How to invest for a living
Before you go “all-in” on a portfolio full of the highest franked dividend payers on the ASX, read below to consider being diversified from a political and taxation standpoint. Likewise be wary of going “all-in” to other investments based solely on current taxation incentives in place.
When I come across articles about how Australian investors need more diversification it often does not refer to potentially changing tax laws. There is a bit of overlap with these themes but there are different issues to consider.
Normally the focus is on the lack of international exposure to great foreign companies, or lack of exposure to smaller stocks. The over exposure to the banking sector and risks to a falling property market are also emphasized.
Can you still retire on fully franked dividends in Australia?
The recent news of Labor’s plans to reduce the benefits of franking is a reminder that we should not lose sight of diversification in the context of political decisions. I believe that too many investors like to view certain strategies as all or nothing viewpoints. A good example is the classic Property versus Shares click bait style article. Read the comments section and you will generally find people responding that they strongly prefer one or the other. Another example is when investors struggle with the decision to sell. Or deciding whether to invest a large lump sum in the market today or in the future. Many prefer to make an all or nothing decision, so they can then sit back and cheer for the outcome they hope. Often the prudent decision is perhaps to sell half a holding in a stock if the weight gets quite large. If deciding to invest a very large lump sum in the market, then better to dollar cost average to some extent.
Some of this mentality extends to investor’s preference for a certain strategy that ties in with their beliefs about taxation advantages. For that reason, I don’t think my blog will ever get much of an audience. People prefer to read about one person with one clear method of wealth creation and simple rules to follow. You will find many blogs about the multiple property investor, the dividend only investor, or lately the guy who sold everything and invested in Bitcoin!. Think of the click bait from news.com.au you see in the finance section.
The debate over all the potential tax changes coming into the next election makes me want to avoid strong biases to any given strategy. I find it all very difficult to predict. It feels like politicians prefer to change tax laws more than their underwear. I won’t make this post a political debate but wanted to point out that the potential changes to franking I read about today did surprise me. It looks as though many retirees that may be on modest budgets can be affected quite a lot.
I find many investors use an all or nothing approach to wealth creation. We have the camp who loves negative gearing into property. This can extend to enjoying the 50% discount on CGT for assets held above a year. We have those who like placing as much as possible within their super fund to enjoy the better tax treatment. Then of course those who love generating all their retirement income via full franked dividends, and perhaps enjoying some of the associate refunds. Some believe stretch yourself as much as possible on your principal place of residence as it is CGT free. Others believe they have the skills to trade stocks for a living.
If you go all or nothing down one of these tracks hopefully your predictive powers of politicians are strong. I don’t know how the taxation policies are going to come out after the next election. Even the election itself is difficult to predict!
I can tell you though some of the various issues that I have read that may be subject to change. Along with franking as I have just mentioned, CGT is also being looked at for changes. Will the 12-month discount be scrapped or reduced? What is going to happen to negative gearing? Is borrowing within your SMSF likely to stick around? What will the company tax rate be? What will the personal tax rate be? Will the primary residence always keep its preferential tax treatment to the same extent? Will land tax partially get phased in so that stamp duty can be reduced? What will happen with family trusts? Will the GST be increased down the track?
I would offer someone very good odds to predict all the outcomes above for over the next decade.
How to achieve political diversification?
Well to answer this first I will examine things I wouldn’t do.
I wouldn’t have all my wealth (leveraged further with negative gearing) in investment properties. (as we know from the regular click bait articles many still do).
I wouldn’t look to put every extra dollar toward my super if I was many years away from retirement.
I wouldn’t plan to generate all my retirement spending income via fully franked dividends.
I wouldn’t look to accumulate all my wealth via my principal place of residence.
Now the next few comments are not applicable to myself but worth thinking about for very wealthy investors. Over time to address the budget the easy political move is often to take a slice off a certain area and specify balances that are deemed very wealthy. We have seen this with certain amounts of super fund balances, and salary levels relating to contributions.
