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LICs vs ETFs (Index Funds) – Which is the Better Investment?

June 9, 2017

LIC's vs Index Funds

There is a mountain of evidence that supports index funds being the superior investment for long term sharemarket investing.

Despite this, in Australia, I’m quite hesitant to plough all my savings into our stock market index.

This is because the Australian Sharemarket is quite top heavy.  The top 10 companies make up nearly 50% of our entire market value.  Almost 40% are in the Financials sector alone!

Over in the US however, it’s a totally different story!  The US stockmarket is very well diversified.  The top 10 companies only make up around 16% of the entire market value.

There is a great spread across different sectors too, with 20% in Financials and 17% in Technology.  Then Consumer Services, Industrials and Health Care sectors all have around 13% each.  If I was a US investor, I would use index funds with no hesitation.

 

Why not just buy a US Index Fund?

You may be wondering why not just invest in the US stockmarket, since their index is more investor friendly.  The simple answer for me is income.

Dividend yields in the US tend to be around 2%.  Very low, compared to the 6% we can get here in Australia.

This means 500k in US shares would provide only around 10k of income.  The same 500k in Aussie shares would provide 30k of income.

It’s truly a massive difference!  You would need three times as much savings to be able to retire on this income stream.

Remember, our focus is creating a passive income stream to live on.  The more sustainable income we can get from our investments, the less we need to save in order to reach financial independence.

Crunching the numbers and comparing income streams is so critical to early retirement, it can’t be overstated.  Unfortunately, it’s not just a case of ‘investing’ and eventually it will work out.

 

The Benefits of ETFs and Index Funds

Index funds are awesome.  You won’t under-perform the market at any stage because index funds match the market index.

The evidence is heavily on the side of indexing, with many professionals failing to outperform the index over time.  This is especially true in the US, where fees tend to be higher and a higher percentage of managed funds lose to the index, than here in Australia.

You can be comforted that in 50 years from now, the index will definitely still be around and its value much higher.  That makes long term investing about as easy as possible.  You will own all the most valuable companies on the market and your index fund will only keep the surviving companies over the years.

But, by owning every company in the index, you also inevitably own some crappy ones.  This can be fine, since it’s not obvious which companies are going to do poorly in the future.

If a company does do poorly and falls out of the top 300 (in the case of the ASX 300), you will no longer own it.  Owning the index also means owning companies in order of their market size, whether they pay dividends or not.

Index funds are an excellent option, but I think LICs (Listed Investment Companies) are a good substitute for Australian investors wanting to retire early and live on their dividend income stream.  (I’ve reviewed a number of Aussie LICs here.)

 

Why I like LICs for investing in Aussie Shares

—  The LICs portfolio of shares are often more diversified than the index by sector.  Argo’s portfolio – see here

— Most invest with an aim to provide income which increases over time faster than inflation.

— Dividends are often more consistent and more stable than the index.   (Investing nerd side note: Because the LICs operate as a ‘company’, they have control over how much dividends they pay out so they can smooth the dividends over time.  Index funds operate as a ‘trust’ structure which forces them to pay out all earnings, including capital gains from re-balancing the index.  This tends to make the income from the index fund quite lumpy.

— There is sometimes the opportunity to participate in Share Purchase Plans, allowing you to buy more shares at a discount with no brokerage fees.

— Certain LICs tend to avoid companies that pay very low or no dividends, which improves the income of the portfolio and generates a higher level of dividends for shareholders.

— LICs usually offer Dividend Reinvestment Plans (DRP) – this gives you the option to reinvest your dividends, often at a discount without paying brokerage. You will still receive the franking credits and are still required to declare the income.

— Some LICs also offer a Bonus Share Plan (BSP), sometimes called Dividend Substitution Share Plan (DSSP) – where you are able to forgo your dividend in exchange for more shares in the company, often at a discount and pay no brokerage or tax.  This can be incredibly tax effective for those in a higher tax bracket.  I wrote in more detail about this here – The Surprising Tax Efficiency of Dividend Investing

 

The risks of LICs

It’s not all roses and rainbows!  With LICs there are more risks.

There are plenty of fund managers out there that have delivered poor results for shareholders and in many cases you’d be better off with an Index Fund.

The manager may start making poor investment decisions or some talented team members may leave. They could also increase their fees unexpectedly.  Realistically, fees are much more likely to be lower in the future. Still a risk though.

Some of the risks are manageable though, by owning multiple LICs and those run by managers with a great long term track record, that is more reliant on their investment process, rather than the magic skill of one individual.

 

Low fee LICs

The fees of different LICs vary wildly and usually depends on their strategy and turnover.  The older style LICs such Argo, Milton and AFIC are fairly ‘index’ like – being weighted towards larger companies.

They tend to be very long term holders of their investments, so do very little selling. Their fees are very low – around 0.16% or less per annum.  Check out my LIC reviews page where I look at these companies in detail.  And make sure you’re using a very low-cost stockbroker to keep fees down.

 

Higher fee LICs

Something to remember here is, all LICs are not equal.  Many of the more active LICs charge high fees, so this puts them at an instant disadvantage when trying to deliver out-performance for shareholders.

Some LIC portfolio managers have still managed to deliver good out-performance, over time, despite charging higher fees and/or performance fees.

This is true more-so in the LICs that focus on the small-mid sized companies, where the companies tend to be less researched and there is a greater chance to outperform the market.  These LICs tend to be much more active. Fees for this type of LIC tend to be around 1% per annum. Some (not all) charge performance fees too.

Honestly, many high fee LICs are rubbish, so it pays to be very selective and only invest with a LIC or manager who has proven themselves by delivering good performance (after fees) for a long time.

A couple of LICs I like in this space are QV Equities, which is managed by Investors Mutual (approx. 1% fee), and Mirrabooka Investments, which is managed by the same guys as AFIC for around 0.6% fee.

 

Summary

I’m obviously a big fan of Listed Investment Companies and clearly biased, but not without reason.  Don’t get me wrong, index funds are great too!

I just feel that in Australia, the index is a bit too concentrated in one or two sectors to rely on indexing alone.  So here’s my answer to the question “which is better?”…

I would say in the US, indexing is the best option for long term returns, low fees and low fuss.  But it’s my view, that in Australia, investing in good quality and proven LICs, are often a better fit for income focused investors.  That also doesn’t mean you can’t own both.  Each have their pros and cons.

My preferred LICs are the older ones with very diversified portfolios and low fees.   By using LICs, we can build a well balanced dividend-paying portfolio, without sacrificing that all important income we need for financial independence!


Recommendation:  The low cost broker I use to buy shares is Pearler, which is purpose built for long term investing. Simple, clean and great features like Autoinvest, with none of the trading-focused rubbish other brokers have!

Join using my link and get free brokerage on your first investment. Pearler also has a referral program, so if you sign up using that link it also supports this blog, and thanks!

