Regal Funds Share Purchase Plan

Regal Investment Fund (RF1.AX) is doing a share placement and a share purchase plan (SPP). Under the SPP you can buy up to AUD 30k of shares at the recent NAV of AUD 3.41. They have made an official 20% average rate of return since inception. My internal rate of return is higher than this. So, I think I should take up all of this, but don't have anything I want to sell in the SMSF's brokerage accounts. I could either make an additional AUD 30k non-concessional superannuation contribution to my account or withdraw something from one of the SMSF futures investments. It's probably the last chance to make non-concessional contributions to my account, as I could hit the balance transfer cap of AUD 1.9 million by 30 June 2025. Also, the futures investments have been weak recently, so I think they might see a return to the mean in terms of performance and selling now might not be a good move.

Transition to Retirement

I am thinking of setting up a transition to retirement pension (TTR pension). This allows you to receive regular payouts from your superannuation once you reach the age of 60 even though you are still working. I will be 60 years old in about 6 weeks time! There are lots of strategies this can be used. In my case, I am thinking to continue working full time at least for the next year and to recontribute all the payout to superannuation as non-concessional contributions (post-tax contributions). This has two advantages: 

1. It will convert money that was contributed as concessional contributions (at the 15% or 30% contributions tax rate) and earned as investment returns into non-concessional contributions. If my children inherit some of my superannuation when they are past the age of 18 they then won't need to pay tax on this part of the payout. The "death tax" is only on concessional contributions and fund earnings.
2. Once I hit the transfer balance cap, of currently $1.9 million, I can contribute the money to my wife's superannuation instead. I am currently at $1.7 million and she is at $800k. So, there is still a lot of unused capacity there. 

When you retire or reach age 65 you can transfer money up to the transfer balance cap into a zero taxed pension account. Money over the limit stays in an accumulation account where earnings are taxed at 15% (10% for long term CGT). The TTR pension does not affect the calculation of the transfer balance cap unless you are still holding it at age 65 when it becomes a regular tax free pension account.

My Unisuper account is close to 100% concessional contributions and earnings. So, I would start with that and transfer $600k to a pension account and pay out 10% of it each year, which is the maximum withdrawal rate. You have to leave some money in the accumulation account to receive new contributions... But actually 60% of my SuperGuardian account is also concessional contributions and earnings, and so it would make sense to transfer $400k from that into a TTR pension account too. So I would be withdrawing $100k per year and recontributing. The reason I wouldn't withdraw the maximum annual non-concessional contribution level of $110k is because my employer contributes more than the allowed cap on concessional contributions each year and the excess becomes non-concessional contributions.*

The downside to recontributing to my wife's superannuation is that I could make those contributions from non-superannuation money resulting in getting even more money into super. After all, even if you have more than $1.9 million in super, the amount above the limit is concessionally taxed compared to non-super investments.** But right now I am not making those contributions. Instead, I have been building up a pile of cash offsetting our mortgage. This is partly to reduce our interest bill but also part of a plan to buy a more expensive house in the future. So, as long as I was planning on saving to buy a house, I wouldn't make non-concessional contributions to her account.

Anyway, I sent an email to Unisuper yesterday expressing my interest in TTR pensions and asking what the next step is. 

Originally, I planned on switching to half time work when I reached 60 years old, but I seem to have fallen victim to the one more year syndrome. Seems silly to sacrifice $120k in pre-tax salary and superannuation just to have a bit easier time in the teaching half of my year. Also, my university is enacting a major cost-cutting exercise that likely will see more than 500 jobs cut in total. Academic jobs will not be cut till next year. They are not putting in a voluntary redundancy scheme. But I figure that if I am made redundant then I will get a bigger payout if I am still working full time. I could be wrong about that.

* That's why my Unisuper account isn't 100% concessional contributions and earnings.

** The government plans to tax superannuation in excess of a $3 million threshold at higher rates that include unrealised capital gains. But I think the senate will not pass that legislation and we are still a long way from the $3 million level.

Should You Keep Your Superannuation in Accumulation Mode?