On the property side of things often countries like to clamp down on investors owning perhaps their second or third investment property. In Australia we are starting to see a debate around those that live in an expensive PPOR but with very limited cash flow. The PPOR does not restrict the pension entitlement yet but perhaps eventually a certain price level of the PPOR will be deemed as very wealthy. Maybe one day there will be extra costs for property investors with a certain number or wealth tied up in their property investing strategy.
How to beat Labor’s franking proposal
If you are in the fortunate category of being very wealthy, it seems logical to spread out strategies and avoid being hit by any crackdown that becomes the flavour of the day for politicians. This way maybe you can keep a bit under these levels that are deemed as very wealthy and easy targets. Strangely though today’s news about franking changes seem to be a grab from the middle class rather than the top end. Just highlights the unpredictability!
In terms of stock selection maybe don’t have an extreme bias on dividends versus capital growth one way or the other. Can we honestly say what will happen with franking and CGT in a few years?
As I write about LICs on this blog a lot I guess I shall provide with a few comments on this aspect. I certainly don’t advise knee jerk reactions to news flow like we have just seen. But if you haven’t given much thought at all to the above it may be timely to have a good think about all the issues.
Are you overexposed to the likes of AFIC, ARGO, WAM funds?
Let’s say all your wealth is in the LICs that are very popular with investors seeking the current high fully franked dividends. If so, then this whole topic might be worth more thought. Such a portfolio could be well diversified across large/mid/small cap and various sectors, even international, but could become less attractive to future investors pending certain potential legislation changes.
The LIC sector has had a good few years now and the taxation landscape and ability for LICs to smooth out fully franked dividends have played a role.
The LICs I currently own don’t seem to be all that popular with investors who want to rely on franked income for all their retirement income, so I am not all that fussed. I write about activism and sometimes capturing the discount arbitrage a lot as well so that is another reason I am not that bothered. I also have some REIT exposure and stocks with unfranked income.
When I have mentioned Australian residential property on this blog I haven’t sounded very optimistic. I do still though own one property and a significant factor to holding it is for some diversification from political decisions. I got tired of all the biases that politicians seemed to have when addressing (or rather lacking to address) housing affordability issues in the past!
Maybe the best coping mechanism to all of this is the following? When you think you have uncovered a tax strategy to enjoy, perhaps just expect the government to close it one day.
EDIT March 17th
Warning these additional comments as an edit are long and more a blog post within a blog post!
Interesting if others here have a view on this story. Relates a bit to what I wrote about in the post.
The couple in the article emphasise the diversification they are undertaking via various different property types. It’s not my personal idea about what diversification means.
They are still keeping a significant amount of debt. Arguably a little exposed if politicians focus more on those using property to grow their wealth.
Now despite the heavy transaction costs with selling a lot of these properties, they could become debt free and lock in plenty of wealth. Maybe not as much as may seem at first glance. The values may be optimistic, CGT and selling costs to pay. Still a few million in net wealth at their age would sound great to most.
If they can structure it with maybe a million in super, same with one property they like as a main residence, then a couple of million in a balanced portfolio outside of super.. Future governments may not consider them wealthy targets. The super balance isn’t extreme, likewise the value of their residence or property exposure. They also wouldn’t be overly relying on franking or the generous tax treatment in super.
Could things really go pear shaped from there?
But this suggestion doesn’t give them the chance of getting as rich from then on compared with the leveraged exposure they have right now.
It also won’t get them articles on news.com.au
But what if property markets fell by 20%? Ok many feel this is impossible I get that. But if it did happen the alternative strategy I wrote about above wouldn’t cause them worry. Their current strategy would! Or if rental vacancies increased.
They can also then worry less about the government cracking down on those with huge amounts of property exposure.
Back to the saying I have used before. We are all geniuses in a bull market. If they value their freedom and flexibility now, perhaps some humility with their investment prowess can increase the chances of them hanging on to all the wealth.
Not a criticism because with investing the facts are they are far more successful than me. Just a discussion of how I look at things compared with others.
The residence they purchased is probably way more than using one million as I suggested. That may be what they need to be happy in life, therefore my plan may not be ideal.