78 Comments

78 Replies to “LICs vs ETFs (Index Funds) – Which is the Better Investment?”

  1. I agree – LICs in Australia are awesome, they certainly offer more consistent dividends. The American index is hard to beat when it comes to diversification etc.. We will look to add lots of both to our portfolio over time 🙂

    Mr DDU

    1. Thanks for stopping by MR DDU. It’s hard not to get excited about Aussie LICs, that’s for sure.
      Sounds like a mighty fine plan! We’re happy just to keep the overseas exposure to our super fund.

  2. So how do LIC’s differ from Managed Funds? And what kind of fees are you looking at? They sound like actively managed investments, which generally means higher fees eating into your returns.

    1. LICs are very similar, being a managed portoflio of shares. Some small differences – A good overview here on AFIC website. The fees vary and generally LICs can be split into 2 groups. The older style LICs that are much less active and have very low fees – around 0.15% – such as Argo and AFIC, they’ve been going for 70+ years and are much more ‘index’ like. The more active style LICs – fees tends to be around 1% pa, some have performance fees also. Many of these are rubbish but the fund managers I have listed have provided above market returns, importantly after fees – which is what counts to us. Otherwise what’s the point! 🙂 I’ve updated the text to include the fee figures – thanks.

  3. Congratulations on what you’ve achieved. Great blog too and excellent write-up on LICs.

    It’s always great to see others as passionate as myself about investing in Shares for income, especially LICs. There’s no better way to invest in my mind.

    An important point you raised:
    “Quality LICs tend to avoid companies that pay very low or no dividends, such as speculative resources companies. This improves the income of the portfolio and generates a higher level of dividends for shareholders.”

    Investors so often focus on whether a LIC consistently outperforms the index. But I’m more concerned with consistency and reliability of dividend income. If a LIC underperforms for a period because it avoids those stocks you mentioned above then that’s fine by me.

    I look forward to following your journey.

    Cheers
    Gordon

    1. Thanks Gordon!

      Glad the write-up was to your liking. I know for a fact you know more about LICs than I do 😉

      I have really been won over by dividend investing, that’s for sure! Even Mr Bogle himself has suggested that is what investors should focus on.

      Yeah, completely agree mate. Income reliability is more important than constant outperformance. I’m happy even if we just receive index-like returns, but with a more predictable income stream. It’s actually preferable if they underperform at times, because we know there is sometimes rubbish that gets hyped up in the market.

      Good to have you here, hope you stick around 🙂

  4. So how you you allocate your portfolio or Index fund (or ETF) and LIC? Currently I’m in all index ETF of 30% VAS, 30% VTS, 40% VEU.

    1. Thanks for your commend BlackPinoy. You have a nice spread there! Much more diversified than I am.

      Currently more than half our wealth is still in property, and we are transitioning to shares. We have a basket of individual shares and the rest is LICs.
      So how I plan our portfolio is having majority in LICs for simplicity, and some individual shares. All with a dividend focus. The portfolio will be ASX only, as this will give a much higher level of income (around 6% gross). Later I plan on adding international index funds. such as VGS for diversification, but that will be after the main dividend focused portfolio is built.

      The LICs are a mix of large cap and small/mid cap for diversification. Such as Milton, Argo, BKI, AFIC for large cap and QVE & WAX for small/mid cap. The blended yield of this mix comes out to around 6% incl. franking credits. For allocation levels, equal weight would probably be fine. What I am likely to do is have a higher weight in the LICs that have a longer/better track record of consistent dividend payments, dividend growth and performance. Or the ones I consider lower risk. Like anything, it can be as complicated or as simple as you want to make it!

      There is no way I could achieve that level of dividend income with index funds, and I’m not a fan of selling shares for income, so this is the approach that fits best for me. Build ASX dividend income first to retire ASAP, diversify into international index funds afterwards. Will write more about this soon.

      Hope that helps 🙂

  5. I have just come across your blog as only recently started taking a look at some of the other Australian investing blogs out there.

    Have just read the posts on your journey, the rent v buy, and now this one on LICs & Index funds. Very refreshing to read some well-balanced discussions on those last two topics I mentioned.

    I can never get my head around the fact that I rarely run into people who use the strength in Australian property, particularly Sydney & Melbourne, to consider reducing the property exposure in favour of an investment structure that will give your more cash flow and financial freedom.
    I like this article also, I come across too many articles that don’t address the issue of lack of diversification in the Australian index when discussing LICs & Index Funds.

    I can certainly relate to the post about you and your journey. I shall try and read your other posts and check back now and then. Looks like some interesting topics you have tackled, so I am not just here stalking Austing’s posts 😊.

    1. Thanks for stopping by mate.

      Glad you’ve enjoyed a few of my posts 🙂 I do try to keep somewhat of a balanced view, even though we each have our preferences.

      Yeah, I think a lot of people would benefit by considering reducing their capital city property exposure, in favour of more cashflow from shares. Many people are equity rich and cashflow poor.

      I much prefer the LIC approach since we can create a more balanced portfolio, and receive dividend income from a larger variety of businesses. Not to mention, some of the LIC managers here have also delivered excellent returns over time.

      Haha, hope to see you and Austing around here in the future!

  6. Intriguing, thank you StrongMoney. It’s refreshing to get an Aussie perspective on this. I’m about invest in a mix of Indices, LIC’s but I’ve paused to consider the ‘vehicle’ through which I accomplish this and would like to hear your thoughts. Do you invest through a trust of some sort? Perhaps in the future you could blog on the merits of the most effective (tax, security etc). Many Tks

    1. Thanks Brandon. The best ownership structure is different for everyone – it depends on a lot of things. For us, we invest only in our personal names at this stage – we’re not large tax-payers, nor are we in jobs with a high chance of getting sued. I’m aware of some investors using a trust+company structure – that is the trust owns the shares and distributes to individuals who are at lowish tax rates, once low tax brackets have been used, income is distributed to the company – making it quite protective for ownership and quite efficient for tax. I can’t really provide much info on structures though, as I’m not well researched or qualified in this area. Check out this thread which may provide more info – Bucket Companies + Trusts
      Hope that helps and thanks for reading!

      1. This is exactly what I’ll be doing in the next few weeks. Just waiting on the paperwork. Much more tax effective.

        However, I won’t be setting up a bucket company for a few years as the ROI won’t be worth it to start with so my accountant has advised to hold off on that for a while until I’m earning a significant amount from my shares to make it worth while.

      2. I looked into trusts recently and I don’t think the trust structure (eg family) necessarily offers great benefits. Seek your own advice!

