Aussie has also risen 0.83% against the Trade Weighted Index now at 72.8. This puts it up by9.31% since the same time last year and up 5.97% for the calendar year so far. (The Trade Weighted Index measures The Australian dollar against a basket of foreign currencies.)
General News
Since our last edition the Australian Bureau of Statistics has released a range of interesting data. For the month of April, retail trade figures have reduced by 0.2%. This was worse than analyst expectations of a 0.2% rise.
They have also released the latest business indicator data up to the end of March 2008 with a 2.2% increase in company gross operating profits for the first quarter of 2008 compared to the December 2007 quarter and up 7% over the year. News reports suggest that economists were expecting gross operating profits to rise by 1.0 per cent in the quarter.
Today sees the June meeting of the board of the Reserve Bank of Australia with the expectation that official interest rates will be kept at 7.25%.
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Eureka Report Articles Update
Since our last edition Scott Francis has contributed another article to Alan Kohler's Eureka Report. Click on the link below to be taken to this item:
Gateway: Enter with caution - A capital guarantee makes products more attractive to "volatility shy" investors. Macquarie's MQ Gateway has such a guarantee but is very complex.
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Our Golden Rules of Investing
Scott's Financial Happenings Blog - Posted Wednesday 28 May
The Australian's Wealth supplement published today contained a really useful article outlining the simple but central rules of investing - 10 golden rules for successful investment.
The rules were:
- Invest regularly
- Stay the course
- Diversify
- Avoid get rich schemes
- Regular reviews
- Get the structure right
- Borrow to invest
- Look long term
- Seek professional advice
- Spend less than you earn
The article provides a good summary but in our opinion would benefit from a re-jigging of the order of items. We would also suggest the removal of borrowing to invest as we do not consider that this is necessary for investment success. Borrowing to invest increases the risk of a portfolio. Sure, if the returns from the investment are greater than the cost of the loan it will be a successful strategy. If not it can be a good way to destroy value. Many do not need to take on this extra risk to reach what is a successful result. Therefore it should not be included as a rule.
Finally we would include the need to keep investment costs low to round out the list.
Our order would look more like this:
- Spend less than you earn
- Before you can invest you need to establish and continue to build a capital base from which to invest
- Seek professional advice
- Unfortunately this seems a little bit of self-interest, but nevertheless good quality professional advice put in place early will pay for itself. Professional advice should first look at the risk-free strategies such as reducing tax, getting structures right and then assist with identifying the actual investments
- Get the structure right
- It is important to look at where investments are placed in terms of superannuation or non-superannuation and in who's name
- Look long term
- Investing in higher risk assets such as shares and property requires a long term focus of more than 5 years. There have been period through history where higher risk asset classes have had periods of negative performance for more than 5 years.
- Diversify
- The old saying rings true - don't put all your eggs in the on basket. It is essential to invest across a range of asset classes and assets within those classes to avoid the risk of one or two individual asset collapsing and taking your whole portfolio with them.
- Keep costs low
- Unfortunately this was left off the list in the Australian article. We see this as really important. High costs eat in to the returns of investors and inevitably lead to poorer performance.
- Avoid get rich schemes
- Choice of investments should take into account the trade-off between risk & return. If an investment promises high returns, make sure you understand the risk involved.
- Invest regularly
- Investing regularly not only builds the portfolio but also takes out some of the timing risk i.e. investing everything today and tomorrow the value falls sharply. If you regularly invest over time, even if markets fall you will be buying new investments at lower prices.
- Stay the course
- Jumping in and out of investments is a great way to destroy wealth because research shows that investors tend to buy at high prices and sell at low prices.
- Regular reviews
- Even though you should keep your follow your investment approach for the long term, circumstances will cause the need to re-assess the strategy such as a change in life circumstances or the need to re-balance after a period of strong growth in a particular asset class
Regards,
Scott Keefer
Click here to be directed to Scott's Financial Happenings Blog
Other blogs over the past fortnight:
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Scott Francis appears on Channel 9's Brisbane Extra
Since our last edition Scott has been interviewed for a Channel 9 Brisbane Extra story on the use of debit cards. He was interviewed to provide some brief analysis of the use of debit cards including any traps to look out for. Click on the following link to be taken to a transcript of the story:
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Monday's Money Minute Podcasts Update
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We hope you have enjoyed reading the latest edition. If you have any comments or suggestions for future topics please do not hesitate to get in contact.
Have a great fortnight!
Cheers,
The Two Scotts
The Financial Fortnight is a publication of A Clear Direction Financial Planning. It contains general financial advice. Readers should check this advice with a professional financial adviser before acting on any of the material contained in this email. |
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