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Warren Buffetts’ s 11 tips for investing and life

1. “If you’re smart, you don’t need a lot of money. And if you’re dumb, no amount of money is going to help you.”

If you’re smart you will understand the power of compounding interest. You will know the difference between a company that has a durable competitive advantage and one that doesn’t. And you will know how to value a company to determine if it is overpriced or underpriced. With that knowledge, you can take even a small sum of money and grow it exponentially to be worth millions of dollars. But if you’re dumb, even if you start with millions, eventually you are going to lose it all.

2. “The important thing is to know what you know and know what you don’t know.”

The secret behind Buffett’s incredible success is not an incredible intellect or being the all-knowing oracle of Omaha. In fact, it’s just the opposite. It’s actually about knowing what he doesn’t know. This stops Buffett from making investment decisions he isn’t qualified to make. An accountant would be inviting folly if he tried to play doctor.

Buffett feels the same way about investing. There are certain companies he has no idea how to value, and as a result he stays away from them. Then there are companies that he understands and feels very qualified to value – these are the ones that have made him super rich.

Buffett refers to this world of businesses that he understands well enough to value as his “circle of competence”– which means he is confident in his ability to value them. If he can confidently value companies, he can confidently tell if the sharemarket is undervaluing them or overvaluing them.

For Buffett, being able to spot when the market is undervaluing a company shows him where the big money is.

3. “Don’t save what is left after spending; spend what is left after saving.”

One gets rich by getting their money to work for them, but that won’t happen unless they first have money saved up to make that initial investment. For most people, the first money they have to invest comes from saving a percentage of what they earn from a job.

In Buffett’s teenage days, he was obsessed with saving money from the various little businesses he ran. And with his obsession for saving money came an aversion to spending it.

Buffett was so averse to spending money that he drove an old Volkswagen Beetle long after he had become a multimillionaire, and he still lives in the same house he paid $US31,500 for in 1957. In Buffett’s case, saving money was way more fun than spending money, unless, of course, he was buying stocks.

4. “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it earns it … He who doesn’t, pays it.”

Buffett took this to heart early in his life and it truly has been the gift that kept on giving.

Here is how compounding interest works: $50,000 compounding at 10 per cent a year will be worth $55,000 after one year, $60,500 after two years, $66,550 after three years. After 10 years it will be worth $129,687. After 20 years it will be worth $336,375. After 30 years, $872,470. After 40 years, $2,262,962. After 50 years, $5,869,542.

In the first 10 years, we made $79,687 in interest on our $50,000 investment. But between the years 10 and 20 we made $206,688 in interest. And between years 20 to 30 we made $536,095 in interest. Between the years 30 and 40 we made $1,390,492 in interest. Between the years 40 and 50 we made $3,606,580 in interest. As the pot gets bigger, we make more and more in interest, which grows the pot even larger.

When Buffett took over Berkshire Hathaway, he stopped the company from paying a dividend so all the earnings would build up in Berkshire. Using his investment prowess, Buffett got Berkshire’s shareholders’ equity to compound at the phenomenal rate of 18.55 per cent a year for 59 years, growing shareholder’s equity from $US24.5 million in 1965 to approximately $US561.2 billion in 2024, for a total gain of 2,290,512 per cent.

Responding to the increase in shareholder’s equity, the market price for Berkshire’s stock, from 1965 to 2024, grew from $US12.50 a Class A share to $US632,000 a Class A share, which equates to an annual compounding growth rate of approximately 20.15 per cent.

Note: Our $50,000 investment compounding at a rate of 20.15 per cent a year, for 59 years, would be worth $2.52 billion in year 59, which is exactly how several of Buffett’s early investors ended up billionaires.

5. “From the standpoint of investments, you need two courses in a business school: one is how to value a business, and the other is how to think about sharemarket fluctuations.”

If Buffett was teaching a course in business school on how to value a business, he would teach students that there are basically two kinds of businesses.

(1) Businesses that sell commodity-type products, which have lots of price competition, low profit margins, low returns on equity, and volatile net earnings. These are the companies you don’t want to own.

(2) Exceptional businesses, which have some kind of durable competitive advantage, as evidenced by little price competition, high profit margins, high returns on equity, consistent earnings, and are buying back their shares. These are the right companies to own, and once identified, Buffett would explain to the students how to tell if they are selling at a price that makes business sense to buy them.

Buffett’s course on sharemarket fluctuations would provide a historical study of what market forces create buying opportunities. He would teach the students the history of events and forces that dramatically affect stock prices, what drives them from insane highs to depressing lows, and how these events can affect the share prices of companies with a durable competitive advantage and in the process create investment opportunities.

6. “You don’t want to be a no-emotion person in all of your life, but you definitely want to be a no-emotion person in making an investment or business decision.”

Buffett’s investment decisions – after weighing the economics of the business and the price he is paying – are based solely on whether or not he believes he is getting good value for his money. He’s very cold about it. In his early days, if he had a position that was making him money, even if he loved the company, if something better came along, he would sell it in a nanosecond and go with the new prospect.

He bought and sold his favourite Capital Cities Communications several times before he settled into a long-term position with it. This is the reason Buffett doesn’t react with fear in a stock market panic. His lack of emotion enables him to see long-term value and buy when everyone else is running for the fire escape. It’s also why he doesn’t get caught up in the euphoria of a bull market and end up paying insane prices for businesses.