        Firstly – it comes as a cost to setup and maintain. Perhaps $1500 per year or so.
        Secondly – it is not the vault for asset protection that people necessarily assume.
        Thirdly – as a trust, net income must be distributed. If you don’t have a low tax individual to distribute to then the advantage is lost. If you are on the highest tax bracket you will pay the 30% company tax within the trust and top up as an individual on your personal annual tax return when declaring the income. Distribution to minors is covered by the ATO – in fact above an income of $416/year minors will be taxed at 66% which then drops down to 45% when income exceeds $1307/year.

        Thornhill and others say choose your asset on the value of the asset. Don’t let tax handling sway you. Tax laws change and circumstances change. I think the DSSP for AFIC and the BSP for Whitefield offers something but you don’t want to overweight there just for that benefit.

        If you are in a high tax bracket that’s great – you are earning lots of money. Focus on your spending and saving and you will be just fine. Ultimately what is your end point. If it’s dividend and income for retirement whether early or later you will be in a lower tax environment at that point.

        We live in a country with high tax – but we can’t change that. Of course factor in tax for your calculations to know true yield etc but one way or another you will pay tax. Even the CGT discount may disappear some time and even then do you really want to live on selling assets.

        1. Thanks for sharing your thoughts. It’s really an individual choice this structuring stuff.

          The costs are not to be taken lightly, it’s a big chunk of change and adds complexity to one’s affairs.

          I believe one of the more effective ways is to have a company as a ‘bucket’ to fill up the extra earnings over and above anyone paying above 30%.

          I agree it’s not always about tax, it’s about choosing your investments first. Although I think if someone is happy to invest mostly in old Aussie LICs then choosing AFIC and Whitefield for DSSP/BSP makes a lot of sense – same exposure and tax efficient.

          As you suggest – the rules can always change, so pick your investment style/strategy first. And I think where possible, we should do our best to keep it simple.

  7. Just trying to wrap my head around what you’re trying to do. If you were on a higher income would dividend investing would be the most effective way to grow your nest egg if you take tax into consideration. Say you get a dividend of 6% on average. You will be paying tax of 48% since your are in the highest tax bracket. Effectively you get 3.12% return which isn’t that wonderful. Compounding 3% a year will not grow your investment very much at all. If you invested in companies that mainly had capital growth it saves you on paying alot of tax which could eat into your returns. To get your portfolio to a size that is large enough to give you a higher income its gonna take a long time at 3%. It makes the more sense to me if you use this strategy once you have a large nest egg and want to retire and live off your dividends.

    1. It’s a good question Tom…

      Sure 3% isn’t great after-tax, but you’re forgetting growth. Company earnings and therefore dividends will grow over time. So when you add in growth of 3-4% also, now you’re looking at 7% – your money will double in a decade.

      The difference is that when you want to switch on that income stream, which is hopefully around 10 years or so from the starting point, then you’re looking at 6% gross and much lower tax rates, possibly close to zero.

      To take a capital growth focus is to put your future in the hands of the market more, as you’ll need to then sell-off your capital growth assets to put into higher income assets – possibly a lot of tax payable and large amounts to invest at once can cause stress and market timing problems.

      It’s a personal choice at the end of the day. I’d rather take the Oz market for higher income. There’s plenty of ways to have a lower tax rate to achieve higher after-tax returns, and therefore higher compounding returns – such as Bonus Share Plans offered by Whitefield and AFIC (caps tax at 30%), investing in a spouses name, investing through a trust+company structure to cap tax at 30%.

      It’s perhaps just some short term pain to setup the ideal income stream in the future. I don’t fancy the idea of ‘changing horses’ and needing favourable market prices to facilitate financial independence.

  8. Hi Dave
    Yes I didn’t factor that in. The devil is in the details. Will your funds have capital growth of 3 to 4%?? You have to take more short term risk to get longer term gain. If the companies are paying dividends they aren’t putting that money to use in growing the business. I’m not sure you can have it both types of growth. Its been 10 years since the GFC and the sharemarket has only crepted back to pre GFC levels recently. Most of the growth in the last 10 years was from dividends. The bonus share plans give you a slight discount and no share buying fees but it doesn’t save you tax.

    Regarding lowering tax the only effective way I can see is to use imputation bonds. They are a funny structure but basically dividends are paid at company tax rate of 30% ( instead of 48% if you’re on a high income) and if you keep them for 10 years you get to keep everything without paying any capital gains. You can only increase your annual deposits by 125% of the previous years. However the things you can buy within that structure may not be to your liking. And the entry fees, maintenance fees and kickback to financial planners are quite hefty adding to 3% or more! Warren Buffet won that famous bet with the managed funds vs a simple index fund over a 10 years investing period. It was quite telling how much the fees eroded away the returns and even more telling was the pathetic excuse the fund manager gave for his underperformance.

    The only thing more tax effective is super where you will pay tax on your dividends at 15% and once you retire all earnings on the first 1.6 million are tax free ( and earnings on super above the 1.6 million cap you only pay tax at 15%). Of course you can’t touch it till you’re 60 years old. No use if you want to retire early.

    If you retire and earn no income from any other source you will be in a lower tax bracket IF you have a small portfolio. Paying no tax means you’re not making alot of money (and vice versa)! So if you have shares under your spouse’s and your own name than you can both earn 18K from dividends before you pay any tax. Together you will have 36K to live on. That’s not much. If you both earn 37K each then you will have (37K x2 minus 3.5Kx2 tax) 67K to live on. Thats kind of tolerable if you don’t have kids to feed and a mortgage to pay off. But its not much either.

    I haven’t figured out what to do to transition from a capital intensive growth portfolio to a high dividend one. Berkshire Hathaway are attractive to me for this reason if you can swallow the currency risk. If you’ve forgone the dividends than you’ve saved alot of tax but get to pay it back with capital gains where you loose up to 25% in one big hit if you’re in the highest tax bracket. I guess you just sell up in the year where you don’t work to minimise this.

    My point is when you have to fight for every single percent of return you have to take tax into consideration. The returns quoted by the companies are really quite dishonest because they don’t include this. Compounding at 3% is very different to compounding at 7% which is the case if you’ve already paid tax on your dividends. Over long time frames that impacts enormously on your returns.

    1. Tom, the Bonus Share Plans (BSP) are an offer from 2 LICs, and approved by the ATO, which allow you to receive no dividends, but instead, receive ‘Bonus’ shares. You’re thinking of the DRP, dividend reinvestment plan. With a Bonus Share Plan, no cash changes hands, so you don’t need to declare this income, but also don’t get franking credits. In the end it means you receive a 4% dividend (approx) paid via new shares, no franking, and no tax to pay – effectively means it’s been taxed at the company rate (30%). Please see here http://www.afi.com.au/Registry-info-forms-and-explanatory-info.aspx – they’ve called it (Dividend Substitution Share Plan) same thing. There is tax implications if you sell these shares (it lowers your cost base), but for early retirement this wouldn’t be an issue.

