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Sitting Down with Strong Money – Your Questions Answered #4

June 22, 2019


Welcome to our fourth edition of Strong Money Q&A – where readers send in questions and I share my answers with all of you!

More great questions this time around, about LICs, super and lots more.  So let’s get stuck in.

(Remember – nothing on this blog should be considered financial advice.  And as always, do your own research before making investment decisions ????

 

Question #1

Hi Dave,

In my quest to build my mortgage deposit as quickly as possible, I’m thinking of ways to increase my savings, instead of the slow term deposit returns I’m getting.

For instance, let’s say a company is about go to ‘ex-dividend’ and pay the dividend next month.  If the company has a yield of 4% – if I was to put $50k in today to meet the deadline, then would I be in line to make a $2000 dividend?

Then after the date I sell my shares.  This is all assuming there is not much change in share price when it’s time to sell.  What are the implications with this system?  What am I missing, as it seems like a great idea and if I’m being honest (more fun) way to help me get to my target deposit more quickly?

Brad

       

Strong Money’s Answer:

Hi Brad,

The strategy sounds amazing doesn’t it?  Problem is, it’s too good to be true!  That’s because as soon as shares pass the ex-dividend date (when new buyers are no longer entitled to the upcoming payment), the shares tend to fall by the amount of the dividend.

Also, with a 4% yield, you’d receive around half of that for the half-year dividend, and the rest 6 months later, in most cases.  Not 4% for every payment!

The safest bet for your house deposit is simply the old savings account/term deposit route.  Sure it’s not exciting, but at least you definitely know the money will be there when you want it.  Not worth exposing your money to risk since you need it in the next couple years.

Sorry mate, there’s no Easter Bunny – keep plugging away with the savings, you’ll get there!

 

Question #2

Hi Strong Money.  Where do you have your super money?  Which funds and why?

Thanks, Dan.

 

Strong Money’s Answer:

Hi Dan,

Until recently, our Super was invested in individual stocks as a bit of an experiment.  After a few years I pretty much gave up/lost interest with this and recently switched back to a more effortless style of investing.

There’s a few good low cost Industry funds.  But we chose SunSuper, and went with 100% indexed international shares (managed by Vanguard) for 0.19% all up, plus $78 annual account fee.  This is because outside Super we’re 100% Australian shares, so this diversifies some of our wealth.

Those fees are cheap as chips (though there are other low cost funds too).  I don’t really like the ‘zero’ fee funds as they typically use derivatives to create sharemarket exposure, rather than actual ownership of the index and having it managed by a proper index fund provider.  Maybe not a big deal, but I feel funny about it.

In general, I’d say choose something with a very high weighting to shares at low cost.  For most of us, this is money we won’t be using for many decades, so we want it invested in the highest returning assets we can.

 

Question #3

Just getting into the FIRE movement, doing my research and building up my understanding.  One thing that keeps coming up in FIRE literature is the concept of automating your saving and investing.

However, I am not sure what this actually means or perhaps more specifically how this might work.

The saving bit is simple (put money regularly into a bank account).  But on the investing side it doesn’t seem clear.

From what I am reading FIRE people suggest investing in ETFs or similar on a regular basis at the lowest cost.  But to do this you need a brokerage account and to make the purchases yourself.

The issue I can see is that my wife and I have jobs that get busy during the year and we could easily forget to make the purchase.

Is there a way to automatically just purchase ETFs each week/month?  And be more automated so that the process happens in the background?

 

Strong Money’s Answer:

Interesting issue you raise.  As you said, saving is easy to automate, investing less so.  There’s currently no way to automate ETF purchases as far as I know, unless you pay to use a Robo-Advisor like Six Park.

There is another option, though also more expensive, which is to setup an account directly with Vanguard for the fund you wish to invest in.  They’ll give you a Bpay number and you can setup an automatic bank transfer to sweep cash over to your Vanguard account.

Costs are quite high until you have a larger balance.  Vanguard Aus shares starts at 0.75% per annum for balances under $50k, then scales down to 0.35% for over $100k.

But it’s often mentioned that Vanguard will let you open a wholesale account with a $100k lump sum (rather than $500k as the website states) which charges 0.18%, almost as cheap as the ETF version, and international shares is also 0.18%.

For some people, the extra costs will be worth the ease of use.  Hope this helps.

 

Question #4

G’day!

Thank you for all the effort you have put into this site.  I’m finding the information extremely valuable.

