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Greetings!
Welcome to the latest edition of The Financial Fortnight That Was.
It has actually been three weeks since our last edition and we apologise for the one week delay. Scott Francis has been busy presenting alongside Alan Kohler and James Kirby, from the Eureka Report, at the Brisbane Trading and Investing Expo. He has also been busy presenting two seminars and been part of a panel last week at the Australian Investor's Association conference held on the Gold Coast.
Scott Keefer, on the other hand, has been off to Yeppoon, Central Queensland, visiting family and clients.
In this edition we look at dollar cost averaging, provide a summary of the movements in markets over the past fortnight and look at investing for income. We hope that you find the material informative and relevant.
Enjoy the read! |
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A Quote for Consideration
"Let other people overreact to the market ... if you can stay cool while those around you are panicking, you can surely prevail."
James Pardoe
Author - How Buffett Does It, 2005 | |
Financial Topic Demystified
Dollar Cost Averaging
There is no hiding that share markets around the world have had a poor year to the end of June 2008, and July has not provided any comfort. History tells us that there will likely be an upswing in returns but unfortunately it does not provide us a guide to the exact date of that turn around. It could be tomorrow, in a month, the next quarter, a year or even multiple years time.
A number of you may now be sitting in the position where you have accumulated cash through savings, or from a hesitancy to invest over the past 9 months or you may be the holder of managed funds and have recently received income distributions into your portfolio. You are most likely pondering whether it is time to be buying into growth assets.
If you take the decision to buy into growth assets, a wise option would be to undertake a dollar cost averaging approach. So what is dollar cost averaging and how might it protect you from downside risks?
The following is taken from Scott Francis' latest book - A Clear Direction - Your Guide to Being a Successful CEO of Your Life
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Investing regularly over time is sometimes given the 'Flash Harry' name of dollar cost averaging. It is called this because if you keep adding investment amounts regularly you buy more of an investment if prices go down and less if prices go up - tending to average out your entry price over time.
In the first chapter of 'A Clear Direction - Your Personal Finance Guide' I indicated that I felt there was a bias towards the use of the phrase 'It's time in the market, not market timing that counts' within the financial services industry. I feel that this bias comes about because promoting the idea that provided you leave an investment in the market for three to five years you will make a reasonable return, means that there is never a bad time to invest. For commission based financial planners who earn their money through distributing financial products, and for fund managers who charge a fee based on the percentage value of assets that they are managing, the fact that it is always a great time to invest means it is always a great time to take clients' money - which is great for their own profits.
The reality is quite different. For example, if you had invested a sum of money in the stockmarket in July 1970, it would have taken until July 1985 for you to receive a positive return above the rate of inflation. Even without considering inflation it would have taken eight years to have the investment return to its purchase value again.
If you had invested $10,000 into Australian Shares in July 1970 by July 1985 that portfolio would be worth $27,454. This sounds impressive. However because of inflation by July 1985 $27,454 would only buy you the same amount as $10,000 would in July 1970 - all in all a disappointing investment return.
If, rather than invest the $10,000 all at once, you had invested $1,000 a year for each of the first ten years by July 1985 your investment portfolio would have been worth $30,245, an investment return nearly $3,000 stronger.
This is a demonstration that in times of volatile markets, such as during the early 1970's, the strategy of regularly investing smaller amounts of money can be an effective one - more effective that just assuming any time is a great time to invest and blindly investing money. Of course there are periods of strong investment returns where it would be better to simply invest the $10,000 up front. Just as the strategy of investing small amounts regularly helps smooth volatility that will protect against losing capital in less attractive markets, it will reduce your investment returns in more attractive investment markets.
It is also practical to assume that most people will set their investment goals and invest periodically. For example, they may decide to save and invest $5,000 a year, so the practicality is that they will be investing regularly over time, which we have seen is a prudent way to enter investment markets, allowing them to use any downturn in investment prices as a buying opportunity, and smoothing market volatility.
Let's assume that a person decides to invest $1,000 at three different times into an Australian share, called share X. At the first point of investment the price of the share was $1, so she purchased 1,000 shares. At the second point of time the price of share X was 50 cents, so she bought 2,000 shares. At the third point of time the price of share X was $2, so she bought 500 shares. The share price then fell back down to $1. At this point in time she had 3,500 shares, worth $3,500. So, even though the price of these shares is the same as when she first bought them, dollar cost averaging means that her $3,000 investment now has a value of $3,500.
To look at a realistic example of regular investing over a period of time I put together a model based on the time between July 1970 and July 2005, a 35 year period. I assumed that a person worked and earned the average weekly wage for each of these years, as per the Australian Bureau of Statistics (ABS) figures for each year. Each year they contributed 5% of their income. This means that in 1970 they contributed around $185 through to 2005 where they invested nearly $2,000. I have assumed that they invested all their money in Australian Shares, and reinvested all dividends. I used the actual returns from the sharemarket over this period. If they did this, by July 2005 they would have an investment portfolio valued at $288,000. The effect of compound interest is that they would have only contributed $36,410 over the 35 years. The remaining value of the portfolio is made up of investment returns. While this example has not taken into account tax, the final balance is significant.