      The GFC is a misleading starting point, over 15-20 years and longer (a more meaningful timeframe), earnings dividends and share prices have all grown strongly. Also, I’m not investing for capital growth specifically. I’m investing for dividend growth. That is, a good dividend flow that grows steadily over time. We only need those dividends to grow with inflation in retirement, which I think is extremely likely over the decades.

      As for growth, well the Aussie sharemarket despite being dividend-heavy has had growth of 5-6%+ for many, many decades. Growth may likely be lower in the future, but if the economy grows at around 3% or so, and with population growth, I don’t think it’s a stretch for company earnings to grow at 3-4%. There’s actually not much evidence to suggest that higher dividend payouts equals lower returns, sometimes the opposite is true, as management must be more selective with how they deploy capital and don’t waste money chasing growth.

      I’ve just showed you a few other ways to reduce tax for high tax payers wanting to retire early. If not wanting to retire early then super is a great option – the friendliest tax environment there is! Other than that, I’d personally be happy to suck it up and pay the tax for a few years until becoming FI. The way I see it is that being on the highest tax rate is a huge benefit, since it’s possibly to save a way higher amount of cash, provided one is living a efficient lifestyle. And two incomes on the highest tax bracket means a ridiculously high level of income! So the extra tax is only for a few years.

      With the low income tax offsets, it means you can earn 20.5k and pay no tax, so a couple can earn 41k of dividends tax free. This amount is actually around the same level as our living expenses (including rent).

      67k is kind of tolerable with no kids or a mortgage? Wow, we must have different tastes and opinions on what’s reasonable. I think 67k is way more than enough to live on, and that works out to be a tax rate of only about 10%, pretty damn good.

      Which companies are you referring to? Not sure I know what you mean here? Given everyone has a different tax rate, I don’t think they should have to give breakdown figures. The return is what they deliver to you – and everyone’s own circumstances and ownership structure will dictate how much tax they pay.

      Will just add – I think trying to save tax in the short term can create more problems in the long term, such as needing to switch investments later (as you’re considering now) and focusing on the tax more than the investment.

      While returns are super important, it can be dangerous to get too hung up on this stuff. Personally, I would find the investing style that suits me best (indexing, dividend investing, other)and and stick with it. The reason for me is, tax payable on the road to early retirement is only short-term. After retirement, the tax rates are lower on a reasonable income, then we can maybe look at more growth-focused stuff or more likely different holding structures such as super or a bucket company.

  9. Dave
    Thanks for the info on the BSP’s. So you get the benefits of company tax rates and save 18% tax if you’re in the highest tax bracket. I’ll have to factor that in. So this would be much better than getting fully franked dividends?

    I get annual reports from my managed funds showing how a 7% turn will double my investment in a decade but not telling me that after tax return is half that much. No way will it double in that time if what i get is a return of 3.5% after tax. The rates quoted for ASX returns again don’t show tax if you do a search on the internet. The only company that does that is Vanguard which shows the effects of different tax brackets. You are right a good investment is a good investment and tax is of secondary concern but my point is that we need to be more realistic what returns we actually get. A rising market makes everyone look good. I almost wonder if I need to get an accountant to go through my numbers just to double check I’m doing them right!

    You’re right I can live on 67K. I pay rent and have 2 kids. So $500 a week in Sydney for a modest place 40km from the CBD means 26K gone. School fees modest school 7K each means 14K gone. Sure you can just go to the local school but that’s not where I want my kids educated. Car rego, maintenance, insurance , petrol totals 3.5K. Try using public transport with young kids or going somewhere for the weekend. Phone bill, power bill say 2K. So I’m left with 20K after that. Health insurance? Dental bills? Doable for sure and enough for a holiday too.
    The only thing it won’t cover is if one partners gets permanently incapacitated like a friend of mine who become a quadriplegic last year. You have to get a carer to help look after them, modify the car and home etc. 67K doesn’t really go that far. You either need insurance or have spare million to cover this contingency. Its a fate worse than death.

    1. No worries Tom.

      Ideally, a high tax payer could use the BSP while accumulating to cap tax at 30%. Then when they wanted to retire, they simply tell the share registry they want to stop the BSP and receive the dividend flow. Now they’ll receive the dividends as normal with full franking, and pay whatever tax rate applies.

      Oh I see what you mean. Managed funds are a little different to LICs in the sense that no tax has been paid and all income and gains are passed thru to you – whereas the LICs have paid 30% tax already, so reported returns are much more accurate I guess you could say. Some end shareholders will be on zero tax rates, some on 48%, so reported returns after 30% tax is quite fair.

      It’s probably not the place for me to start trying to optimise your spending, but sounds like you think 67k is definitely a reasonable income to retire on (even with optional luxuries like private schools). And don’t forget, expenses may well be lower in retirement than while at work (we’ve certainly found that to be the case). You may even plan to earn a little hobby income doing something enjoyable, which boosts your income or lowers the amount you need to save.

      I’m sorry to hear about your friend. Quite often individuals will have TPD cover within their super fund, but that could be something to check out to cover that type of scenario, while not affecting your savings rate or investment portfolio.

  10. Hi Dave,

    Thanks for the great read! I’ve got a question for you. How many LICs or other shares/indices do you spread your portfolio over? I’m only just getting started and have a lump sum of around 100k to invest and am considering how many I should spread this over to start.

    1. Well, given we’re investing just in Australia at this stage, our investments are spread across a few large LICs, and a couple of mid/small cap LICs. There isn’t really a right answer, just what the investor feels comfortable with. We also have individual shares, but this is completely unnecessary! We plan to add international shares later on, but at this stage we’re focusing on income, so sticking with Oz.

      To be honest, the simplest way of investing in Aussie shares is just to go with perhaps 2 of the biggest LICs (like Milton, Argo, AFIC or BKI). Alternatively, there’s nothing wrong with making VAS (Vanguard Aussie Shares) the entire portion of someone’s Aussie shares. It comes down to whether folks prefer LICs for their dividend focus, or the simplicity of indexing. If you want to then add international shares as well, then you could look into VGS (Vanguard International Shares).

      I would keep it very simple at first, and learn more as you go. Hope that helps, and remember, simple is better 🙂

  11. Great article about LICs. Only discovered your blog today. I hadn’t thought about LICs in quite this way from the point of higher dividend pay out compared with ETFs. I currently have a mixed bag of LICS and ETFs — so MLT and AFI and also VAS, VTS, VEU and VAP. I began all of this in early 2016 so as you can imagine the capital growth on the ETFs has been big. I allocated about 50% to AU shares and about 20% to VTS, 20% to VEU and 10% to REITs.

    What I would be really interested to hear is your method of building your LIC holdings. Do you simply add cash into them with regular consistency in the same way superannuation payments go in (monthly for me) with no regard for the LIC stock price or do you “buy the dips” to keep your dividend yield as high as possible? Cheers

    1. Cheers Scott 🙂

      Nice job by the way, sounds like you’ve got a well diversified and solid portfolio there! Just keep in mind VAP is already part of VAS, as VAS contains REITs too. And the LICs hold some REITs, but not much. Your REIT weighting might be more like 15%.