My fiance and I started a savings account for our daughter when she was born.  She is currently 6 and we want to give her a financial start in life when she turns 18.

We currently have $8k saved (with an additional $1k per year to be added to this) but I am curious in how you would invest this for the next 12 years rather than leaving it in the bank.  Any tips would be amazing.  Cheers, Anton.

 

Strong Money’s Answer:

Glad you’re finding the blog useful.  And great job getting started and thinking long term!

To be honest, I would simply invest it the same way you invest your own money.  You could simply bundle it together for simplicity and decide mentally that say $20k is going to be for your daughter and when the time comes, give that to her.  Or you can keep it separate of course, if you prefer.

Either way, make sure it’s in your name (or your partner’s), whoever is on the lowest tax rate.  Investing in a child’s name will attract massive tax rates which you really don’t want!  All the best with it Anton.

 

Question #5

Thanks for sharing all the information on your blog.  I’m very new to investing and trying to learn as much as I can.  Sorry if you have already answered this question before.  My question is trying to understand why on annual basis, the dividend distribution from VAS varies so much.

For example, the following CPU (cents per unit) data from Vanguard’s website;
31 Mar 2017: 54.02
30 Jun 2017: 45.28
30 Sep 2017: 100.88
31 Dec 2017: 68.09
(Total 268.29 cents)

Compared to;
31 Mar 2018: 65.52
30 Jun 2018: 101.72
30 Sep 2018: 112.74
31 Dec 2018: 71.06
(Total: 352.04 cents)

On an annual basis, there is almost a 30% increase.  I don’t understand how the dividend can increase so much each year.  Am I reading something wrong?

I understand you mentioned on your Q&A before each quarter distribution can vary because companies pay dividends in different months, so the distribution can vary a lot on each quarter.  Thank you for your time in answering my question!

 

Strong Money’s Answer:

Good question.  That’s the thing with index funds.  The payouts vary and there’s little commentary to say why.  For investors focusing on income, that can be frustrating.

Every year there is some turnover in the fund as some companies are removed (because they’ve been acquired by other companies or de-listed etc).  This creates extra cash which has to be paid out because VAS is a trust structure.  There can also be large one-off special dividends.

I believe the June 2018 payment was much larger because Westfield was de-listed as it was sold to a European company and removed from the index.  The sale resulted in cash which was paid out to VAS holders.  Could’ve been other things too, but that’s one cause.

Looking at the other quarters you’ve listed there, we can see the dividends are not massively different from last year.  It was mainly the June payment that was way up.  I’m not sure of the exact breakdown, but I hope that helps explain the possible reasons!

 

Question #6

Hi.  Just wondering why you choose to invest in VAS (Vanguard Australian shares) instead of VHY (Vanguard High Yield).  The dividend payout is better with VHY, and there is still capital growth.

Thanks

 

Strong Money’s Answer:

Very fair question.  I used to own this actually and it sounds good for those who want cashflow, but it doesn’t meet our goals (relatively reliable growing income over time) as well as VAS and old LICs.

VHY is much more concentrated.  Has only 50-ish holdings in total.  VAS has 300.  This includes a good amount of companies that are lower yield now but should have stronger dividend growth over time, rather than just holding only high yield companies.

It’s not all about yield now, dividend growth is very important too for our income to grow quicker than inflation.

VHY’s top 10 holdings are 66% of the fund.  For VAS it’s more like 40%.  That’s concentrated enough!  VHY has 40% financials.  VAS is closer to 30%.  VHY is higher fee at 0.25%.  VAS is 0.14%.  Not much but still matters.

VHY has higher turnover (meaning more buying and selling).  The fund switches in/out the new highest yielding companies each year.  Turnover was 37% last year, meaning a third of the companies were sold and new ones bought.  That creates large taxable events and you end up receiving capital gains in your distributions which are not tax efficient.  VAS turnover is way less at around 3% last year.

VHY distributions are much more variable because of the turnover in the fund.  VAS is mostly just pure dividends from the underlying companies.  This means the income is much more reliable and sustainable.

So while it sounds like a good fit, these are the reasons why I feel VAS is a superior choice – even for a dividend focused investor.

 

Question #7

Hi Dave, I’ve enjoyed reading your blog posts, especially the ones regarding LICs and dividend investing.  I plan on doing a 2 stage FIRE – accumulate outside of super for the next 8 years (until age 50) where I should have about 400k in ETFs and/or LICs.