7. “The most important item over time in valuation is obviously interest rates. If interest rates are destined to be at very low levels … it makes any stream of earnings from investments worth more money.”

Let’s say that Company A constantly produces earnings of $10 million a year. In a world of 10 per cent interest rates, we would have to invest $100 million in bonds that were paying 10 per cent to earn $10 million a year. Buffett would argue that Company A is worth $100 million relative to a 10 per cent interest rate. ($100 million × 10 per cent = $10 million.) Now, let’s say interest rates dropped to 2 per cent. We would have to invest $500 million in bonds paying 2 per cent to earn $10 million a year. ($500 million × 2 per cent = $10 million.) Buffett would argue that Company A’s earnings of $10 million a year are now worth $500 million relative to the 2 per cent interest rate.

The same inverse relationship also exists when discounting the future cash flows of a business to present value. The higher the discount rate, the lower the present value. The lower the discount rate, the higher the present value. So, a payment of $10 million a year for 10 years, discounted to present value, using a rate of 10 per cent, would have a present value of $61.3 million. But if we used a 2 per cent discount rate, a payment of $10 million a year for 10 years would have a present value of $89.4 million.

When interest rates drop, the relative value of what businesses earn goes up – and eventually, stock prices will follow upward as well. But when interest rates go up, the relative value of what businesses earn goes down – and stock prices will eventually go down as well.

8. “Obviously, profits are worth a whole lot more if the government bond yield is 1 per cent than they’re worth if the government bond yield is 5 per cent.”

For Buffett, all investment valuations are invariably linked to interest rates. If you owned a share of Apple stock and it earned $6.43 a share in 2023, you would need $128 invested in a 5 per cent government bond to yield you $6.43. But in a world of 1 per cent government bonds, you would need $643 invested in 1 per cent government bonds to yield $6.43. So as interest rates go down, stock prices “tend” to go up. And if interest rates go up, stock prices “tend” to go down.

Why government bonds? If they are United States Treasury bonds, they are thought of as being risk-free of default. In 2024, 10-year US Treasury bonds traded at 4.3 per cent, which gave Apple’s $6.43-a-share-earnings a relative value of $149 a share, against Apple shares reaching an all-time trading high in 2024 of $225 a share, which was 66 per cent above its relative value of $149 a share.

Buffett’s response to this overvaluation was to start selling his holdings in Apple. Even the best of companies can become overvalued – and when they do, Buffett will often cut his position.

9. “We do like having a lot of money to be able to operate very fast and very big. We know we won’t get those opportunities frequently … In the next 20 or 30 years there’ll be two or three times when it’ll be raining gold and all you have to do is go outside. But we don’t know when they will happen. And we have a lot of money to commit.”

Charlie Munger used to put it like this: “You have to be very patient. You have to wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.”

This is not the investment strategy of any fund manager in the world. Hold billions in cash and wait for the world to fall apart. But it is true – every 10 years or so, the financial world does fall apart and stock prices tank across the board. It happened in 2000 when the internet bubble burst, it happened in 2008 to 2009 when Wall Street imploded with the mortgage-backed bonds, it happened in 2020 with the COVID shutdown, and it will happen again and again.

And when it happens, stock prices will collapse, and the banks of the world will do what they always do, which is print tons of cash to pull us out of it, which will ultimately be bullish for stock prices. The hedge funds, mutual funds, and investment trusts of the world can’t play Buffett’s waiting game, they can’t sit on cash waiting for the mega opportunity. But Buffett can. And so can you!

10. “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

Buffett often talks about temperament. He means having the patience to wait for the right opportunity. By his own admission, he has sometimes sat waiting patiently for several years for the right investment opportunity to show up. And when it finally shows up, he takes full advantage and buys big.

Back in the 1980s, Buffett spent $US1.3 billion on Coca-Cola stock – which, today in 2024, is worth approximately $US24.4 billion. In the 1990s, he spent $US1.4 billion on American Express shares, which are now worth approximately $US32.4 billion. In the 2000s he bought $US14 billion worth of Bank of America stock, which was worth approximately $US35.1 billion in 2024 when he started thinning his position. In the 2010s, he spent $US31 billion for his Apple shares – which in the beginning of 2024 were worth a whopping $US176.8 billion before he started selling his position.

Invest big and win big if you follow in Buffett’s footsteps and buy shares in a company with a durable competitive advantage, and you buy it at a price that makes sense from a business perspective.

11. “There are a lot of businesses I wouldn’t buy even if I thought the management was the most wonderful in the world because they are simply in the wrong business.”

This goes back to something Buffett said in the 1990s: “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”

Some businesses have inherent underlying economics that are so bad that even the best managers in the world can’t improve upon them. These are usually companies that sell a commodity-type product or service in which there is a lot of price competition, that historically sees a repetitive cycle of boom and bust. In the boom years demand outstrips supplies, creating huge profit margins, but in the bust years, low demand kills their profit margins, and their fixed costs end up killing them.

You can easily identify these businesses by an erratic earnings history – losses some years, very profitable in other years. They never buy back their shares, and usually carry a large amount of debt. All of which tells you it’s the wrong business to own – no matter what the selling price is.

The New Tao of Warren Buffet by Mary Buffett and David Clark, is published by Simon & Schuster.