      Just as you said, simply make a purchase each month or so. I do check the NTA before I buy to make sure the share price isn’t drastically different from the LICs portfolio value. Some people don’t bother with this as it often evens out over time. I try to buy a larger parcel if the price has gone down, but otherwise it’s just steadily accumulation. It’s the simplest and easiest way. Also likely to give a much better result than trying to be clever with it.

  12. Dave – I think another salient point about whether to choose ETFs or LICs is the stock price itself. Consider that the price of LICs are usually much lower than say VAS. Currently VAS is trading at $74.28 and MLT is at $4.50. Someone starting out with about $5,000 would see some faster compounding with MLT. In fact, a $5,000 investment in VAS probably wouldn’t deliver enough to buy many shares at all. And $5,000 in something like VTS would not deliver enough to buy one share — which is currently trading at $174.61.

    1. Scott, no the dollar price of the shares makes absolutely no difference, it’s like cutting a pizza into more slices – the whole pizza is worth the same amount.

      You will get returns on the total value you’ve invested. Both Milton and VAS will pay around 4% dividends plus franking, even though their prices are drastically different – it’s all relative. It’s hard to wrap your head around at first, but important to understand. Dividends reinvested results in leftover or fractional shares which are either honoured as a fractional share (I think this occurs in US) or carried forward for you. See here

  13. Dave – instead of us debating this, have a look at a real example on Sharesight (www.sharesight.com/au/) where you can compare different initial share purchases and see the effects over time for free. Create an initial $500 purchase of VAS on 1 April 2010 and switch DRP on and observe the results. You will see that in this scenario and with such a low initial purchase there was not a single additional share purchased in 8 years through DRP. Now do the same again in a new example but this time make the initial purchase $50,000. Have a look at the number of new shares that came through with DRP and then look at the difference in both capital growth and the increase from the dividends. Cheers

    1. I see what you’re saying. But it’s not a permanent flaw. As soon as there is enough for the first new share to be granted, those figures would jump up drastically for the small purchase scenario, because one new share is a massive amount of the initial purchase price. So eventually it will even out.

      But in any case, how realistic is it for someone to purchase $500 of shares and then leave it at that, forever.

      If you think it’ll be a major drag, then by all means, purchase shares/etfs with a lower price. I simply think it’s only a temporary glitch in accounting for very small holdings with a very large sticker price – not a permanent feature. Thanks Scott

  14. Dave – agree the overall difference isn’t much to worry about but I think people should be aware that they should at least aim to keep adding to the investment over time. It’s interesting to play around with different scenarios to see which one works out best — such as buy once and never look at it again for 10 years versus buy at regular intervals over those 10 years and buy even more if there is a significant market dip.

    There’s something else I found out today that people should consider if they choose to buy ETFs such as VTS or VEU. Both are domiciled in the United States. This means that should the holder of these stocks build them up to $US60,000 or more and suddenly drop dead, the holdings will likely be subject to a US “death tax” of 35%. There is a US-AU treaty in place for this. Another good reason to focus more on LICs.

    1. Definitely – adding more to investments regularly should be a non-negotiable commitment 🙂

      Yes, the overseas ETFs could create tax issues. It’s hard to find concrete information on this, but it’s not a risk to dismiss. Although it’s not as broad, I would use VGS for international shares. Covers all developed markets in one ETF, and domiciled in Australia, so no estate tax issues. Fee slightly higher though, but still very low.

    2. You just make sure your partner or whoever you are leaving your portfolio to is aware of this death tax that they need to log onto your accounts and sell them in the case of your death or otherwise just invest in Australian domiciled ETFs as Dave suggests. Easy fix either way.

  15. Oh man… you’ve given me much more to think about.

    Now I’m not sure about what to do. What if the index is Aus heavy, wouldn’t that give me the same sort of dividend returns?

    1. The older low-fee LICs and our index (ASX200/300) are both full of dividend-paying shares, so yes. The difference being those LICs have and will always focus on income, whereas the index will simply hold the largest companies whether they pay dividends or not.

      For early retirement when growing income is extremely important, I feel the LICs are a better match for me, even if they don’t beat the index. But right now, there’s not much difference between the two in terms of largest holdings or fees. Either is a good choice. For what it’s worth, if I had been buying VAS (for example) for a while, I wouldn’t bother selling it to buy the older LICs.

  16. The structural anomalies of the Australian market is something I have been thinking about recently with some concern. This has been alluded to in some comments above and in the post.

    As mentioned somewhere in the thread, the ASX 200 is very top heavy. The top 20 companies cover 58% of market capitalization of the entire ASX200. Not only is this highly concentrated in a few companies it is also dominated by a few sectors. Firstly, the large banks. Sure, they have a great history of profits and dividends but will this keep going? With the Banking Royal Commission, tightening of lending rules and the coming property decline (whether a correction or a bust or whatever) their profitability will decline. Infact they have been a drag on the index recently. The other big sector is resources/mining – sure they have done great the past few years, but as dividend producing companies this is well covered by Thornhill.

    The big index ETFs – VAS or A200 are clearly top heavy even though you think you are well diversified. The big LICs (AFI, MLT, ARG etc) are also top heavy. Perhaps Argo offers the best diversification of the bunch. Whitefield obviously skips the resources but still has a heavy bank weighting.

    So if you think this is a problem what are the options? As I see it;
    1. Go international – clearly the US market is very different structurally. Whatever your international ETF of choice is – VTS/VEU or VGS or emerging markets etc. Though as mentioned not as great for dividends. International LICs another option.
    2. Go it alone on buying small/mid cap companies. Well beyond my level of understanding and too high risk.
    3. Australian Small-mid cap LICs – I think not a bad idea but they come at a cost with high MERs. Can the golden run of WAM LICs continue. They come with a high premium to NTA and high management fees. Even a QVE or MIR come in at 0.6 – 0.9%
    4. Other Australian share ETFs for diversification. I think this area is interesting. Vanguard VSO comes in with a still competitive MER 0.30% – 1 and 3 yr yields 14.68% and 12.06% but lower dividend yield 1.97% and lower franking 39%. The other interesting one was Betashare’s EX20 which is the ASX 200 with the top 20 companies removed. There are other rules with maximum weights on individual stocks and sectors. Low MER 0.25% with only 1yr performance available 12.74%. It has higher dividend yield 4.37% but lower franking 10.28%

    There is probably a degree of fear mongering in this thought given the long track record of the ASX but maybe we are at a turning point. I don’t think the big LICs or the broad ETFs address this possibility.