The accepted wisdom is that as soon as you retire in Australia and are over 60 years old, or as soon as you hit 65 years old even if you are still working you should shift your superannuation from accumulation to pension mode. You can transfer up to $1.9 million per fund member into pension mode currently. Investments in pension mode have zero tax. This is in comparison to 15% tax in accumulation mode with a 1/3 reduction for long-term capital gains.

But what if you have a lot of investments outside of superannuation? These are highly taxed and so doesn't it make sense to run these investments down first to reduce your overall tax? In pension mode there are required minimum withdrawals each year. If you don't spend that money it is simply added to your highly taxed non-super investments. So, despite not having to pay tax on your money in super, you are transferring more and more money out of super into your taxable accounts. Does it make sense to wait till you have spent your non-super investments?

I ran a simulation in my long-term projection spreadsheet. This isn't a Monte Carlo simulation. I just assume my historical average rate of return over the last 20 years applies into the future. I assume that I retire at age 65 and convert my super to a pension and Moominmama converts her super to a pension at age 60. She stops working when I do. I also assume that the tax rate on investments outside super is 20% of returns (without any attempt to define realised and unrealised gains) and in super in accumulation mode is 12.5%. Both are probably at the high end of what might actually happen. But the contrast with zero tax in pension mode, makes pension mode more attractive relative to accumulation mode. The simulation runs to 2050.

I also run a simulation where all our super stays in accumulation mode. This no pension scenario has 8% more assets in 2050 than the pension scenario.

This modelling is still not that realistic. I assume that all our superannuation can be moved to pension mode, even if we exceed the $1.9 million threshold. Also, we are likely to make more non-concessional contributions to Moominmama's account before 2029 and I assume we don't. I'm think that these tweaks won't change the fundamental result. We would have to have a lot less non-super investments to change the conclusions.

Superannuation Returns for the 2023-24 Financial Year

The Australian reports on the performance of superannuation funds for the just completed financial year. This year, retail funds tended to perform better than industry funds because of their higher allocation to public stock markets rather than private assets. How did our SMSF do by comparison? I don't actually compute comparable after-tax performance figures, which are how superannuation returns are reported.* Public offer funds make an allowance for future tax payable, which includes capital gains tax if the assets are sold. This means that members who withdraw funds don't push tax liabilities onto those that stay. This is unlike a regular unlisted managed fund where tax is at the investor level and attached to distributions... 

So, instead I estimate what the performance of our employer funds might be pre-tax. This probably over-estimates the performance of the employer funds, but reconciling tax expected with tax actually paid on our SMSF would be hard work. On that basis, the SMSF returned 9.54%. Unisuper returned 10.89% and PSS(AP) 10.55%. Both the latter are balanced funds. Even though we underperformed for the year, we are still ahead overall since inception:

PSS(AP) has, however, inched ahead in risk-adjusted performance. It now has an information ratio (Sharpe ratio with zero risk free rate) of 1.02, versus 0.96 for the SMSF. Unisuper is on 0.83. 

Since inception, the SMSF has returned an annualized 7.9% pre-tax versus 6.44% for Unisuper and 6.63% for PSS(AP).

* Reported performance does deduct administration, audit, ASIC fees etc. As an example, for the year to 31 December 2023, Unisuper report a return of 10.3%, while I estimate a pretax return of 11.15% for the fund.

Revisiting Inflation vs. Investment Returns

In January, I posted about how much of investment returns were being taken up to cover the effects of inflation. I fitted a quadratic curve to monthly investment income to smooth it out and compared that to the current inflation rate multiplied by our net worth. It didn't look good. How are things looking now that inflation has come down a bit?

On this graph, I have also added fitted saving and an alternative calculation of expected investment returns. To calculate this one, I fitted a linear trend to the monthly percentage rate of return and multiplied that by net worth. It doesn't include any gain in the value of our house, and turns out to be relatively more conservative. On the other hand, the "boiling point" where investment returns exceeded saving was still around 2012.

The picture has improved in the last few months as inflation has declined. Using the more conservative measure of projected investment income we have a surplus above inflation of around AUD 15k per month, which is in the ballpark of our current spending not counting taxes. If inflation stayed low, retirement should be feasible. But there is still huge uncertainty around future inflation, investment returns, and spending, which continues to make me cautious.