Warren Buffetts’ s 11 tips for investing and life2024-11-25T17:12:28+11:00

Why Australia needs an institute for applied ethics

Capitalism depends on government to provide a trusted framework of rules around it. But when politics turns into reality TV, we must ask the ethical questions ourselves.

The capitalist model, detailed in Milton Friedman’s 1962 classic, Capitalism and Freedom, is often criticised by non-economists for celebrating the pursuit of self-interest.

Yet capitalism’s claims to moral legitimacy come not only from its promotion of liberty, but also from its impressive claims to aggregate economic efficiency. Specifically, capitalism claims to produce community outcomes that are Pareto optimal, meaning that no one person can be made better off without at least one other person being made worse off.

Except as required by the law of the land, individuals in a capitalist system are not obliged to attend to the interests of another. They are free to pursue persistently divergent interests, as workers, investors and consumers. And those who run businesses have no social responsibility beyond the pursuit of profit.

But while the capitalist model is founded on the pursuit of self-interest, it will not function in the absence of trust. Mutual confidence in the functioning of the capitalist system is critical to its claimed efficiency benefits. A lack of trust means a suboptimal number and size of transactions, and underinvestment in innovation, with significant implications for the level of aggregate economic activity, productivity and real income growth. Moreover, a sudden loss of trust can have catastrophic social consequences, as the global financial crisis of 2008-09 illustrates.

A recent report by Deloitte Access Economics, commissioned by The Ethics Centre, explains how large gains in economic activity can be achieved with modest improvements in levels of trust.

Readers of this newspaper have observed how trust in business has been undermined by apparent failures to meet community expectations in the treatment of customers in many sectors of the economy, including through impenetrable information disclosures, automated customer call centres and store closures. And, like all other Australians, they would be wondering about their capacity to cope with the many ways in which businesses and governments might make use of advances in AI and robotics.

In the capitalist system, businesses are not to concern themselves with meeting community expectations, except to the extent that doing so increases profit. Ensuring that business meets community expectations is the responsibility of government.

As Friedman puts it, capitalism relies upon a functioning democratic system that both enables and obliges its citizens to elect governments to ‘‘determine, arbitrate and enforce . . . a framework of law’’ to ensure ‘‘free and open competition’’ and protection from ‘‘fraud or deception’’. And Friedman goes on to explain, if somewhat grudgingly, that government also has responsibility for attending to negative externalities and making adequate provision of public goods.

Capitalism casts business and ‘‘the rest of us’’ (Friedman’s expression) as adversaries, and government as our protector.

So, it is something of a paradox that, year after year, surveys of ‘‘the rest of us’’ report that, among the principal institutions affecting our lives – businesses, not-for-profit entities, government and the media – it is government that enjoys the least trust.

Capitalism demands a lot from government. Mostly, our political leaders fall short. Instead of attending to frameworks of law and enforcement, many have preferred the role of business-bashing critic, pointing an accusatory finger at business executives, not themselves, for having failed the pub test or for failing to meet community expectations.

It may be the case that the 24/7 reality TV show, through which citizens get to observe the workings of modern politics, encourages this sort of spectacle.

Yet, no matter its explanation, it is corrosive of effective governance, which depends upon elected officials having some detachment from outrage and mania, not seeking energetic immersion in it.

We have a problem.

Following the global financial crisis, serious thinkers around the world began questioning whether the adversarial contest at the core of the capitalist system might not be its Achilles heel.

Capitalism proposes a system in which business is motivated by nothing other than profit, and its executives by nothing other than self-interest, and leaves it to the rest of us, also motivated by nothing other than self-interest, to elect politicians to protect us with laws that we cannot possibly comprehend and regulatory bodies with which we can have no meaningful contact. This is not an arrangement designed to build trust.

Recent global efforts to make more transparent the social and environmental impacts of business activity, and to have business leaders accept accountability to the community for these impacts, seem to me to be steps in the right direction.

But these will only take us so far. The big problem we have is that, as individuals and as a community, we confront a set of ethical questions that are just damned difficult. And we have not invested sufficiently in respected institutions that might help us think them through.

In all democracies, there is a compelling case for centres of expertise that facilitate sober reflection. This is why we fund universities, a professional public service and, within the public sector, institutions that enjoy a higher level of independence, such as the CSIRO and the Productivity Commission.

Yet, when you reflect on the recent and emerging causes of a loss of trust in democratic capitalist systems, and the economic and social gains that would come from addressing them, you have to think that something is missing. That is why I have come to the view that it is time for us, as a community, to invest in an Australian Institute for Applied Ethics. This is a modest investment, promising very large rewards.

Ken Henry is a former Treasury secretary, and one of 1600 signatories of an open letter calling for federal funding for an Australian Institute for Applied Ethics.

Why Australia needs an institute for applied ethics2024-03-08T16:36:12+11:00

RBA change is coming, like it or not

More people, more input, more cooks in the kitchen. That’s ultimately the price the Reserve Bank of Australia will pay for a couple of years of bad or miscalculated calls, made in response to the pandemic.

Ironically, the review was conceived in the pre-COVID days when the RBA was criticised because inflation was running below its 2 to 3 per cent target range. All the attention is on what has happened since.

When money was flooding into the financial system and the economy, it is now clear the RBA board was too slow to apply the handbrake. The result is the highest level of inflation since the 1990s and an unprecedented 10 straight rate rises that were never going to be popular with ordinary Australians or politicians. No one seems to care that the unemployment rate is around its lowest level in nearly 50 years.