That should last me for 10 years (I spend about $50k a year) but I’ll need to sell them off in order to make it last.  Once I hit 60 (or whatever the age is then), I will have enough super (between $1.2 and $1.5M) to last me indefinitely.

I like the idea of LICs for accumulation and income stream but what about selling them off?  All the LIC strategies I read about are about accumulating, living off the income and never selling.

If I have to sell over the 10 years, would an ETF portfolio be more suited this?  I’m interested in your thoughts.

 

Strong Money’s Answer:

Thanks for the tough question!

As you know, the sharemarket doesn’t move in a straight line!  So making forecasts of how long money will last is almost impossible, because we simply don’t know what future returns will be and more importantly, which order they will come in.

I can’t say what vehicle would be better for that particular goal.  As always, I’d choose what you feel most comfortable with.  The real issue is what happens with market returns.

Ignoring franking refunds for a moment because they’re not guaranteed.  You’d likely get a comfortable $16k-$20k or so income stream from this $400k of Aussie shares, but then have to sell to make up the shortfall, as you know.

Definitely doable, but I’d also want some backup plans in place, in case you get bad market returns.  This could include part time work (great if you’re keen to wind down slowly), flexible spending, and other things you’ve probably read in my Financial Independence Backup Plans posts, here and here.

Maybe not the answer you’re looking for.  But this approach needs more backups in place, because this aggressive withdrawal method would be more risky than simply living off the income.  If you’re okay with working a little during those 10 years, and flexible with spending then I think you should be fine.

 

Question #8

Hi there,

I really enjoy your work.  I have been following you for a while now.  I’m trying to get my head around the LICs buying shares in each other.  Any chance of explaining what’s going on here?  Cheers, Brett.

 

Strong Money’s Answer:

Thanks Brett!

I believe these investments were made a long time ago, perhaps during the market recovery after the GFC, when many of the old LICs were trading at substantial discounts of 10% or more.  So combine that with the fact that, up until the last 5 years or so, many of them had long term performance ahead of the market, that’s probably why those investments were made.

Of course, performance hasn’t been as good in recent years as in past decades, so it doesn’t look like the best move with hindsight.  But I believe that’d be the rationale for it anyway (without asking the companies themselves of course).

Hope that makes sense.  And thanks for being a long time follower, much appreciated!

 

Question #9

Hi Dave.  Love your work and thanks for posting regularly.  I’m on-board with purchasing a growing portfolio of LICs/ETFs for 20-30 years, however it is all foreign to my partner.  She is great with money (and very much keen to retire early) so no problems there.

However, in the next couple of years I want to start building a portfolio and need her to become comfortable with putting say $20k-$30k a year into the market.

I’d imagine there are quite a few others in the same position looking to educate their partner and get them on-board.

Perhaps a new topic for you?  Aimed at partners of FIRE followers that explains the basics for them in order to help generate understanding and support?  Thanks again and keep up the good work.

 

Strong Money’s Answer:

Awesome idea, and likely a common issue!  (After this email I ended up writing this post – 7 Steps to FIRE for Newbies and Spouses).

One major thing that gets people to come around to realising the sharemarket isn’t some giant casino is when they start getting paid dividends.  And when you start tracking your future dividend income, as I mentioned in this article, it gives you something to focus on other than the daily market movements.

For some of us, this is what helps us stay the course and realise it’s about businesses and cashflows, not squiggly lines on a chart or frantic traders swapping pieces of paper.

Every time you buy you can update your little notepad or spreadsheet, because now your annual dividend income has gone up – and you can simply focus on that instead of the market.

Incredibly simple but powerful in my opinion.  Maybe that’ll help.  So instead of earning interest on savings, you’re earning cashflow from your businesses.

And maybe explain that the ONLY way you’re going to be able to retire early, is if you’re invested in assets which provide growth over time, otherwise your cash hoard will dwindle away to zero, and be worth less every year thanks to inflation!

The truth is every investment is risky.  But cash is probably the riskiest of all, since at current interest rates, it’s effectively guaranteed to go nowhere after inflation and tax.

Shares are volatile, but the earnings generated by companies grows over time with the economy, and when combined with dividends, lead to solid long term returns, which is how you’re compensated for this ‘risk’.

Hope that helps and see if the ‘annual income’ focus helps 🙂

 

Question # 10

Enjoying your work as always.  Would love your thoughts on the below.

I’m currently happy with LICs outside of super, but I’m still a bit unsure about what to do with my super.  I’m 38 and currently have Super in HostPlus Index Balanced for cheap fees.