    1. Wonderful comment SJ, really appreciate it. It’s an interesting topic.

      Banks have been a drag recently, but I actually see that as a good thing, especially for someone like me who is only invested in Australia. Their weighting in the index has dropped quite a bit. From almost 30% down to closer to 20% (banks not financials). The larger they get the more worried I’d become about the concentration.

      Our largest resources companies (BHP & RIO) have actually vastly outperformed the market over the last 35 years or so (have a chart somewhere) – that’s why they’ve become so large. I’m not generally a fan because their profits and dividends are volatile, but they are still important companies to our economy and remain useful for the world as a whole.

      I suppose much of it at the end of the day comes down to whether you believe the market will weight these companies fairly according to how relevant and profitable they are. In the future if banks/miners do poorly, that will be reflected in the index/LICs and you’ll naturally have less exposure to them over time, which is the great thing about owning 100-300 companies from a broad group of sectors.

      If financials are 30%, that still means that the majority of our money is invested in the other 70% that are sectors outside financials, that’s pretty good to me. Again it’s always a personal choice.

      On point 4, for Betashares ex-20, if you look at the taxable statement it shows that around 50% of the distribution was from capital gains (meaning higher turnover), so I don’t think that’s naturally a 4.3% yield from dividends. So Vangaurd’s fund is likely to be more accurate in terms of yield because they display ‘equity yield’ not total distribution which (includes cap gains) and looks to be what Betashares is showing.

      It’s a very valid point you raise but my thinking on this has actually mellowed in recent times. I do hold small/mid cap LICs to boost diversification but I also think the following…

      Given our banks outlook is for probably slow growth for the foreseeable future and they pay out most of earnings as dividends, this means they’re unlikely to grow in price/value. And we have quite a decent number of companies which are growing strongly, many with overseas operations, which are quickly becoming larger and larger parts of the index. So as this increases over time I expect the banks to become less dominant, while still paying huge dividends, and these other companies will continue growing in relevance and creep up into the top 30, 20, and top 10 stocks in the index. The likes of CSL, Amcor, Ramsay Healthcare, Cochlear, Treasury Wine Estates, Sonic Healthcare are good examples.

      I’m not here to dictate people’s allocations, but simple share what I’m doing and what makes sense to me. These are my updated thoughts on the topic and, as always, as I learn more and things change over time, my view will likely adapt. But at the moment, I’m becoming more content to let the market decide on how to weight companies in the market. Hope that makes some sense SJ 🙂

  17. I am still trying to work out all the mechanisms at play here.

    I understand how the ETFs will mirror the index and rises and falls will largely take care of the redistribution with maybe some buying and selling. Capital inflow into the ETFs is huge facilitating this.

    The closed end structure of the LICs is obviously different. Capital inflows rely on new share issues/DRP etc. I imagine these LICs are not buying up the banks or say Telstra but may be working to slowly change the portfolio characteristics. This will take time given their large funds under management and significant CGT payable for selling long held shares.

    If all the major banks say fall by 20-30% then presumably the NTA of the large LICs will fall accordingly. I suppose the question here is does it really matter if you are buying to hold, as long as dividend payments don’t fall in a similar manner. A significant fall in dividends from the big banks will surely have a material impact on the LICs dividend payments. This is I suppose what is at stake.

    1. I try to not overthink this stuff too much honestly. The index is already cap weighted so it doesn’t need to do any selling at all, unless stock fall out of the 300 and enter, which is at the bottom end obviously.

      Yeah from LIC commentary most are not really adding to their bank holdings but simply adding to other parts of the portfolio, which itself diversifies more without any CGT. I don’t think it will take long really if they want to because remember many of the mid-size companies are growing larger in their portfolio’s anyway. So just a little top up here and there, while the banks have little growth, will see the top heavy nature diluted.

      With a fall in the banks, they’ve already fallen well over 20% over the last few years. Remember CBA at $95? And the market is actually higher now than it was then, because of these other sectors and mid-size companies growing fairly solidly. So it didn’t even matter they fell.

      And at the end of the day the banks aren’t going to disappear, they’ll still remain huge cash generators which means they still deserve a decent place in a dividend oriented portfolio. If we have a banking crisis of some sorts, this will definitely be an issue. But if the banks make up 35% of income and their dividends drop by 30%, that equals a 10% reduction in total income. Obviously there’d be other companies hit in such a time, but just noting it might not be as bad as it sounds. And the fact that the last issue (GFC) was a banking crisis which makes it incredibly unlikely the next issue will be the same cause.

      But who knows. We each have to do what we think makes sense to us and diversify accordingly. Some will choose international ETFs for that job which is a sensible choice. Others will choose small/mid LICs. And some people will just roll with whatever happens with a market-like portfolio (VAS/old LICs) and adapt to any new realities. I’ll write an article about this soon, what happens when the sh*t hits the fan 🙂

  18. So we all know the current bull market is going to end at some point, next year or the year after or whenever. I assume the audience here by way of their long term view will largely continue to invest and take advantage of lower prices. I am trying to avoid a discussion about timing the market or asset class (bonds, property, cash etc.) Let’s assume just equities and continued investment.

    What do you think about investment vehicles in the coming bear market? Does your strategy change at all depending on market conditions or do you just carry on in the belief that the foundation is true regardless of the market.

    LICs will obviously drop in price with the index. Discounts to NTAs may increase? The older style LICs presumably will behave similarly to the index given their composition. Dividends as discussed tend to drop less than price – so this is an advantage.

    Index funds obviously follow the index. My understanding of the active/passive debate is that much of the longer term advantage of index funds is a smaller fall during the bear market as compared to active funds. So capital preservation may be an advantage of index funds in this scenario.

    Then of course, every down market is followed by a bull market which tends to outdo the declines from the preceeding bear market.

    So do you just stick the course?

    1. As an example, during the heights of the GFC, the Australian Foundation Investment Company (ASX:AFI) continued to pay dividends as per usual. NOTHING changed except the price of the stock. In other words, if you were Joe the fisherman living on a remote island, who relied on dividends for a passive income but never watched the news, you would think nothing had ever happened. You’d just carry on with ignorant bliss. So yeah, stay the course.

    2. No change. In fact, I’ll try to buy more in any case. I’m trying to get into the habit of getting happy when my portfolio goes down, and bored when it goes up. Being able to buy future income streams at lower prices is nothing but a good thing 😉

      Unless society itself crumbles, I don’t see why LICs or index funds will prove to be a poor investment over the long term. I believe lower share prices (when they come) will simply mean higher returns from that point of lower valuations.

      As for LICs – actually they tend to trade at a premium when the market falls quickly. Think of them as very slow movers. So when the market spikes up, they take longer to catch up, and when the market drops, they take longer to drop. This is likely because the old LICs are mostly owned by long-term holders so the prices move around a little less. Buying the index in a crash may offer better value as the LICs may trade at very large premiums (10%+). But in reality, both will likely deliver strong returns after purchasing when the market has a nasty fall.