Right or wrong RBA governor Philip Lowe wears the blame. He will be all over the newspapers and nightly television news bulletins, even though markets (equities, bonds, currency) barely blinked. Mr Market saw the review coming, and now says the changes are some way off.

From the market’s perspective, next month’s budget is more material. Treasurer Jim Chalmers needs to set up the books for the next few years, which means finding more money. The economy is finely poised: it would be tempting to throw money around to ease cost of living pressures, although money’s tight and the inflation doesn’t need stoking.

In the meantime, old-head RBA watchers said it was a significant day. The fact that the central bank, which has such a great impact on Australians’ daily life, was subject to such scrutiny made it a historic day.

Lowe and the RBA will be hauled over the coals for what happened a few years ago, even though it was just as much the government stoking the fire that continues to burn today. The critics argue he should be accountable for the combination of low rates, forward guidance, yield curve control, quantitative easing and the term funding facility, which combined to whipsaw the economy and may yet cause a recession.

Of course, Lowe’s monetary policy is just one tool.

Once the commotion passes, we should all still be worried about the rising cost of rent and energy and how both can be addressed. The review doesn’t change that.

The review prompted plenty of thinking about the RBA, its corporate governance, board composition and decision-making. It recognised that in more normal times, the RBA had done well to keep inflation around the midpoint of its 2 to 3 per cent range for the past 30 years.

However, it is the past few years, a wartime for central bankers when no one escaped with a goldilocks path out the other side, that will now shape the direction of Australia’s monetary policy system.

What’s the answer to it all? Get more people involved in the decision-making. A specialist monetary policy board, fewer board meetings and more outsiders sitting around the table.

Reading between the lines, there seemed to be concern about how insular the RBA either is, or has become. Lowe is a perfect example; he’s got a great temperament for the governor’s job, is clearly smart and well regarded by colleagues and peers globally, but he is an RBA lifer and ingrained in current-day practice.

The creation of a new nine-person Monetary Policy Board, widely tipped by pundits, is about getting more rigorous thinking into rates decisions.

The nine people would include the RBA governor, deputy governor, Treasury secretary and six outsiders. The review recommends that ‘‘external members should be able to make a significant contribution to monetary policy setting through expertise in areas such as open economy macroeconomics, the financial system, labour markets, or the supply side of the economy, and in the context of decision-making under uncertainty’’.

So, this specific rate-setting board should mean more challenge and debate to the house view, which appears to have become more entrenched. At the same time the review calls for RBA’s operatives to spend more time with board members, making it a bit of an each-way bet but a good use of what is a big and expensive research team. (The need to spare a day a week or so in the RBA’s offices surely tilts the external board positions towards academics.)

The undertones were that the board wasn’t functioning properly, either because it didn’t have the right people or the right information. Lowe defended his board at a press conference yesterday, saying discussion around the boardroom table was robust and not dominated by himself.

It’s all well and good to have more people in the room on rates decision day, but it does not mean the board will function more efficiently or come to better decisions.

But big boards do not necessarily mean better outcomes. Corporate Australia is littered with poor boards and ‘‘jobs for the directors club’’ type attitudes that ruin what can be otherwise good businesses.

Often the bigger the board, the more constipated the decision-making process. The other scourge is chairmen roping in old mates and colleagues from other boards.

Ultimately, whether a separate and bigger Monetary Policy Board works will depend on who is on it. It was a logical and welcomed decision to create the separate board, and clear rate-setters of the governance-type matters that tend to dominate board meetings.

The review recommended a transparent appointment process, starting with advertised expressions of interest. External members would be appointed for five years, and up to another year depending on the circumstances.

There would also be fewer board meetings; eight not 11. And the governor would have to front the press following each meeting to explain the board’s decision, with more emphasis on the expected path of inflation and the labour market. That shouldn’t prove too onerous. External board members would also be required to make one public address each year.

The idea of more communication is conceptually good, although post-meeting press conferences can be a double-edged sword. We’ve seen Federal Reserve chairman Jay Powell mix his messages in a live setting, which can leave the market with more questions than answers.

Fewer meetings mean more time between rates decisions and arguably more punting and reading the crystal ball for fixed income investors. There could be more focus on monthly/quarterly economic data, to fill the information void between meetings.

Market economists liked that there could be more briefings, as it should (in theory) help them with their forecasts. They also probably like that there would be an unattributed published vote after each policy decision.

Other parts of the review said RBA should work more closely with the government/ Treasury, although it remains to be seen how. The review said fiscal and monetary policy should be set separately, however the RBA and Treasury needed to ‘‘have a good understanding of the intentions of the other and informs better policy choices’’. The two institutions are already close, but the review said their co-operation should include increased information sharing on risks, scenarios and policy constraints, and some joint scenario analysis.

Lowe was gracious at his press conference, although it was clear he did not love all the recommendations. For example, he bristled at any notion rates decisions were his alone and thinks it’s important to be careful with the number of public messages out of the RBA to ensure consistency and stability.

Lowe said he would leave his reappointment to the RBA top job in the Treasurer’s hands. He said he would be happy to go around for another term if asked. If not, he said he would find another way to contribute to society.

The fact that the RBA was subject to a 294-page review and there were 51 recommendations suggests change is on the cards.

Next week’s CPI reading could be material to the situation. Economists are tipping a number just shy of 7 per cent.

