Making a good thing better
[ March 13, 2015 ]
We have had a busy week and have reviewed more than 150 SOAs with only a few requiring significant changes. Its been a good week. Turn around times have been on target with several advisers receiving same day service for urgent SOAs involving SMSF gearing strategies. Don’t hesitate to be demanding: send your (genuinely) urgent SOAs in directly to Yin and we will respond virtually immediately. We also had several requests for “pre-approvals” where rough outlines of advice were sent in before pen was put to paper in a formal SOA. We have no problems with such requests, in fact I think they are a good idea and am more than happy to pre-approve as this makes things even more efficient. Once again, the following comments are intended to help advisers continue to improve their SOAs and to make good thing even better. Let me know if anything is not clear or needs further explanation or clarification.
What do shares and property usually earn? Which is best?
Clients often ask what sort of rate of return is it reasonable to expect on an investment? Or, which is better, shares or property? Personally, I tend to quote page 6 of the ASX Russell Investments Long Term Investing Report dated 1 July 2013 which says that the gross returns for the 20 years to December 2012 were 9.8% for Australian shares and 9.5% for Australian property. These were the highest earning asset classes over this period. Since 2012 both the share market and the property market have risen significantly, so its seems reasonable to continue with this data even though it’s getting a little old. You may notice that Australian shares beat international shares. This is expected, since international shares do not generate franking credits and the Australian economy was just about the best performing economy in the world right through this period, including the GFC years from 2008 on. You may also notice that most fund managers have not beaten these twenty year gross returns. That’s mathematically expected, and one of the reasons why Dover encourages you to recommend direct investments in shares and property. Its also why we like index funds. I routinely provide this document to my clients, in PDF form via a hypertext link embedded in the SOA, so they can see it for themselves. I often use a paragraph like this:
“You were interested in the long term performance of shares compared to property. The answer is they tend to be almost the same, and this becomes more likely as your time horizon increases. For example, the ASX Russell Investments Long Term Investing Report, dated 1 July 2013, says that the gross returns for the 20 years to December 2012 were 9.8% for Australian shares and 9.5% for Australian property. Property and share values have continued to rise since December 2012. We stress that past returns are not always a good guide to expected future returns, that shares require a minimum holding period of at least ten years, that property requires a minimum holding period of at least twenty years, and that the true long term value trends will only emerge over these time frames.”
Household contents are not assets
We routinely see advisers ascribe values of between $60,000 and $100,000 to “household contents” and values like $15,000 car 1, $10,000 car 2, $20,000 caravan. It’s particularly misleading when these items comprise, say, one third of total assets. To be frank, this means the clients’ total assets are overstated by 50%, and net assets by even more. Please leave “household contents” and similar items out of lists of assets.
Don’t forget the basics
This week we had a cluster of SOAs for older clients being treated as growth orientated this week. We agreed with each conclusion, but generally thought more expansive comments were needed. This is discussed below under the heading “Conservative or not? It may not be as straightforward as you think The SOAs were fine, as far as they went. The problem was they did not go far enough. Obvious questions hung, un-discussed, in the air. The two most obvious ones were:
- how is your home loan going to be paid off by age 65? And
- how are you going to build your super up by age 65?
You need to discuss these questions with your clients and make sure your strategies present solutions. For example, you could write.
“We recommend you supplement the ten year growth orientated SMSF investment strategy with increased salary sacrifice contributions arranged through your employer. $10,000 after tax contributions each year for ten years invested at 8% after tax a year will compound to $166,455 by the end of the tenth year. This will make a significant difference to the economics of your retirement.”
And/or you could write:
“We recommend you increase your home loan repayments by $10,000 a year each year for the next ten years. You are in the 40% tax bracket, so paying off a non-deductible home loan of 5% a year is the same as earning a capital protected $16,667 before tax each year. Reducing the home loan by say $ by age 65 will make retirement that much easier and more comfortable. We can help you prepare a cash budget to identify ways of making these payments without giving up current lifestyle (or at least too much current life style) if you need assistance here.”
You could also write:
“In ten years time you will be age 65, and we believe you should plan to pay off your home loan completely, setting the stage for retirement. This will be done by:
- paying an extra $10,000 a year off the mortgage each year over the next ten years, as discussed above; and
- drawing on your tax free super to pay off the remaining home loan.’