SMSF Portfolio Allocation

As there has been a lot of recent change in the SMSF portfolio allocation, I thought I would have a detailed look at it. The last time I updated this spreadsheet was in August 2022, when the portfolio was quite different.

We also are long two Australian Dollar futures contracts. The asset classes are where each investment is classified for my reporting based on asset classes. PBDC is equity of private credit lenders, Defi Technologies is a crypto asset manager, and bitcoin isn't mostly actually futures. So, their designated asset classes are a bit to a lot misleading. Regal is actually only about 50% hedge funds now, with real assets (water and royalties), private credit, and venture capital in the mix. In my reporting on asset classes I break it down along these lines.

So there is about 30% managed futures exposure, 21% crypto exposure, about 17% private equity, 16% property, 15% hedge fund with some real assets thrown in, and 1% cash.

There wouldn't be much point in having an SMSF if the portfolio looked like a typical industry fund 😊. 

We pay only 0.26% per year in admin fees to SuperGuardian.

Checking in on the SMSF

 We have now been running an SMSF for almost three years. How is it doing?

The obvious benchmarks are our employer superannuation funds - Unisuper and PSS(AP). All these numbers are pre-tax. I probably over-estimate the tax paid by the funds, while I know the exact amount of tax paid by the SMSF. So the funds have a bit of an advantage here. 

The SMSF got a good start after which it gradually trudged higher. The two industry funds both declined substantially in 2022 and then recovered. PSS(AP) is almost catching up with the SMSF now.

The SMSF has had lower volatility than the two industry funds, though, at 1.85% per month, its standard deviation is only marginally lower than PSS(AP) at 1.87%. Up and down moves are both penalized using this metric. Unisuper's standard deviation is 2.23%.

Using Unisuper as the benchmark, the SMSF has a beta of 0.42 and an annualized alpha of 4.75%.* Another way of expressing this is that the SMSF captures 64% of the Unisuper's upside but only 24% of its downside. Reducing downside risk is one of our main goals.

* This is treating the risk free rate as zero. The official CAPM alpha using the RBA cash rate will be a bit lower.

Projected Retirement Income

If we retired today, how much would our retirement income be? To answer the question, I updated an analysis I did a few years ago and came up with this graph:

Passive income is what our combined tax returns would be in each year if we had not received a salary nor made any work related deductions. I also added back charitable deductions and personal concessional superannuation contributions to our SMSF as these aren't costs in the same way that margin interest is, for example. So, it is not 100% passive as it includes realised capital gains and losses. I also plot how much a 4% withdrawal from our superannuation accounts and US retirement fund would amount to under the assumption that we apply the 4% rule to these accounts. My thinking is that unrealised gains on the non-retirement funds would be sufficient to maintain purchasing power. Taxes are likely to be very low, so I just ignore them.

Last tax year our income would have been AUD 154k. Our spending not including mortgage interest and life insurance was AUD 152k. So, this is one reason why I don't feel comfortable retiring as we are spending very close to our sustainable income and spending is likely to continue to rise. On the other hand, if we apply the 4% rule to our entire portfolio at 30 June 2022, it would yield AUD 175k. But maybe the 4% rule is not conservative enough. My recent analysis of how much of our returns is needed to compensate for inflation, was much more pessimistic than this.

If we were forced to stop working we could easily slash spending by taking the children out of private school, which accounts for an expected 30% of our budget.

How Much Investment Income Do We Need to Compensate for Inflation?

 

This chart compares the fitted investment income curve from my previous post about the "boiling point" with the monthly loss of value of our portfolio (including our house) due to inflation. I just took the monthly percentage change in Australia's consumer price index and multiplied by the value of our portfolio that month. The gap between the blue and orange curves is a naive estimate of how much can be spent each month in retirement mode.

Currently, projected investment income is only just enough to cover the loss from inflation. Smoothing inflation over twelve months tells a similar story:

Here I divide the CPI by its value twelve months earlier, take the twelfth root and subtract one before multiplying by the value of the portfolio. This shows that inflation is coming down a little but is still high. We really need to boost our rate of return relative to inflation in order to retire and maintain the real value of the portfolio. It is hard to think about retiring until in inflation is more under control.