For all the focus on Lowe, in the near term the real attention should be on Chalmers and the budget. That’s the real showstopper for the economy.

a.macdonald@afr.com 

RBA change is coming, like it or not2023-04-24T16:53:10+10:00

Financial Planning Message – December 2022

As 2022 draws to a close we are reminded of the recent period of intense volatility in capital markets and the reality that a global recession is likely next year.

 

Markets are pricing in a lower probability of a recession in Australia.

 

This in turn will depress corporate earnings and valuations across all asset classes and significantly increase default rates among high-risk borrowers.

 

The correction to valuations is likely to be more severe during this economic cycle due to valuations starting from elevated levels compared to previous corrections.

 

We are also yet to experience a high number of fixed loans move from fixed interest rates of sub 2% to levels of 5%+ prevailing rates, something in the order of $500bn are due to mature in mid to late 2023.

 

This will no doubt impact the already depressed property market in Australia.

 

All the major banks and APRA are keeping a close eye on this development as we progress into 2023.

 

As inflationary pressures persist ( highest in 40 years ), geopolitical tensions and tight labour supply, the  central banks are forced to aggressively press on with higher interest rates and keep for much longer.

 

The RBA has so far moved the cash rate from .1% in March 2022 to now 3.1%, markets are now pricing in another two .25% increases in early 2023 before a potential pause to evaluate the impact on inflation.

 

The Federal Reserve was pricing in a rate increase of just 1% in December 2021, it is remarkable that their view now is that it is likely to peak at approximately 5.25%.

 

Consequently, 2023 is poised to exert added stress to highly leveraged borrowers, specifically those that have acquired property / equities in 2021 / 2022, are now in nil or negative equity positions.

 

It is worth noting that during this business cycle, we have had an explosion of companies that have become addicted to cheap debt, on the other hand, these same companies are not generating sufficient cashflow to support increased interest payments.

 

Clearly, there will be consolidation particularly in property related businesses in 2023.

 

There are no doubt significant headwinds for Australian households and the economy in general as we enter 2023.

 

Accordingly, extreme caution and sound strategies need to be implemented for the year ahead, including but not limited to :-

  • Be clear on what and who matters given the many conflicting sources of information and ‘investment opportunities’ across the media.
  • Understand your portfolio and position appropriately taking into account your forward plans and risk / return / management costs.
  • Review cashflows and eliminate unnecessary lifestyle costs in light of higher interest rates in 2023.
  • Let’s not forget managing your tax position, this is always relevant be it during your working life, in retirement ( with respect to investments) or as part of your estate plan.
  • Focus on what can be controlled / influenced as opposed to factors over which we have no control or influence.
  • Make incremental ‘dollar cost savings’ as opposed to taking a significant position when investing.
  • Diversification and history are our best friends, reflect and actively rebalance asset allocations.
  • Consider Dividend Reinvestment Plan ( DRP) in light of the attractive valuations.
  • Confirm borrowing / refinancing options well before due dates and explore potential savings across relevant lenders – competition appears to be intensifying across the major lenders.
  • Insurance is always important, however potentially critical during extreme business cycles as are likely to unfold in 2023. It is not desirable to execute forced sales at depressed values.

 

In closing, we would like to take this opportunity and thank you for placing trust in AMCO since inception 26 years ago and making our Integrated Wealth Management practice what it is today.

 

We are aware of the challenges you are facing during these uncertain times and are there to advise and navigate all matters with professional care and promptness.

 

It is vital that fundamental mistakes are prevented during these critical periods, hence the need for sound advice.

 

From the team at AMCO, we wish you and your loved ones good health, peace of mind and prosperity in the year ahead.

 

Merry Christmas.

 

 

Danny D. Mazevski 

Chartered Tax & Financial Adviser

FIPA   CTA  FTMA  MBA (Un.NSW/SYD)  Dip.FS   JP

Financial Planning Message – December 20222022-12-22T08:01:23+11:00

What It Means For Your Money

There are numerous opportunities for astute investors and consumers to take advantage of. Aleks Vickovich and our expert writers break it down.

As expected, the Morrison government’s pre-election budget had plenty of sweeteners. The 2022-23 budget documents revealed total expenditure of $628.5 billion, of which social security and welfare ($221.7 billion) made up the lion’s share, alongside funding for health ($105.8 billion), education ($44.8 billion), defence ($38.3 billion) and transport and communications ($18.9 billion).

Included was a one-off, $8.6 billion package of short-term handouts described by The Australian Financial Review as a ‘‘shameless voter bribe’’.

Whether the cash splash is effective remains to be seen, with voters to go to the polls in May. But the budget’s short- and long-term measures contain a range of opportunities that astute investors and consumers may seek to take advantage of.

Here’s what you need to know.

Women

Australian women remain on track to earn $2 million less than their male counterparts due to what economists and critics deem a lacklustre, pre-election federal budget.

While it included $9 million in funding to support emerging female entrepreneurs and $58 million in funding for endometriosis, experts warn the measures do not go far enough to promote women’s earnings capacity and – in the case of the paid parental leave changes – may even backfire.

The government’s paid parental leave scheme will now be 20 weeks shared at the couple’s discretion at the minimum wage. Previously, primary carers – who tended to be mothers – were eligible for 18 weeks, while partners were eligible for two weeks. The income test will be changed to a household limit of $350,000 each year rather than the individual test.