In hindsight, this is a bit conservative.  I might use HostPlus ‘ChoicePlus’ to invest in shares directly instead, but still working it out.

Questions:  What happens to shares purchased in super upon preservation – does the Super provider sell them to pay you out or can you transfer them out under your name?

Based on the above I’m not sure if LIC or ETF’s would make more sense?  I was thinking about VAS/VGS split in super and LICs outside for a bit more diversification, but I like the idea of buy and hold, never sell.

Cheers, Stephen.

 

Strong Money’s Answer:

Hi Stephen.  Hostplus is a good low cost Super fund, but I’m not really a fan of the Balanced option having 25% bonds/cash for long term investing.

On preservation age – I’d assume that your portfolio stays as is and it’s up to you to liquidate or not.  I don’t think you can transfer them to personal names – I believe they’ll need to be sold, your account closed down and then the super fund sends you a cheque for the balance.  Or you can withdraw some each year and keep it open.

And I wouldn’t go for LICs inside super as well.  There’s really no need, and you’re then doubling up on fees (Choiceplus fees, plus investment fees).

Instead, I’d find a super fund which is ‘high growth’ or 100% shares at low cost, choose your split between Aussie and International shares and let it run.  You can either take your super out tax-free at preservation age and put the cash into your personal portfolio, or leave it in and take some out each year (the dividends perhaps?).

You’ll slowly be forced to sell it down as the mandated withdrawals increase as you get older.  Leaving Super open can make sense for tax purposes if you have a substantial personal portfolio.

It allows you to keep investing at a 15% tax rate (currently).  So depends on your balance and whether you wanted/needed all the money at 60ish or not.

Keep in mind, super is not my strong point at all – given my age I haven’t read up on it that much, so any of the above could be wrong!  Hope that helps mate!

 

Notes

I hope you enjoyed this Q&A session and found it useful or interesting!

Remember, the point isn’t to blindly follow this stuff.  It’s simply to share more behind-the-scenes thinking, clear up common queries and give readers extra info to evaluate things for themselves.

As always, you can send me a question through my Contact Page, and I’ll do my best to answer it.  Thanks so much for reading!

Do you have any additional thoughts for our readers?  Please share in the comments…

26 Comments

26 Replies to “Sitting Down with Strong Money – Your Questions Answered #4”

    1. That’s a solid suggestion Aleks. I believe investment bonds are taxed at a minimum of 30% through accumulation phase though, similar to Bonus Share Plan from AFIC? This may not be as good as investing in his partner’s name where she may be at zero or a very low tax rate. Also fees are generally higher with investment bonds.

  1. Excellent questions and responses. Great session. You know Dave, with a quest to simplify and declutter many aspects of daily life, your blog’s are one of the few to survive my email subscription cull. Love your approach and the way that you write. Cheers.

    1. Thanks for sharing that Sleepy John. I’m not sure that’s quite the reason for the old LICs doing it – they are extremely unlikely to be a takeover target like Brickworks/Soul Patts.

  2. Hello Dave,

    This was sure to elicit extremes of opinion.

    Starting point – I have had an avid life-long aversion to both insurance companies and salesmen and will continue to do so. That feels better already. Having said that when I feel I need insurance I do my homework about whom I turn to for advice and have the greatest respect for them once I have completed my due diligence.

    I will try to keep my response totally un-emotional and make it easily digestible. Put simply if you can identify that which you are insuring against you either choose to insure it (and it is catastrophe that you insure against) or not. What genuinely needs to be insured against is the un-quantifiable risk that comes with some contingencies. Some have been alluded to in the above responses. Examples include third party (the other vehicle), and public liability (your house, commercial property, almost any pursuit where you choose to participate, including driving the aforementioned car).

    This is an area that requires prudence and judgement ( as for example your investments require). Some people are in a better position than others to make these calls; those that aren’t might consider different advice.

    As always there is no right or wrong decision.

    1. Thanks for this comment Peter – it was directed at my insurance post but somehow ended up here, not sure what happened there.