And/or you could write:
“On current projections we believe you will not be able to afford to retire at age 65. Improving the net investment performance of your SMSF will obviously help; but realistically you will still fall well short of your target capital of $X. We should meet again to discuss your options here, but at this time we can say they include:
- analyzing your current spending pattern to identify how you can build up your expected net assets position by:
- speaking to your doctor or health consultant to create a health management plan that will maximize your prospects of working past age 65, say to age 70, possibly on a part time basis. Apart from improved health and life satisfaction, this will probably have at least four financial advantages:
- your partner re-training and re-joining the workforce on a part-time basis, say 20 hours a week, for the next ten years and dedicating all her earnings to a “retirement fund” comprising home loan repayments, concessional super contributions and non-concessional contributions.”
Clients may not be happy discussing these issues. They can cause discomfort. But as your client’s financial adviser you have an obligation to raise them as concerns and to proffer suggested solutions. There is no magic wand, and the best investment returns on the best financial products are unlikely to fix the problem on their own. The mid-fifties is the latest you should have this discussion: by the mid-sixties it is too late. Remember, financial planning is about financial planning not financial products.
Conservative? Or not? Classifying clients may not be as straightforward as you think
We are seeing a lot of SOAs where the product advice is fine, but where the thinking behind the advice is a bit weak or incomplete. You have to explain why your client is not a conservative investor and is a growth investor. You cannot just say “you are a growth investor because you have a ten year time horizon”. It’s not as simple as that. More detail is needed. In particular, if some facts suggest that the client should be conservative and some suggest the client should not be conservative, you have to weigh them up and see what the net position is. For example:
- A client may be age 52, and employed in a physical job such as deck hand on wages including overtime etc of $100,000 a year. Yes, this is a high income. But for how long can it be sustained? What is a reasonable remaining working life for a 52 year old deck hand? Is it sensible to assume he can keep working for ten or more years?
- The client may present as single, but be in a relationship. What happens if the relationship breaks up? What claim might the partner have on the client’s home? Super? Other assets?
- Are the client’s parents still alive? What is their net asset position? Is it reasonable to assume an inheritance will be received in the next five years? The next ten years? Should this be discussed in the SOA? Should the expected inheritance be included in the assets now?
- How will the client live after say age 65? Will the client qualify for the old age pension on current trajectories? If the client has a home loan of say $400,000 at age 52, how is that loan going to be repaid by age 65? How is that loan going to be re-paid if the client has to stop working?
Be a bit skeptical about what clients say is their expected retirement age. The ABS says only 9% of workers expect to retire before they are age 60. Nevertheless, the average retirement over the last five years is only 62 for men and 59 for women. (The long term average retirement age is actually much lower: about 55 for men and 50 for women: yes, we are working longer, but bear in mind the widening definition of “working”. If you work just a few hours a week these days you are “working” for these purposes.) You can read more about this here: ABC article on average retirement age, by Michael Janda 10 December 2013.
Advisers Dover does not want
Dover speaks to aspirant advisers every day. Some cases are straight-forward. Many applicants will have been with another AFSL for say five years, have an established practice and be of good reputation. Such applicants are welcome. Provided they can adjust to Dover’s more stringent compliance standards and the absence of product bias they should do well in our system. Other applicants will be fresh to the profession, and not have much relevant experience. These are welcome too. And Dover is happy to provide further assistance to help them get started including co-writing the early SOAs and double-checking their advice before it is provided to the client. Accountants are particularly welcome. Dover is connected to McMasters Accountants and accounting is in our DNA. Free SMSF set up and low cost SMSF support through Dover Outsourcing appeal here. Accountants are used to working with clients and (usually, and hopefully) automatically look to the next thirty years with the client, not just the next thirty days. Accountants usually make good financial planners. So which applicants does Dover not take on? I have been thinking about this lately and I can see a definite pattern. Dover does not take on “mono-product” advisers, ie advisers who only have one angle on the client relationship, ie to place a particular product or service, and who cannot or are not interested in providing a wider range of services. (And I will leave risk specialists out here, for reasons that will become obvious in a moment.) The two best examples are the pseudo share broker and the developer’s puppet, aka accidents waiting to happen.
