How Much Money Do You Need for Retirement?

I went to a seminar by our superannuation (retirement fund) provider at my employer today. The presenter referenced a recent Australian survey that tried to define how much income retirees need based on surveying actual retirees. They found that for a "comfortable" retirement a couple need after tax $A54k ($US58k) per year after tax, assuming that they own a house 100%. In Australia there is no tax on retirement accounts once they are in pay out mode after age 60 and so the before and after tax numbers are the same. The presenter said: "That means you need $1 million. If you want to take a bit more risk or run down your capital then you could get away with less than that." The article I linked above says you need $A815k to provide that level of income. The presenter at today's seminar was assuming a withdrawal rate of 5.4% p.a. and the article is assuming 6.6%. But it is a well-known rule of thumb that 4% of the initial amount (adjusted upwards over time by inflation) is the most you can withdraw annually without risking running out of money. And that rate assumes a moderate amount of risk (like 60% stocks and 40% bonds). Also, the advice by the presenter today made no allowance for inflation between now and the date you retire (the linked article does note that the $A815k is in today's money).
Why is this dangerous advice being given out in Australia?

Based on current expenditure we could live OK on less than $A54k a year if we didn't pay rent. $A42k would be enough - halfway between the modest and comfortable levels. But then there are property taxes and house maintenance so we can't just take our rent away to find the comparable number. So I think $50k a year is a reasonable number. But to find the required net worth you need to multiply by 25 and then adjust for inflation. If I retired at age 60 and prices rise by 3% p.a. between now and then I will need 51% more capital than now. The lump sum I get is $A1.89 million + a house. A house costs currently about $A700k near where we live. Adding the same inflation adjustment to the house gives a total required net worth of $A2.9 million ($US3.2 million) in 2024.

Something I learned which I didn't know about the tax rules for Australian Superannuation. If a non-dependent (not spouse or child under 18) inherits your superannuation account they will have to pay 15% tax on funds derived from concessional contributions (contributions taxed at 15% from pre-tax income) but no tax on non-concessional contributions (contributions from after tax income). I knew that tax could be payable in these circumstances but didn't know the details. This is a reason that you don't want your superannuation to be paid to your "estate" in the case of your death. 15% tax will be charged on the concessional contributions.

Save, Inherit, and Invest

I love reading the Millionaire Interviews at the Earn, Save, and Invest Blog. One of the questions they get asked is "What would you say is your greatest strength in the ESI wealth-building model (Earn, Save or Invest) and why would you say it’s tops?" Compared to many of his interviewees, our earning has not been that strong. Despite my salary putting me in the top 5% of Australian earners, it's only nominally about USD 125k per year. On the other hand, our household income including superannuation contributions and net investment income is nearer USD 250k per year. Historically, I would have said that our strength was in saving. Before we bought the house and had children, we had a very high saving rate. But, in the last few years, our investment profits have really taken off. Now the sources of our net worth are roughly 25% saving, 30% inheritance, and 45% investment returns.

I've posted earlier versions of this crazy chart before:

It separates net worth into saving and investment returns in superannuation and non-superannuation accounts, inheritance, and housing equity. Part of housing equity is saving and part gains. Maybe, in the future I will split that up in the graph. Only recently is that difference becoming significant.

Up till the end of 2014, we saved a lot apart from the meltdown following the dot.com crash. Since then we moved savings into housing equity and superannuation, resulting in negative current savings. More interesting is that after the first transfer to housing equity the growth rate of savings (i.e. the slope in the segments without a transfer) is much lower than before 2015. On the other hand, retirement contributions remain strong.

P.S. 25 November

So, I made a chart showing just total savings, inherited money, and investment returns:

Investment returns are the gap between net worth and the other two categories. As investment returns went negative a few times, plotting them in the same way as the other two sources would be confusing. This graph shows that savings continue to increase but at a slower pace than they did in the first part of the previous decade.

And Yet More Proposed Changes to Superannuation

Turns out the government has decided to abandon the idea of taxing distributions from larger superannuation accounts. The latest idea they are floating is taxing earnings of larger accounts. But the threshold would be much higher than $800k. This after destroying further the confidence of investors that superannuation payouts won't be taxed. And of course, this further complicates the system. Probably this won't happen because there is no chance I think that this government will be re-elected in September. Of course, none of these changes applies to the huge superannuation benefits that members of parliament receive. Those should definitely be abolished.

Trading, Tax and Superannuation

Gradually, I'm getting up to speed on Australian taxation, retirement etc. A combination of reading the Australian Financial Review (horrible website only read the paper version) and Sydney Morning Herald (great website, The Australian's website sucks too but not as bad as the AFR) and then going and checking out the ATO website (not such a great website).