      Usually the opinion is active funds fall less in a crash because they’re able to hold cash and may hold value stocks which hold up better – but that argument has been mostly debunked I believe. In any case it’s not a factor that I think about at all.

      Bottom line is, yes absolutely stay the course. When the market falls, try to buy more. If we’re buying equities over the course of our lives, and especially for the income stream, why would we want the price to go up? We get richer on paper – so what? It’s the earnings and income that matters.

      Far more attractive if the price is lower, considering the long term trajectory of the economy and the wealth created in society doesn’t change all that much.

      1. Agreed, absolutely keep buying as long as income and savings allows.

        So to clarify – what you would buy would remain unchanged? Buy the exact same LICs at lower price, assume dividends remain relatively stable and enjoy the higher yields?

        1. Yep I’d be buying the same LICs. The only other thing I’d look at is buying the index (VAS) if the LICs were trading at a large premium.

          Nobody knows what the next crash/recession will look like of course, but it’s very likely that LIC dividends will be more of a comfort than share prices.

  19. Interesting discussion Dave & SJ. That can be an interesting blog post in itself Dave, how much cash to keep aside for someone who has reached “F.I.R.E.”?

    Some may say a couple of year’s living expenses. That can shield you from a big fall in dividend flows if it were to occur. But is then there an extra amount to use for buying stocks if they fell by 30% for example? Peter Thornhill has remarked he took advantage of some hugely discounted rights issues in the GFC that performed well.

    It is easy to say that if you were on a desert island during the GFC you would come back and see your old school LIC dividends unchanged. Yet it may still be very frustrating just sitting back and doing nothing for many.

    I am guessing for Peter Thornhill it probably wasn’t even a worry for him if his dividend income was cut by 70%. So it’s easier for him to pick up bargain buys in the GFC. Maybe that is the answer, accumulate a lot first before you stop working! I might have to go back and get a real job again now!

    If you are already fully invested and don’t have a salary coming in though it is harder to look at falls in the market as being exciting buying opportunities.

    1. It’s on the list to write about Steve 😉

      I think in retirement, you have to accept you won’t be able to be buying when the market drops, unless you’ve retired with a large surplus. In any case, most people will probably not be suited to buying heavy when the market drops. Everyone says it, but how many do it?

      Survival will be the goal at that point. So cash will be used to top up dividends and spending reduced where possible. With any part-time income we might even be able to buy some shares. While it may be frustrating to see values drop, dividends drop, and do nothing about it, that’s simply what we have to accept I think. If we really want some extra cash to buy shares, we can get a real job like you said haha 🙂

  20. Thank you for your blog and to all those that have commented above. I have learnt so much by reading your post and the views of others.

    Not only do you provide a balanced view but also clearly put forth your investing strategy without trying to convince others that it’s the “best” method. Over the last three years I have read many blogs where it is very clear the writer is trying to “sell” their trading strategy as the “best” alternative.

    I have been picking stocks and developing a portfolio with 25 Australian companies mainly in health care, financial, consumer staples, industrial, consumer discretionary and telecom with companies such as COH, FLT, RHC, CSL and CBA making up 43% of my portfolio.

    More recently I have added VEU (17%), WHF (5%) and MOGL (23%) and was looking to change the diversification of my portfolio, but didn’t want to continue stock picking. However, although I considered adding more LICs I wasn’t sure which LICs would fit best.

    Also I wasn’t sure if I should add more international equities to my international portfolio which includes VTI, Facebook, Alibaba, Tencent and Travelsky (51% of this portfolio).

    You have provided great insight to help make this decision and your arguments for building your portfolio with LICs that focuses on income growth resonated greatly with me.

    Gaining FI is very important to me and I felt the need to reevaluate my investment strategy as my portfolio was moving away from my objective. I will now be looking at increasing my WHF weighting and adding Milton and AFIC to improve my income stream.

    Your Q and A with Peter Thornhill’s also helped clarify things for me. (BTW I loved his book too and have re-read it twice now).

    The universe works in mysterious ways and I found your blog at just the right time.

    So once again thank you for your insight!

    1. Thanks for such a great comment Rose!

      Glad you’ve enjoyed my various blog posts, and Peter’s book/videos are a big help.

      I do try to share my passion for the dividend investing approach while acknowledging there’s plenty of other ways to invest – this is just what we’ve settled on and think the approach is underappreciated 🙂

      Also, appreciate you sharing your investment experience with us here, and your new plans going forward. The growing income focus of these LICs is really what lines up so well with investing for FI and retirement in general. Other strategies may perform better, no question, but if there’s a better match for a hassle free income stream I haven’t found it!

      We’re lucky to have quite a few savvy readers who visit this blog and you being an experienced investor it sounds like we now have another one 🙂

  21. I’ll second Rose’s comment. I am relatively new to investing and I really appreciate being able to read this discussion and get a balanced exposure to others’ views. Great thread, thanks. I’ll be working my way through your other posts.

  22. Hi mate,

    love your blog! I am still a newbie so I am sorry for a stupid question: Why should I buy several LIC’s rather than putting all my money in one?

    Thanks

    1. Thanks Vlad. There are no stupid questions here!

      Some reasons people buy multiple LICs are… diversification between managers (in case something funny gets into the water at Argo for example), some extra diversification between scompanies (they don’t all hold exactly the same portfolio), more opportunity to buy at a discount to NTA. Also during a downturn one LIC might cut their dividend, but another might keep theirs stable, so owning more than one is likely to have a smoothing effect.

      No need to go nuts with it, if choosing this option I think more than one makes sense, but you don’t need to own all of them! Hope that helps.

      1. Thanks for the quick reply. May I ask which ones you own? I myself (since I just started) only have AFI and VGS at the moment.

    1. Thanks Larry 🙂
      My unsophisticated view is that over the long term I would go for unhedged. Hedging tends to result in wildly erratic or no distributions which isn’t great and the currency diversification by staying unhedged is probably good for Aussies. Some great thoughts in this thread here by people smarter than me. Hope that helps.

  23. Hi Dave,
    Really appreciate the insight and have learnt enormously about your approach to Financial Independence. As you can appreciate there is a lot of information, not to mention data, “floating” in the ether, and you’ve done well to develop a strategy to achieve your objectives. I’ve read your LIC reviews and now feel a little more informed. You’ve covered the major LICS and wondering if you intend to include others – MIR and ECL?
    Regards
    Dave

    1. Cheers Dr Dave!

      Yes there’s a ton of opinions on the ‘best’ approach when I really don’t think there is one – only whatever meets our needs and helps us stay the course.

      I’m still undecided whether to write many more reviews. People will likely enjoy it (including me) but I don’t want to overwhelm others and make investing seem complex or intimidating (with too many options) because it certainly doesn’t have to be!