Investment income accounts for superannuation taxes, but assumes that the only tax on investments outside superannuation is exactly equal to the franking credits paid.* In retirement, the superannuation tax would go away, but there would be capital gains and other taxes on investments outside superannuation. So, probably it is in the ballpark.

* This is because the series is computed as the change in net worth minus saving and inheritances. Saving is computed after tax including superannuation contribution taxes and income tax.

Superannuation Returns in the Long-Run

Following up from my post on how our SMSF is performing compared to our managed superannuation funds, here is how our superannuation in general has done over time:

Note that the y-axis is a log scale! Our superannuation has outperformed the MSCI index in AUD terms in the long-run. The big win was in the couple of years after 2002 when I rolled over my Unisuper fund to Colonial First State and invested in geared funds. Then I got too conservative leading up to the GFC - the flat top you can see on the red line. Superannuation returns crashed in the GFC because I got aggressive again too early. After that, we have followed the market more closely until after 2018 when we have gone into a bit more of a capital preservation mode again. This reduced the volatility in 2022 but returns in 2023 are a bit disappointing so far.

On the other hand, our non-superannuation assets had catastrophic performance up to 2009. After that, I got my act together, which eventually gave me the confidence to set up an SMSF. But you can see the value of handing control to an external manager early on.

Superannuation returns are pre-tax but after fees. My method of imputing tax paid for public superannuation funds probably exaggerates their performance a bit. These time based returns are quite different from dollar based returns. All the early volatility wasn't that important because total assets were small. Performing well now is much more important.

Enough Wealth followed up on my original post by comparing his SMSF over a longer period to a basket of industry funds.

Superannuation Performance Update July 2023

Inspired by this article in the AFR, here is an update on how well our SMSF is doing compared to Unisuper and PSS(AP). after underperforming for a few months, it outperformed in June and July:

Looking at the longer term, it is still ahead of the two super funds:

It rode out the 2022 downturn with less "volatility". PSS(AP) actually has a slightly lower standard deviation of monthly returns but also a lower mean. As a result, the SMSF has an information ratio (Sharpe ratio with a zero return hurdle) of 1.1, while Unisuper is at 0.61 and PSS(AP) at 0.73. Relative to Unisuper, the SMSF has an annual alpha of 5.36% and a beta of 0.44 (Relative to PSS(AP): 4.61% and 0.61).

I compute all these returns pre-tax. This probably overestimates the taxes paid by Unisuper and PSS(AP), giving them a bit of an advantage. OTOH, I don't charge for my time in managing the investments.

Superannuation Performance Update

 

I just calculated the return on my TIAA-CREF 403b in Australian Dollar terms to compare to our Australian superannuation funds. While the SMSF has done a lot better than Unisuper and PSS(AP) since inception, TIAA has really shone. This is mainly due to our investment in the TIAA Real Estate Fund and partly due to the fall in the Australian Dollar. Now, I am wondering whether to switch out of that fund.

Pre-tax returns for the 2021-22 financial year were: SMSF 2.6%, Unisuper -5.0%, PSS(AP) -2.9%, TIAA-CREF 28.5%. I am very generous in estimating the tax paid by Unisuper and PSS(AP). This boosts estimated pre-tax returns on the way up a little but detracts a bit on the way down.

Division 293 Humblebrag

It looks like I will have to pay Division 293 superannuation contributions tax for the first time. This is an extra 15% tax on superannuation contributions that you have to pay if your income including concessional super contributions is above AUD 250k. My preliminary estimate of my taxable income is already above AUD 250k. So, for sure the total including around 30k of super contributions will be even if the final income number is a little lower. This is probably going to mean an extra AUD 4,500 of tax. 

I'm also currently estimating I'll owe more than AUD 13k in extra tax after paying AUD 6k in tax installments. Last year I got a tax refund because of the Virgin Australia debacle. Bond losses can be deducted immediately from your income unlike losses on shares. The tax installments were because the previous year's tax return...

I'm reluctant to stuff more money into super as non-concessional contributions to reduce tax in case we'll need it. For example, to buy a bigger or better located house. If I continue to work, we can't withdraw the money from my account till I'm 65 in 8 years time. And much longer in Moominmama's case. That liquidity costs in taxes. 