      Great well thought out comment and approach. I’m perhaps more averse to insurance than could be considered reasonable! Maybe I’ll become more cautious and sensible as I get older. Looking forward to the day when low cost autonomous cars are rolling around everywhere and there’ll be little need for personal car ownership in most cases 🙂

  3. Hi Dave, loving the blog! I have a question about capital gains events in ETFs not being tax efficient in one of the sections above. Would the opposite apply for capital gains events in LICs? The LICs that I hold pass on capital gain discounts which equates to a tax deduction. Is this not efficient from a tax perspective? I’m still relatively new to investing so maybe I’m missing something staring me right in the face!?Thanks

    1. Good question Aaron. ETFs and LICs which pass on the CGT discount are generally the same for tax purposes – that is, the investor ends up paying tax on the gain at their own tax rate. The problem is, with a high turnover ETF such as VHY, the investor is likely getting lots of capital gains paid out, and some of it might be short term capital gains for stocks held less than 12 months (no CGT discount), which means more tax and is not ideal at all. But in the normal process of investing there will be some turnover and CGT, so lower turnover funds like VAS and older LICs still have capital gains tax events, but because turnover is low, so is tax, making them more efficient. Hope that makes sense.

  4. Question 1.
    It should also be mentioned that shares must be owned for at least 45 days if you want the benefit of franking.
    So if you buy and sell too quickly around dividend time, the dividends are unfranked.

    1. Good point Carlos. In any case, I don’t recommend people engage in such a short term strategy, which frankly is unlikely to pay off.

      1. Hey Dave – not sure if that was an intentional pun on Franking (‘frankly’) but I love it. Amazing job here with so many different questions from your readers and some very well considered responses – keep up the good work!

        Cheers, Frankie

  5. Hostplus offers a couple of really good low fee index funds other than their indexed balanced offering. Read the PDS online and check the IFM Australian Shares option and the Indexed Global shares option – both have very, very low fees and you can do 100% allocation of either or whatever % mix of each you want. You can also balance regularly with no CGT (Hostplus absorbs)
    Also, don’t discount holding old LIC’s inside super as you get 50% return on your franking credits (30% – 15%) – not too shabby.

    1. Thanks for that Phil.
      Wow do they really cover the CGT for you? That sounds too good to be true! From memory, I think Hostplus was one of the super funds that uses derivatives to achieve market exposure though… can you confirm that at all? It’s probably fine, but I prefer the funds which use actual ownership of the indexes instead.

      1. CGT – Yes, it is true – I rang Hostplus and they explained to me that CGT event isn’t triggered by an individual member’s withdrawal or the change of investment choices, it is triggered when the fund itself sells the underlying asset. Given the massive size of mot super finds it does not have to sell units every time a member changes their investment options. This only applies to pre-set investment options not individual holding via a self-directed platform inside Super (e.g. Choiceplus).

        Hostplus uses derivatives mainly for hedging purposes across several of its funds, thus the two I have mentioned are not hedged.

        Hostplus International Shares Indexed – Indexed Option’s underlying investment is the IFM Investors Indexed Global Equities Strategy. The portfolio invests directly in equity securities that are listed on stock exchanges in developed countries other than Australia.

        IFM Australian Shares – This closely tracks the S&P/ASX 200 accumulation index thus the portfolio composition closely resembles the weighting of the top 200 ASX listed stocks by market capitalisation. As there is possibility for the fund manager to slightly deviate from the S&P/ASX 200 index, the investment style is more accurately described as passive management rather than purely indexed.

          1. Hey Folks,
            Actually I wanted to have your view on AustraliaSuper please.

            It appears to me that HostPlus performed better but with a slightly higher fee?

            Thanks

          2. Hi Gordon. Both Super funds are fine, I don’t really have a view. No way to know which fund will perform better in the future I’m afraid. So I’d just go for something that is low cost and high growth (high percentage of shares). Then forget about it 🙂

      1. Sounds good. Ill need to do some further reading. Im with Hostplus currently, in a low cost option. But want to use my super to diversify (hold only aus shares outside super). Unhedged is my preference!

  6. Regarding Question #3 about investing for kids, I’d like to get your take on what I have been thinking about doing for my kids.

    My plan was to buy shares in AFIC in trust for the kids, and implement the dividend substitution plan. That way they will not fall foul of the investment income taxing of kids, but the capital will still grow. They would be liable for CGT if they ever sold, but my advice to my kids will be to keep them as a nest egg, continue contributing, and only convert to receive dividends when they are ready to receive the income.

    Can you see any issues with this concept? Obviously I am not asking for financial advice – I will get specific advice from my advisor, but would be interested in your thoughts on this approach.

    1. Interesting scenario Grant! Hmm, the main issue I see is the extra cost and admin of holding these funds in a trust and the likely disputes over forcing your kids to never sell the shares lol. It sounds perfectly fine in theory, but I’m not sure how practical/efficient it’ll turn out to be.

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