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How do we apply this?
Since early 2007, we have been advising new clients and existing clients with new money to invest, to gradually ease into growth markets through dollar cost averaging.
This strategy, combining the effect of compounding interest with regular investments to smooth some market volatility, requires the discipline to start investing as soon as possible and to regularly allocate funds to your investment portfolio.
It is a two step process which involves:
1/ Identifying how much you can put towards long term investments on a regular basis and;
2/ Deciding how you are going to actually invest, using either index funds, actively managed funds or choosing investments directly (or a combination of all three). If you choose a managed investment then you should establish a regular investment facility to keep building your investment over time. If you choose to invest directly yourself, you should open a high interest investment bank account where you can regularly build your savings until you are ready to choose the next investment.
For more information on our approach to building portfolios please take a look at our Building Portfolios page.
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Fascinating Financial Fact
The Economist's Big Mac Index
The Economist magazine produces an annual Big Mac Index which compares the purchasing power of currencies in 120 countries around the world according to the price paid for a Macdonald's Big Mac burger. Comparing these calculations with actual exchange rates indicates whether a currency is under or over valued.
The July 2008 results show that the Euro is over valued by 50% while the Chinese Yuan is under-valued by 49%. Our own Aussie dollar is one of the most accurate comparison being under-valued by 6%.
Out of interest, the results suggest that for the Big Mac to cost the same in the US and Australia the Aussie Dollar would need to be trading at $1.03. i.e. for every one Australian dollar we should be receiving $1.03 US dollars.
The Economist quite openly remind readers that this is not a serious exercise in comparing the purchasing power of currencies however it makes for some interesting discussions.
To get the full details click on the following link to The Economist website - The Big Mac Index - Sandwiched
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Market News
ASX P/E Ratio and Dividend Yields
The P/E ratio is a common broad indicator of the price of shares. It is a calculation of the price of shares compared to expected earnings. A higher ratio indicates that share prices are more expensive. The historical P/E ratio for the ASX has been between 14 & 15. The dividend yield is the calculation of dividend payments divided by the market capitalisation of the company or index. The historical average in Australia is around 4%.
As of July 31st the P/E ratio for the S&P/ASX 200 was 11.01. The dividend yield was 4.69%.
Market Indices
Since our previous edition, Australian and global sharemarkets and \ listed property have experienced mixed movements. The S&P ASX200 Index has fallen a further 1.52% from the 11th of July to the 1st of August. It is now down 17.46% from the same time last year and down 22.65% for the calendar year (2008) so far. Conversely, the MSCI World - ex Australia, a measure of the global market, has risen 1.54% over the same period. The index is down 16.60% from the same time last year and down 16.23% for the calendar year so far.
Emerging markets have experienced negative movement with the MSCI Emerging Markets Index falling 1.94% since the 11th of July. This index is down 8.39% from the same time last year and down 19.09% for the calendar year so far.
Property trusts have rebounded a touch since the 11th of July with the S&P ASX 200 A-Reit Index rising by 7.85%. The index is down 39.32% from the same time last year and also down 36.17% 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 risen 7.55% over the same period. It is down 16.52% from the same time last year and down 11.92% for the calendar year so far.
Exchange Rates
As of 4pm the 1st of August, the value of the Australian dollar has fallen against major benchmarks since the last edition. It is down against the US Dollar by 2.37% at .9374. It is up 10.88% from the same time last year and up 6.33% for the calendar year so far. Since July 11th the Aussie has also fallen 1.92% against the Trade Weighted Index now at 71.7. This puts it up by 5.50% since the same time last year and up 4.37% 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 the latest employment data with the official unemployment rate falling slightly to 4.2% as of the end of June. The participation rate has risen slightly to 65.3% with employment levels rising by 29,800 jobs.
The ABS has also published the latest Consumer Price Index data measuring inflation in the economy. The CPI rose 1.5% during the June quarter and now sits at an annualised rate of 4.5%.
The ABS has also released heir Established House Price Index across capital cities. The index has seen a 0.3% fall in the weighted average house prices of the eight capital cities leaving the annualised rate at a 8.2% rise.
The Reserve Bank of Australia board also met on the 1st of July and decided to keep the official interest rate target steady at 7.25%. The statement published with the decision indicated that the RBA believes that there are tentative signs that inflationary pressures are easing slightly. Since then, effective mortgage rates have actually risen due to increases passed on by individual banks in the system. The board meets again today to set the official cash rate.
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On the Lighter Side
Managed Funds to avoid:
The Lowe Income Fund
Skimmers Select
Stuntid Growth Fund
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Investing for Income - ABC radio segment
Scott's Financial Happenings Blog - Posted Monday 4 August
Last Saturday, 26th July, Scott Francis joined Warren Boland's "Weekends with Warren" program on 612 ABC Brisbane. The major topic covered was Investing for Income. The following is a brief summary of the content covered in the segment:
In really volatile times like these, investors often don't think about the income that their investments are paying to them. Whether it be property, shares, cash of fixed interest, they often focus too much on the price of the investments.