  24. Considering the initial post in June 9, 2017 over the last 2 years have there been any changes in the thought process at all with regards to LIC’s vs ETF’s, adding International, Emerging Markets etc ?

    1. My thoughts on index funds have changed, which you can read here. But not in regards to international shares. We have our super setup as 100% international for a bit of balance, but our personal portfolio is still Oz only. We’re happy with this setup at the moment. Not bothered about emerging markets. Australia is quite exposed to emerging markets already through mining, tourism etc.

  25. Thanks for your great content, i too am a big fan of Peter Thornhill.

    Im looking for an ETF that tracks the ASX 200 industrials index AXNJ, do you know of one by any chance?

    1. Thanks for reading Fay 🙂

      There isn’t one. One LIC called Whitefield is all-industrials though (excludes resources). Peter invests in that one. I wrote a review on it here if you’re interested – Whitefield review

      1. Someone should create an ETF that tracks the ASX 200 industrials index and give it the ticker THOR 😉 Maybe Betashares? They seem to like funky names for their tickers!

  26. Thanks Dave, i did read that review and it was very helpful.
    I thought there might be an ETF seeing as these days there’s and ETF for anything. But it seems LICs are the best option.
    🙂

  27. Hi Dave. I am really enjoying your blog. I have been following the Motivated Money strategy for a while and you have really expanded on it with real life examples and provided detailed research on the LICS / ETFS.

    One thing I have noticed looking at the holdings of some of these instruments is that on some occasions there is cross ownership of stocks. e.g. LIC A owns SOL that owns 60% of the stocks that LIC A already is holding.

    Should this be of concern that the pool is too narrow? What are your thoughts on this?

    1. Hey Hugh, thanks for reading 🙂
      Yes there is some overlap on occasion but this is only to a minor degree really. The bulk of the portfolios are all ASX listed stocks, rather than huge holdings in other LICs. Where they do hold other LICs they would’ve been purchased while trading at a decent discount to NTA some time in the past.

  28. Hi SMA. Thanks for posting your thoughts. I’m trying to decide between ETFs and LICs and want to compare historical dividend performance. You mentioned that LICs tend to provide a better income stream. Could you point me to any data sources that compare dividend performance that takes into account fees etc Thanks again!

    1. Hey Tony. Any dividends that are paid by LICs or ETFs are paid after expenses. This article has a comparison of payouts between STW (an ASX 200 index fund) and AFIC over time. A bit of an extreme example, but shows the difference between the two income streams. LICs come with their own risks of course, with risk of underperformance being the main one.

      In case you’re not aware, my views have changed a bit since I wrote this article. These days I invest in both index funds and LICs, with the main reason being index funds offer greater diversification (including international shares) and no risk of underperformance. Keep reading around and have a think about what feels right for your situation. All the best 🙂

  29. Great post Dave and thank you for sharing your knowledge with us. I am also enjoying your podcast Fire & Chill – well done.
    Would your position/thoughts change if the legislation changes around the franking credits? If so, could you explain more?
    Also, where can I find your current holdings, if they are published here of course. 🙂 Thank you.

    Good luck.

    1. Thanks Camila, glad you’re enjoying the podcast!
      I wrote about my thoughts on franking credit changes a while ago here. And you can find our most recent portfolio update here. Hope that helps.

  30. Great post Dave,

    You mentioned this:

    “Some LICs also offer a Bonus Share Plan (BSP), sometimes called Dividend Substitution Share Plan (DSSP) – where you are able to forgo your dividend in exchange for more shares in the company, often at a discount and pay no brokerage or tax. This can be incredibly tax effective for those in a higher tax bracket. No income needs to be declared because no cash changed hands. ”

    At what point would you switch to a DSSP over a DRP? I assume the DRP will have minimum tax at the start when we begin investing but can you switch back and forth. For example, If I reach $100,000 or more invested in LIC’s, would it be a good idea to use a DSSP instead.

    I hope this makes sense.

    1. I am also wondering the same thing, at what point should i switch from DRP to BSP? I have tried researching online and i got no where, mainly because a few bank websites (i think it was ANZ?) explained that BSP is only relevant for bundles of shares bought decades ago, before some cut off date.
      So its still not clear to me.
      If i buy shares of company XYZ tomorrow, should i select BSP by default if my current income from my job is in the very high tax bracket?

      1. You are confusing bonus shares which, in the past, were issued by companies from its share premium account with the current Dividend Share Substitution Plans. These are available from WHF. MIR, AFI, DJW, AMH. WHF does confuse the matter by using the term Bonus Share Plan.

        Have a browse through this page from the ATO.

        https://www.ato.gov.au/General/Capital-gains-tax/Shares,-units-and-similar-investments/Bonus-shares/

        Also explore the website of each of the above LICs. They have pretty extensive description along with the relevant Terms and Conditions plus a link to the ATO’s Class Ruling for each plan.

    2. Hey John. It is specific to the investor’s personal tax rate, rather than how big your portfolio is. So while you’re working, you might already be paying tax of 37% or more. The DSSP means your investment will be effectively taxed at 30%. Unless you’re on a high income and you want to invest in the LICs which offer these plans, then a normal DRP makes more sense. I go through a proper example of this in another post here.

  31. Hi Dave,

    After much research we have decided on starting a minor trust through our commsec account for our son. As reading through here and other articles of yours (thank you so much for what is a substantial library now!) i feel the best way forward is to invest in LICs with the DSSP. That way we wont be affected by the tax and our son can pay the tax if he ever decides to sell. We are thinking that we will go 50/50 into AFIC and Whitefield given they offer the DSSP.

    Was wondering if you had any thoughts around this?
    Again thanks for your great work!

    1. Hi Joel, thanks – I’m glad you like the ‘library’ of content! Interesting question…

      I’m wondering, if you are going to use AFIC and/or WHF for the DSSP for your son, why do you also need a trust? As you said, tax would be zero, and later he can pay the tax if necessary. But why can’t you just create an account where you have bought the share’s on your son’s behalf? This article explains how.

      To me, trusts seem like an unnecessary layer of complication and yearly cost in most cases. Unless I’m misunderstanding what you’re saying? You may actually be referring to the type of arrangement I described, not sure 🙂

  32. Hi mate,
    Fan of your articles, great content to keep me motivated.
    Quick question – when you say ETFs return lumpy dividends what do you actually mean by that?
    Also – 1 LIC what would you pick?
    Cheers

    1. Hey Baggy, thanks mate. What I mean is, the index has to pay out whatever dividends it receives during the year, which tend to fluctuate quite a bit. LICs are companies so they receive income, then get to decide how much dividends to pay out. This lets them create a more predictable income stream for shareholders.

      If I had to pick one LIC to buy at this very moment, it would probably be Argo. Reasonably diversified, and trading around the value of its assets. Not advice.

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