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News Bulletin : ADA News Bulletin August 2011
41 AUGUST 2011 Compiled by Michael Lannon too much cash is nOt ALWAYS gOOD www.2020directinvest.com.au/ada | 1800 352 021 100% entry fee rebate on managed funds With the new financial year in full swing, many of you are continuing to increase your holdings in cash and term deposits. In fact, Australians are saving over $35 billion every quarter, or $140 billion per year. Over the past few years investors have had to continually deal with turbulent financial markets and a raft of media headlines about the perilous state of the global financial system. Therefore, it is not surprising that when investors are faced with uncertainty they choose the relative safety offered by term deposits. After all, ‘Cash is King’, or is it? Despite all of this ‘noise’ and volatility, the Australian share market still returned 11.9% for the year ending 30 June 2011. I often refer to earning interest on cash and term deposits as a way of going broke safely. What I mean by this is that after taxes and inflation, investors earning interest are actually going backward or at best, sideways. For example, let’s say you invested $10,000 in a term deposit that pays you 6% interest, then this time next year you would have an amount $10,600 dollars, which is your original investment plus the $600 of interest income. GOInG bROkE SAfELy Inflation rate Tax @ 46.5% Difference in buying power Investment amount $10,000 3.33%* Interest income – 6% $600 $330 $279 Total $10,600 $10,270 $9,989 -$11 *Australian annual inflation rate released April 2011 After taxes and inflation you end the year with less real money. It may seem like you have more money but in real terms you have less buying power and therefore can buy less goods and services than you could the year before. I am not saying having cash investments is a bad thing; but putting too much of your money into cash and term deposit investments can seriously affect your long-term wealth. As a rule of thumb, you should have about four to six months cash available for emergency purposes. As an investor, you pay a price for having liquidity or cash investments and that price is a lower return. This is often called the opportunity cost of foregoing potentially higher returns offered by other assets with more risk exposure. At this point, you might be tempted to say, “What higher returns are you talking about?” Admittedly, over the past few years, cash and fixed interest investments have outperformed growth assets but when you look at the longer-term (10, 20 or 30 years) growth assets like Australian shares and property, these are the assets that create enduring wealth. Think about the names on Australia’s rich list. These people have grown wealthy over time and not by simply investing in cash and fixed interest. These successful investors understand that diversification through asset allocation is the key to generating returns that exceed inflation and the key to creating enduring wealth. Factors like dividend franking credits and reduced capital gains tax on assets held for more than 12 months allow investors in growth assets to compound their returns over time rather than giving the tax man a significant portion each year as is the case with interest income. As an investor you have two basic choices: • you can lend your money to someone and earn interest (to a bank through deposits or to the government or corporations or mortgage holders thorough fixed interest/bond investments); or • you can buy real assets – property (residential, commercial land, etc.) or shares in REAL companies (companies that have assets and earnings and a history of providing shareholders with returns. THE dILEMMA – LIvInG LOnGER THAn yOUR MOnEy These days, we are all living longer. Retirement for your parents probably meant they cashed in their investments and invested the proceeds very conservatively. Since they were no longer working, they felt they could not afford to take any risks with their nest egg. That strategy may have been fine when retirement was for only five to 10 years but these days and into the future, retirement for many people will be a period of 20 to 25 years. The greatest investment insight
ADA News Bulletin July 2011
ADA News Bulletin September 2011