‘‘It’s done under the guise of flexibility and allowing more leave sharing between partners,’’ says Grattan Institute CEO Danielle Wood. ‘‘That’s great in the small percentage of households that want to do that, but my theory is it will actually lead to more gendered norms around who cares [for children] in the early years.’’

That policy, coupled with no movement on childcare, confirms Grattan modelling that finds the average mother will earn $2 million less over her lifetime compared to the average father, says Wood.

‘‘[The budget] was a missed opportunity to address some of the disincentives to women’s workforce participation, particularly the higher cost of childcare,’’ she adds.

Industry groups also characterised the budget as lacking for women.

Tax Institute analysis of childcare costs and subsidies found the secondary earner, who is often the mother, faces a steep disincentive to return to full-time paid work.

‘‘If they’re back to a full-time schedule, the secondary earner is only gaining $6 extra for the tenth day of work in a fortnight. By the time they’ve commuted to work and bought a morning coffee, they’re paying to go to work that day,’’ says Tax Institute tax policy and advocacy general manager Scott Treatt.

‘‘The secondary earner in a family can be taxed at an effective rate, including net childcare costs, of more than double the top personal marginal tax rate. This makes returning to work financially impossible for many parents who might otherwise like to.’’

LUCY DEAN

Retirees

In a measure foreshadowed by the Financial Review in March, the government committed to extending its changes to the superannuation minimum drawdown requirement for another year. ‘‘The government has extended the 50 per cent reduction of the superannuation minimum drawdown requirement for account-based pensions and similar products for a further year to June 30, 2023,’’ the budget documents said.

‘‘The minimum drawdown requirements determine the minimum amount of a pension that a retiree has to draw from their superannuation in order to qualify for tax concessions.’’

Drawdown rates range from 4 per cent to 14 per cent, depending on age. The extension of the halved rate would drop the rate from 7 per cent to 3.5 per cent for someone aged between 80 and 84.

While the budget billed this measure as ‘‘supporting retirees’’, experts say it would really only benefit retirees who have already accumulated substantial wealth outside super.

Peter Burgess, deputy chief executive of the SMSF Association, says the extension allows individuals who have access to outside funds to withdraw less than they would ordinarily have to under the normal policy conditions.

‘‘This means they can retain more in their super pension account – which is tax-free – for longer,’’ he says.

The tax benefits of keeping more money in a super environment are clear, says Lisa Papachristoforos, a partner at accounting firm Hughes O’Dea Corredig.

Wealth held in a super fund in pension mode incurs no tax on income and capital gains, she points out – as opposed to income held in an individual’s name, which is taxed at marginal rates.

But tax advantages are not the only potential benefit. The extension of the minimum drawdown also provides ‘‘continued flexibility’’ on how much retirees need to withdraw to fund standard of living, Papachristoforos adds.

Aside from tax efficiencies, leaving more money in super means more can be invested, generating further returns.

Plus, while the policy may be aimed at retirees, all super fund members may profit from the extension regardless of their age or distance from retirement.

‘‘Super funds are potentially faced with an additional year of lower minimum pension withdrawals paid to their members, allowing them to utilise that forgone withdrawal at a pooled level for investment purposes,’’ Papachristoforos says.

‘‘As such, extending the minimum drawdown rule could positively affect all superannuants, not just those drawing an income stream from their account, and the investment managers of super money will have more funds to invest.’’

Certified financial planner Josh Dalton, of Dalton Financial Planners, agrees there are potential tax minimisation benefits from the extended minimum drawdown policy, as well as the prospect of opening up more money to be invested in markets.

But he warns the measure is not suitable for all retirees. ‘‘Retirees need to estimate their annual expenditure and get a good grasp on how much income they can live on comfortably,’’ he suggests.

‘‘They can then decide to reduce their pension payments in line with their budget estimate and conserve more of their account-based pension capital if it suits.’’

ALEKS VICKOVICH

Home buyers

Borrowers planning to apply for the expanded Home Guarantee Scheme should start preparing their applications soon because competition is expected to be fierce, say lenders.

First home-loan applications surged when previous allocations were announced to allow first home buyers and single parents to get into the property market with a deposit of between 2 per cent and 5 per cent without needing to pay for expensive lenders mortgage insurance.

Applicants need to choose a loan from a lender on the scheme’s list that offers the rates, terms and conditions best suited to their needs. It has to be a principal and interest loan. Investors are not eligible.

Prospective borrowers should gain pre-approval for their loan from the lender, which will involve providing identification, age, proof of income, a prior property ownership test, proof of deposit and intention to be an owner-occupier.

Applicants also need to ensure their loan application is within the price caps set for each city. For example, it is capped at $800,000 for Sydney’s central business district and $500,000 for Ballarat in regional Victoria.

The First Home Guarantee, which supports eligible first home buyers to build or purchase a new or existing home with a 5 per cent deposit, has been increased from 10,000 offers to 35,000 a year from July 1. It is capped at $125,000 annual income for individuals and $200,000 for a couple.

There are also 5000 places for the Family Home Guarantee, which enables eligible single parents with dependents to enter or re-enter the housing market with a deposit from 2 per cent.

Mortgage broker Elodie Blamey says single mothers and fathers can earn up to $125,000 – excluding childcare support – to be eligible. ‘‘Unlike the Home Guarantee Scheme, it is not being used nearly enough,’’ she says. Many single parents might not be aware of the scheme and its conditions, or consider themselves eligible.