However income can be a great investment benefit, and is actually more important in some ways to investors.
When you invest in shares, you invest in a company or portfolio of companies. Every year these companies earn some money. They keep some of this to re-invest in new projects, and the rest they pay to investors as dividends, usually twice a year. Investors often forget about this.
John Burr Williams was a famous investment author, and wrote a book in the 1930's on investment analysis. He had this poem about investing, reminding of the importance of income (dividends):
"A cow for her milk,
a hen for her eggs,
And a stock, by heck, / For her dividends.
An orchard for fruit, /
Bees for their honey,
And stocks, besides, / For their dividends."
At the moment various asset classes are paying income of:
Cash - at least 7%
Fixed interest - at least 7.5%
Listed Property trusts - at least 7.5% a year (and will grow over time)
Australian shares - 4.5% a year, plus a tax benefit of 1.75%; total of 6.25% (and will grow over time)
Direct Residential Property - commentary this week about the strong increases in rents paid from investment properties (also will grow over time)
The important point is that income is more reliable than the price of investments:
1/ Shares have fallen in price by about 25% since the market top - there is absolutely no suggestion that the income (dividends) will fall by anywhere near this amount - if at all. Certainly the forecast is for 'slowing earnings growth', but not negative growth at this stage. For example, St George and Woolworths have both indicated that their earnings growth will be around 8% - not too bad really.
2/ Income from growth assets counter the impact of inflation, because they provide growing income streams.
Using Income in Planning a Portfolio
Let's consider a case study of a couple retiring at age 60. If they have $200,000 then they might want to work out a portfolio that they can draw income from at a rate of $10,000 a year, to supplement the age pension of around $25,000 that they will receive.
What they might do is invest $40,000 in cash and fixed interest investments. In this way they will have 4 years of income set aside so even if share and property investments are volatile - like now - they not have to worry as much.
So they invest the rest in growth assets, including Australian shares, listed property and global shares.
The table below shows the expected income:
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Asset Class |
Amount Invested |
Income Rate |
Total Annual Income |
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Cash and Fixed Interest |
$40,000 |
7.25% |
$2,900 |
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Australian Shares |
$70,000 |
6.25% |
$4,375 |
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Listed Property |
$40,000 |
7.50% |
$3,000 |
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Global Shares |
$50,000 |
3% |
$1,500 |
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TOTAL |
$11,775 |
If they were paying reasonably moderate fees of 1.25%, their fees would be $2,500. So after fees there would be $9,275 in income to pay their $10,000 of living costs - so they dip into just $775 worth of cash.
Also - the income from the shares and property would be expected to increase over time, which is pretty powerful.
In this way you don't have to worry too much about market volatility - so long as the investments are paying a reasonable income stream and there is enough cash set aside you can be relaxed about how your portfolio will meet your retirement income needs. Other blogs over the past fortnight:
15th July - Investment Newsletters - Do they help you beat the market?
Click here to be taken to Scott's Financial Happenings Blog |
Eureka Report Articles
Since our last edition Scott Francis has contributed another two articles to Alan Kohler's Eureka Report. Click on the links below to be taken to these items:
21st July - Tollway float not hazard free - Despite the high yield, BrisConnections' lack of a track record makes it difficult to evaluate. Brisbane's other tollway, RiverCity, is trading well below its issue price.
30th July - What price index funds? - In a volatile market that is really tough for a stock picker to beat, index funds are a relatively tax-effective, low-cost investment option.
1st August - The IPO that died of shame - The BrisConnections tollway float destroyed about $250 million of investor wealth - a similar amount to the Fincorp and Westpoint collapses.
4th August - A popular way to lose money - With a portfolio similar to the index, but higher fees than index funds, Colonial First State Imputation Fund stumbles on its promise to make money for investors.
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Other Websites of Interest
Over the next few editions we plan to highlight a number of other sources of valuable financial and investment information on the internet. Our third site is closer to home -
www.vanguard.com.au/Personal_Investors/Tools_and_education/index.aspx
The site is published by Vanguard - Australia. Vanguard are one of the best known (if not the best known ) index fund managers throughout the world.
This part of vanguard's site contains copies of their Plain TalkŪ Guides, calculators and tools, research, other useful websites and sections on investment basics. Well worth a look. |
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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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Scott Francis & Scott Keefer
1 Park Road - PO Box 1688
Milton QLD 4064
(07) 3876 6223
A Clear Direction Financial Planning is an Authorised Representative (No. 283723)
of FYG Planners Pty Ltd ABN 55 094 972 540
Australian Financial Services Licensee (No. 224543)
Registered Office: Level 1, 10 Wilson Street Burnie Tas 7320 | |
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