So if you are a trader you can record your profit and loss as "business income". If you are a derivatives trader (options, futures, CFDs (but not warrants)) then your income is automatically business income. For share traders it is a question of how business-like you are. But then it is going to be difficult I think to claim an long-term CGT discounts. So I don't want to be thought of as a "share trader" but instead investor in shares and trader in derivatives. Then you can deduct all expenses as they occur against your income. Any items that cost above $1000 need to be depreciated over time - e.g. a laptop. You can also claim rent, electricity etc. in proportion to floor area if you maintain a home office (I do). Investors need to apportion these types of expenses when they sell shares unless they can show that they need to do this to earn dividends in which case they can deduct them in the year they occur. Anyway, I plan to claim all these type of expenses against derivatives profit and loss and claim margin interest against dividends (make sure some of the stocks in each of your margin accounts pay dividends P.S. Remember to claim the tax withheld on foreign dividends).

It seems a trader can get an "Australian Business Number" and register for the GST. The advantage of this is that you can then claim credits for GST paid on inputs even if you are not charging GST on your sales (because they are "financial supplies"). I used to run an Australian non-profit and we signed up for the GST for just this reason. If you are in the 30% tax bracket, for example, you'll get back 100% of the GST paid, rather than the 30% you get back by claiming a deduction against income tax. The downside is you must now submit quarterly business activity and GST statements. I'm thinking, that for me at the moment it is hardly worth it - maybe a $100 or so gain if I bought a new computer say. The amount of GST on internet access or my business share of the electricity we use makes this hassle not seem worth it. But maybe an ABN is worthwhile for credit purposes etc. If you fill in a form and say you are self-employed they ask for your ABN....

To contribute to superannuation, at least 10% of your income must come from employment or business. I'll have a business loss this year so I can't contribute. I don't want to contribute much at this stage anyway but if your income is below $28,980 the government will contribute $1500 for the first $1000 you contribute to superannuation (with after tax money). This seems well worth it. From $28,980 to $58,980 the co-contribution gradually phases out. Hopefully, this will be relevant to me for the 2008-9 tax year and not so relevant in future years as I earn more :)

Once I do my 2007-8 tax return I'll understand all this a lot better I hope.

November 2022 Report

In November, stock markets continued their rebound and the Australian Dollar rose strongly increasing US Dollar returns relative to Australian Dollar returns. The MSCI World Index (USD gross) rose 7.80%, the S&P 500 5.59% in USD terms, and the ASX 200 6.78% in AUD terms. All these are total returns including dividends. The Australian Dollar rose from USD 0.6387 to USD 0.6744. We gained 3.05% in Australian Dollar terms or 8.81% in US Dollar terms. The target portfolio is expected to gain 1.23% in Australian Dollar terms and the HFRI hedge fund index around 1.0% in US Dollar terms. So, we out-performed all benchmarks apart from the ASX. 

Our SMSF hit a new high in terms of cumulative returns, exceeding the previous high in September 2021. It is now up more than 15% since inception and well ahead of our employer superannuation funds:

 

These are all in pre-tax terms - franking credits are included but no tax deducted. This will be a bit over-generous to the employer superannuation funds on the way up and the opposite on the way down. The increase in my US retirement account (TIAA) is to a large extent because of the fall in the Australian Dollar. It fell this month as the Australian Dollar rose. But the TIAA Real Estate Fund also performed extremely well over this period until recently.

Here is a report on the performance of investments by asset class: 

The asset class returns are in currency neutral returns as the rate of return on gross assets. I have added in the contributions of leverage and other costs and the Australian Dollar to the AUD net worth return.

Only futures had a negative return. RoW stocks were the best performer partly because of the rebound in the China Fund and hedge funds were the largest contributors to the month's return.

Things that worked well this month:

• Tribeca Global Resources was again the top performer in terms of dollars gained (TGF.AX, AUD 25k). Coming in second and third were the China Fund (CHN, 18k) and Australian Dollar Futures (17k). Also gaining more than AUD 10k were 3i (III.L, 17k), Unisuper (16k), PSS(AP) (12k) Pershing Square Holdings (PSH.L, 12k), and gold (10k). With the exception of the China Fund and AUD futures, this is very similar to last month.
  

What really didn't work:

• Winton Global Alpha Fund (-12k), Aspect Diversified Futures (-6k), and WAM Alternatives (WMA.AX, -4k) were the greatest detractors.
  