Merinda Brooks, a single parent with a three-year-old son, says: ‘‘It has absolutely changed my life.’’

The speech pathologist says it would have been challenging to save a 10 per cent deposit. ‘‘I was working really hard but unsure about how I could have otherwise got a deposit together,’’ she adds.

There are also another 10,000 places a year under the Regional Home Guarantee scheme for anyone who has not owned a property for five years, on the condition they purchase a newly built home or build.

Lenders are awaiting additional details from the government before advising potential borrowers.

DUNCAN HUGHES

Patients

Government changes to the Pharmaceutical Benefits Scheme safety net thresholds, making medicines more affordable, is good news for many self-funded retirees, according to a leading super specialist.

Lower safety net thresholds for the PBS mean potential savings for retirees, and may create an opportunity for others who have ‘‘grandfathered’’ account-based super pensions.

From July 1, the PBS safety net thresholds will be reduced from $326.40 to $244.80 for concession patients, and from $1542.10 to $1457.10 for general patients, which means fewer scripts before the safety net is reached.

Patients will also reach the safety net sooner with 12 fewer scripts for concession patients and two fewer scripts for general patients.

‘‘This is good news for self-funded retirees who do not hold a Commonwealth Seniors Health Card,’’ says Colin Lewis, head of strategic advice for Fitzpatricks Private Wealth.

‘‘There may also be the opportunity for advisers to consider clients who have an underperforming ‘grandfathered’ account-based pension but feel trapped for fear of losing the card if they move.’’

Many CSHC holders have account-based pensions that are ‘‘grandfathered’’ after the income test rule change on January 1, 2015. Account-based pensions started after that date are deemed under the card’s income test, whereas nothing counted with existing pensions. For this reason, many are reluctant to switch pensions or super funds for fear of losing their CSHC.

‘‘It is a matter of doing the numbers.’’ says Lewis. ‘‘Deemed income from a new pension may not push a cardholder over the CSHC income threshold but, where it does, the cost of losing the card is now reduced with a lower safety net, and the potential return from a new pension may well exceed this cost.’’

The same concern may contribute to some self-funded retirees maintaining self-managed super funds rather than switching to a possibly better-performing and cheaper retail or industry fund.

DUNCAN HUGHES

Small business owners

Improving workforce skills, incentives for employing apprentices and increasing investment in technology and digitisation are among the opportunities. Small and medium businesses with a turnover of up to $50 million are getting an additional 20 per cent deduction for the cost of external training provided to employees.

That means a business will be able to deduct $120 for every $100 spent on a course.

As an example, a business needs to train 10 employees in administrative skills to manage jobs. The company enrols them at a cost of $430 per employee. In addition to the $4300 deduction, the company can claim an additional $860 deduction, being 20 per cent of the expense.

There is also $2.8 billion over five years to increase apprenticeships, including $5000 payments to apprentices over the first two years of their apprenticeships, and $15,000 to qualifying employers paid as 10 per cent for first- and second-year apprentices and 5 per cent for third-year workers.

For example, a business employing an apprentice for $40,000 a year will receive $1250 every six months for two years to help with the cost of training. The company can apply for payments of $4000 in the first and second years, and $2000 in the third year.

The calculations were provided by financial adviser Cameron Harrison.

Businesses are also eligible for another 20 per cent deduction for expenses on digital upgrades, such as cyber security systems or subscriptions to cloud-based services, up to $100,000. Installation has to be completed by June 30, 2023 to be eligible.

‘‘This is a no-brainer,’’ says Greg Travers, a director of William Buck. ‘‘Businesses know they need to digitise, and now the government is giving them an incentive to do it. The benefit is not huge . . . but it helps.’’

Digitisation means more pre-filling, data-matching and data-sharing for the Australian Taxation Office.

‘‘The measures are designed to reduce compliance costs for businesses, but also make it easier for the ATO and other revenue authorities to data-match and share information,’’ Travers says. These measures include using real-time data to calculate PAYG tax instalments.

Sam Pratt, chief executive of Render Networks, which develops broadband connectivity, says while it was a good budget for infrastructure, there needs to be more support for the digital economy to keep it competitive with the US and Europe.

Changes to the taxation of employee share schemes will help smaller companies, particularly technology start-ups, attract and retain skilled workers. Limits on the value of shares an employer can issue to employees has been increased from $5000 to $30,000, which puts it in line with international standards.

DUNCAN HUGHES

Aged care residents

With medication management long regarded as the bane of residential aged care, funding to link care facilities with community pharmacists and onsite pharmacists should bring some comfort to residents and nurses.

The delivery of wrong and/or excessive medication has long been an issue waiting to be addressed.

However, at the heart of this and other positive reforms flagged for the aged care sector in the federal budget lies a major problem – recruiting and retaining qualified staff.

Notably absent from the spendathon was any mention of the wage increase for existing or future aged care workers that is so desperately needed to deliver the existing services, let alone promised ones.

Pharmacists are as desperate for the implementation of a workforce plan as the aged care sector, putting a huge question mark over the success of a potentially good idea before it is even rolled out.

The ongoing release of 80,000 home care packages in 2021-2023 – taking the total to about 275,600 people by June next year – is welcome confirmation of intentions to assist older Australians to remain living independently at home.