In the last couple of years we made large non-concessional contributions. I also have illiquid investments in venture capital and art. Our liquid investments are 46% of gross assets not including our house. I doubt I can get a bigger mortgage given my age and Moominmama's low wage income.

Related-Party Asset

I have been trying to invest in a fund on the AngelList venture capital platform. But my SMSF administrator flagged that there might be issues because the fund is organized as a limited partnership. The auditor has now provided the following information:

"A partnership can elect to be taxed as a Limited Liability Company (LLC) in USA or a partnership under the tax law due to the elections that the LLCs make with the US Internal Revenue Office. It is common for such partnerships (US) to be taxed as a company.

To support compliance with SISA/SISR for investments in Limited partnerships we note the following potential scenarios and information for audit purposes:

1. Where the entity is taxed as an LLC, this supports that the LP should be treated as a company where the members of the Fund are not members of the LP and the investment therefore is considered as an investment in an unrelated entity. This is usually able to be ascertained from the financial report of the LP. 
2. Where the entity is taxed as an LP, and the members of the fund are not members of the LP, and the investment is in within a limited capital account arrangement. This is usually able to be ascertained from the financial report and the application agreements. 
3. Where the entity is taxed as an LP, and the members of the fund are members of the LP.

If the investment falls into scenario 2 and 3 then the investment would classified as an in-house asset which would mean it needs to be below 5% of the SMSF’s total assets."

It seems that this falls under scenario 3. I just sent AngelList an email to check. The problem is that the minimum investment required, let alone subsequent hoped for appreciation, would take us over the 5% limit. So, it seems it is not really true that you can invest in anything you like through an SMSF. It seems silly to me to treat a fund where I am only investing through the SMSF along with 1500 other investors as a "related-party asset". Probably, I will need to invest in this fund using my own name and pay higher tax than I would through the SMSF.

Update on TIAA Real Estate Fund

Back in May, I predicted that the TIAA Real Estate Fund would perform well and shifted almost all my US retirement account into it. Well, it has done exactly that:

Since May it has gained 14.4%, while the Social Choice fund gained only 1.3%! I wish all my predictions were this good and I hadn't left anything in the Social Choice fund. The question now is when to start switching back again.

How Has Our SMSF Done So Far?

 

We have been fully invested in the SMSF for 9 months now. It's more volatile than PSSAP – Moominmama's employer super fund and about as volatile as Unisuper – my employer super fund. It has higher mean returns than both of them so far: 1.32% per month vs. 0.30% for Unisuper and 0.81% for PSSAP. Unisuper's return has really been brought down by a more than 5% loss in January. By contrast, the SMSF lost 1.18% (preliminary) and PSSAP 1.52%. If I regress the SMSF returns on the Unisuper returns I get a beta of 0.34 and alpha of 16% p.a. Of course, these are really early days and I don't expect that to hold up. I will want to see a longer track record before considering rolling over any of our employer superannuation into the SMSF.

Defined Benefit vs. Defined Contribution Update

Each time I was given the choice to be in a defined benefit scheme or a defined contribution superannuation scheme, I chose defined contribution. So, now and then I like to check whether I made the right decision. I worked from 1996 to 2001 in the Australian Higher Education sector. In fact, at the same employer I now work for. Originally, defined benefit was the only option. But then they gave us the choice to switch. In 2001, I rolled over my account to Colonial First State and then this year to our SMSF. I have now worked out how much that money is now worth. I estimate that it is AUD 410k. In 2009 I started working at the same employer again and opened a new Unisuper defined contribution account. It now has AUD 477k in it. So, in total I have AUD 888k. Including the 5 years that I worked from 1996 to 2001 my defined benefit lump sum would now be AUD 473k. We are going to need to have a big crash to make those numbers equal...

FI or FIRE?

 

I wrote about FIRE (Financial Independence Retire Early) at least once before. The Retire Early bit is the problematic bit. It makes much more sense for people to use financial independence to do what they want to do rather than just stop working.

A while back I heard that Mr Money Mustache got divorced. Seems his wife wanted to spend more money given their high income. But that wouldn't fit with his frugality message. Now here is a FIRE blogger who retired with a small nest-egg - so-called "lean FIRE". His wife got tired of not spending much either and of having too much leisure time and not making "progress" in life. And here is another blogger who is tired of not having enough money. Many FIRE bloggers who supposedly retired actually work on their blogging business. They stopped being an employee and became self-employed. This is great.