The pseudo share broker
A recent applicant boasted he was an “equities investment adviser” and not a financial planner. This did not get far with us, since Dover is all about financial planning. But we interviewed him anyway. It turned out he was trying to start a boiler room operation selling quasi-stock broking services including operating e-trade accounts for his clients. We had quite a few concerns, including:
- his proposed business sounded perilously like an individually managed account (IMA). Dover does not allow IMAs because they:
- are not permitted under our licence, which is the way we like it;
- usually involve trading shares, which is a great way to lose money fast; and
- are incredibly risky, which is something their operators will find out next time the market turns south for an extended period;
- his proposed business model flaunted the SOA/ROFA advice rules, with a very real risk that advice would not be documented in line with RG 175, which means the adviser is responsible for any losses the clients sustain, and is open to penalties under the Corporations Act;
- the adviser not having the skills, training or experience to advise on a large number of shares including, in effect, every share on the ASX; and
- the adviser’s comment that when his clients said they wanted to buy a speculative mining stock he would have to “move very quickly”, really frightened me for many reasons including the fact that:
- for excellent reasons such stocks are not on Dover’s APL, and
- the adviser obviously did not understand:
- the financial advice process,
- Dover’s compliance processes, or
- FOS’s complaint processes.
We outlined our concerns and encouraged him to instead think about setting up a more traditional financial planning practice, albeit one with a distinct emphasis on direct shares. We suggested he:
- think in terms of 30 years not 30 days;
- focus on advising clients rather than selling clients;
- advise on investment structures such as SMSFs, companies and trusts;
- consider the particular circumstances of each client and make sure the advice is appropriate to them and in their best interests;
- only recommend blue chip shares, with a minimum holding period of at least ten years;
- have regular 6 monthly meetings with clients to discuss opportunities and threats;
- ensure RG 175 is complied with at all times; and
- encourage his clients to run their own E-trade account to avoid the obvious risks connected to the adviser running it.
Doing this means over time he would build up a profitable, valuable, sustainable and compliant practice that was separated from him as the owner and not dependent on short term market moves and frantic manning of client’s e-trade accounts.
The developer’s puppet
We have met this aspirant adviser, and his close cousins, many times over the last few years. The only reason this person wants to be licensed is to set up SMSFs so they can gear up and buy the developer’s off-the-plan units. It’s always a short and abrupt meeting. Dover does not permit off the plan property purchases, and, with few exceptions, does not permit apartments. Full stop. This is because most apartments sold off the plan in Melbourne and Sydney over the last few years have sold at prices significantly above their market value at settlement (not bank value, which is lower again). We are already seeing litigation lawyers trawling for clients, and they are going to have a field day. The exception to Dover’s rule against apartments includes for example, apartments with perpetual views of Sydney Harbor, Melbourne’s Albert Park Lake and similar sites, provided they are bought on the secondary market ie not off the plan or from a developer. If you have clients in this category just let us know what is happening: it will almost certainly be fine with us. Dover encourages its advisers to advise on property. For most clients the most valuable asset is the home and if you do not advise on the home, and allied issues, you are not really acting in your client’s best interests. We like to see SOAs commenting on:
- buying a first home
- up-grading a home
- paying for renovations/improvements/extensions
- down-sizing a home in later life
- reverse mortgages as a way of unlocking equity
- helping adult children buy homes.
These are the property questions that should be discussed with clients. And providing answers, and solutions, is a great way of building a profitable, sustainable and valuable financial planning practice. And you will have real clients. Not just a developer who will drop you as soon their stock is sold or someone offers them a better deal. I hope you can see how this approach fits in with Dover’s overall philosophy of allowing advisers to run their practices they way they want to run their practices, provided they comply with the financial services law. The litmus test is whether your advice is in the client’s best interests and appropriate to the client. Dover is free of institutional bias and is product agnostic. We have no institutional conflicts of interest. We just want advisers to give the best possible financial planning advice to clients, covering all aspects of their financial lives. Please do not hesitate to contact me should you wish to discuss Dover’s approach to SOAs or need any assistance in advising your clients. And I hope you are well and that business is brisk.