But the delivery of the packages and other at-home support is also dependent on attracting a suitably skilled workforce to meet the demand.

It is the same for the 8500 new respite services also announced previously as part of an $18.8 billion, five-year reform program following the Royal Commission into Aged Care Quality and Safety.

On that front, the $48.5 million for 15,000 additional aged care training places for new and existing personal care workers, to a total of 48,800 places, is a positive move.

More money for more training is always welcome, says Sean Rooney, chief executive of Leading Age Services Australia and representative of the Australian Aged Care Collaboration. But he says the budget failed to address the key fundamental deficiencies identified in the royal commission – wages and the viability of aged care homes.

Sticking with the commitment to reform the residential aged funding model through the introduction of the Australian National Aged Care Classification Transition Fund, the budget included an additional $34.60 per bed per day.

The proposed residential aged care funding model, scheduled to begin on October 1, is designed to align residential aged care funding to the care needs of each resident.

The starting price is $216.80 a day per resident for standard care – with more for dementia-related care – compared to about $180 a day per resident under the old funding model.

Council on the Ageing chief executive Ian Yates will be looking to see that the additional money is spent on increasing the number of care minutes with residents as intended by the royal commission, which recommended care homes have a target of 200 minutes per resident per day.

Exactly how that will be measured is yet to be worked out. But Yates wants the government to commit to publishing how many minutes of care each residential facility is being funded to deliver, compared to the number of minutes actually delivered, as part of its new star rating system.

With an election on the way, there is still hope for further announcements that will directly benefit older Australians and those who deliver the care they deserve.

Unlike the government, the opposition has centred its budget promises on fixing the aged care workforce with a $2.5 billion pledge for measures, including a wage rise.

BINA BROWN

Young Australians

Successive budgets chasing the ‘‘grey vote’’ have allowed structural flaws in Australia’s economy to form, with younger generations and economists now calling for bold conversations to help strike out the unwieldy debt bill.

The budget features a projected $78 billion deficit for 2022-23. The deficit is expected to linger for the next 10 years, with gross debt peaking in 2025.

While a deficit isn’t necessarily a problem if the debt brings sustained productivity or lifestyle improvements, Australia’s ability to wind back high levels of spending will be the key issue for younger generations, says the Grattan Institute’s Wood. ‘‘We shouldn’t be so fixated on the deficit per se, especially coming out of COVID-19; it partly reflects that we did need to spend a lot to respond, and that it was appropriate to do so,’’ she says.

‘‘But we should think about the structural budget deficit over time, and that does look a bit concerning.’’

Wood says Australia’s spending appears to be fixed at a higher level after COVID-19, with more money flowing through to defence, aged care and the National Disability Insurance Scheme.

‘‘We haven’t really talked about how we’re going to pay for that over time,’’ she says. ‘‘The risk is if we don’t do anything about that and debt continues to creep up as a share of the economy – that’s the concern that young people, quite rightly, might have.

‘‘It’s that longer-term picture and the lack of clarity around how we’re going to square those numbers.’’

The co-founder of intergenerational fairness advocacy group Think Forward, Sonia Arakkal, agrees government debt is a complex issue, but is concerned that the budget puts older generations’ needs before younger generations’ current and future needs.

‘‘Young people have a sophisticated understanding of the economy – we’re a very highly educated generation . . . we want policymakers to take into account our interests,’’ she says.

‘‘So, if they are accruing debt in our name, it should be debt that is invested in climate change or infrastructure – not pork-barrelling in particular marginal seats or particular states.’’

Faced with baked-in higher spending, an ageing population and a need to decarbonise, Arakkal – who is leading calls for a parliamentary inquiry into intergenerational fairness – is calling for Australia’s political class to engage in more difficult conversations about equality.

‘‘We have a system that is overly reliant on income taxes and doesn’t treat asset taxes in the same way, and we shouldn’t be punishing people for working. We should be looking at taxes that are inefficient, like capital gains tax, or how we tax superannuation,’’ she says.

‘‘We need to be having those conversations to set the younger generation up for success.“

There are two options for tackling the deficit, says Wood.

The first is to find ways to make the economy grow faster, as a faster-growing economy will essentially ‘‘fritter away’’ the debt burden.

‘‘Looking at policies which actually promote productivity and growth is important, so that could be tax reform, reforming cities, and how we do planning and zoning regulation?’’ she says.

Supporting more women to return to the paid workforce after having children is also a key way to uncap economic potential, Wood says, expressing disappointment at the budget’s muted changes in that area.

‘‘Over time, I think taxes will have to rise, even if we do tick some boxes on the growth front,’’ she says.

‘‘It’s inevitable that as government has increased as a share of the economy, that there will have to be an increase in taxes to pay for that. That has to be done carefully. What we shouldn’t do is just rely on income tax to do all the heavy lifting, which is what we’ve done historically.’’

LUCY DEAN

Households

Those earning up to $126,000 will be eligible for an additional one-off $420 that will be paid when their 2022 tax return is lodged. There’s also a one-off cost of living payment of $250 to eligible income support recipients and certain concession cardholders. Fuel excise (a federal tax imposed on each litre of petrol) will be halved, intended to reduce the cost of fuel by 22¢ a litre. In addition, costs of taking a COVID-19 test to attend work are tax deductible from July 1.SI

DUNCAN HUGHES

What It Means For Your Money2023-04-21T14:15:56+10:00