With a net worth of approaching AUD 6 million we are financially independent by any reasonable definition. But I'm not planning on retiring. As I mentioned before, I like my job, at least the research part. I am hoping to not ever teach more than one course a year again. I am sacrificing more than AUD 40k to take long-service leave next year to reduce my teaching load. After that I am planning to take on a "leadership role" for a while and once I turn 60 I hope to go part-time. Also, I don't want to sacrifice the "prestige" and become a nobody. Unless we plan on moving somewhere else, it seems to make sense to do my very flexible job.

And actually I am thinking that our money isn't enough. Our older child is going to private school and the younger one probably will too. The alternative is to move to a top public school catchment area. My wife isn't happy with the public schools here, though I think they are fine. With the way the property market is going that means an AUD 2 million + house price. Or maybe move to Sydney because the best public schools in Sydney are better than the private schools here. My wife puts a big weight on education. I thought Jewish parents like my parents and me were into education. Chinese parents are at another level.

And, actually, I did the retire early bit already. I just wasn't financially independent.

Already Making Changes Based on the Investment Review

I've only done the first two parts of the Investments Review, but am already making changes to our portfolio based on it. I switched our holding of the Platinum International Fund for more units in the Generation Global Fund. The internal rate of return of the latter is twice that of the former and the alpha of the former is about zero, while the latter is around 3%. We still have a holding in the listed investment company Platinum Capital (PMC.AX). I also cancelled the automatic investment plan for Moominmama's account that holds the Generation Global Fund. Now that we are trying to get more money into superannuation, it doesn't make sense to keep putting AUD 2k per month into these accounts. Her account now holds the Generation investment (now 2.45% of net worth) and holdings in CFS Imputation (0.98% of net worth) and CFS Developing Companies (not reviewed yet).

Career Decision-Making

My university has a big deficit currently and one money-saving move has been to ask people who are eligible to take long-service leave. Every pay period money is put into a long-service leave account. The university can't access this money unless the employee takes long-service leave. When they take long-service leave, the university stops paying their regular salary thus reducing the current deficit. I haven't yet been eligible as you need to have 10 years of service, and I started in 2011 in my current position. But I was thinking of taking long service leave in the first half of next year. I was vaguely thinking about retiring by the end of next year.

According to standard criteria we are financially independent. 3% of our net worth is AUD 150k and our annual expenditure is around AUD 120k. However, I expect our expenses to rise faster than the rate of inflation. We have two young children who my wife is determined to send to private schools (I tend to think that public schools are fine). We are spending on one private school and daycare right now. We don't get much childcare subsidy from the government because our income is high. But high school is more expensive than this.

My wife (Moominmama) is working (2 days a week), though I told her she doesn't need to if she doesn't want to. She said that holding on to the job has option value. Which I kind of agree with. Things feel very uncertain.

Now I was asked whether I could again take on a leadership position in my school (school = very large academic department in US terms - our school has 4 departments within it - think something like a business school of a university). This is probably the best of the leadership positions. I think it is kind of unfair because I spent five of the last ten years holding such positions, which are a lot of extra work, and some full professors have never done even one. The argument is that I am good at it and they're not... 

So if I started this in January, I couldn't take long service leave and it would be for two years probably. Usually, you get AUD 10-20k a year extra pay. After tax, that is half that, of course. After discussing with Moominmama she said that I should ask instead to reduce my teaching. This has happened in the past and the incoming director might be more open to this than the current school director. Moominmama also think I should hold onto my job for the "option value" and not retire. So, I suggested to her that after doing the leadership position for two years maybe I would switch to half time, which means I could keep the low teaching load. The truth is that without leadership duties my job is a very easy way to earn AUD 200k a year (including the superannuation contibutions). AUD 100k a year is also good money. So, I think I will tell the incoming director that I will do it, but only if I can teach less. I would still earn the AUD 200k a year for the next two years. I won't tell her about dropping to half time after that. Or should I just say no, because others haven't done their fair share of the work?