The investment performance statistics for the last five years are:

The first three rows are our unadjusted performance numbers in US and Australian dollar terms. The MSCI is reported in USD terms. The following four lines compare performance against each of the three indices over the last 60 months. The final three rows report the performance of the three indices themselves. We show the desired asymmetric capture and positive alpha against the ASX200 and the MSCI but not against the hedge fund index. We have a higher Sharpe Index than the ASX200 but lower than the MSCI in USD terms. We are performing more than 3% per annum worse than the average hedge fund levered 1.79 times. Hedge funds have been doing well in recent years.

We are now very close to our target allocation as Regal Funds diversifies its holdings. Our actual allocation currently looks like this:

About 70% of our portfolio is in what are often considered to be alternative assets: real estate, art, hedge funds, private equity, gold, and futures. A lot of these are listed investments or investments with daily, monthly, or quarterly liquidity, so our portfolio is not as illiquid as you might think.

We receive employer contributions to superannuation every two weeks. We are now contributing USD 10k each quarter to Unpopular Ventures Rolling Fund and less frequently there will be capital calls from Aura Venture Fund II. In addition, we made the following investment moves this month:

• I sold 5000 shares of WAM Leaders (WLE.AX) and bought 1000 shares of the China Fund (CHN).
• I sold USD 17.5k of the TIAA Real Estate Fund and bought the Social Choice Fund instead.
• I bought 4000 shares of Regal Partners (RPL.AX).
• I sold the 2000 shares I held in Fortescue Metals (FMG.AX). We made about AUD 4k on this trade.
• I sold 10k shares of Regal Funds (RF1.AX) and bought 500 shares of URFPA.AX - the US Masters Residential Fund converting preference notes.
• I sold 1,000 shares of Ruffer (RICA.L) to get money for our next subscription payment for Unpopular Ventures.
  

Spending 2020-21

For the last four years I've been putting together reports on our spending over the Australian financial year, which runs from 1 July to 30 June. This makes it easy to do a break down of gross income including taxes that's comparable to many you'll see online, though all our numbers are in Australian Dollars. At the top level we can break down total income (as reported in our tax returns plus superannuation contributions):

The gross income for this year is just an estimate. Tax includes local property tax as well as income tax and tax on superannuation contributions. Investing costs include margin interest. Mortgage interest is included in spending, while mortgage principal payments are considered as saving. Spending also includes the insurance premia paid through our superannuation. Current saving is then what is left over. This is much bigger than saving out of salaries because gross income includes investment returns reported in our tax returns. The latter number depends on capital gains reported for tax purposes, so is fairly arbitrary. Still, it has increased each year over this period. Spending also increased until this year when it was flat. Graphically, it looks like this:

We break down spending into quite detailed categories. Some of these are then aggregated up into broader categories:

Our biggest spending category, if we don't count tax, is now childcare and education, which has risen steeply. Given this it is surprising that spending didn't increase this year. Commentary on each category follows:

Franking credits: Income reported on our tax returns includes franking credits (tax paid by companies we invest in). We need to deduct this money which we don't receive as cash. Foreign tax paid is the same story.

Life and disability insurance: I have been trying to bring this under control and the amount paid has fallen as a result.

Health: Includes health insurance and direct spending. Spending peaked with the birth of our second child.

Housing: Includes mortgage interest, maintenance, and body corporate fees (condo association).

Transport: Continues to rise as I spend more on Uber and e-scooters and Moominmama drives more.

Utilities: This includes spending on online subscriptions etc as well as more conventional utilities.

Supermarkets: Includes convenience stores, liquor stores etc as well as supermarkets.

Restaurants: This was low in 2017-18 because we spent a lot of cash at restaurants. It's low this year because of the pandemic.

Cash spending: This has collapsed. It's hard to believe it is really that low, but that's what the numbers say. Moominmama also gets some cash out at supermarkets that is included in that category.

Department stores: All other stores selling goods that aren't supermarkets. No real trend here.

Mail order: This continues to rise. For example, I recently bought a new iMac by mail order.

Childcare and education: We are paying for private school for one child, full time daycare for the other, plus music classes...

Travel: This includes flights, hotels etc. It was very high in 2017-18 when we went to Europe and Japan. This year it was down to zero due to the pandemic and having a small child. We haven't travelled in Australia either. With the family it needs a lot of planning and borders are likely to suddenly close.

Charity: A growing category.

Other: This is mostly other services. It includes everything from haircuts to professional photography.

Clearly, we only kept spending under control in 2020-21 because we have stopped spending on travel and greatly reduced spending on restaurants.

Murray Report on the Australian Financial System and Superannuation

The findings of the Murray review of the Australian financial system have been released. I am most interested in their recommendations for superannuation (retirement accounts). Of course, there is no way to know yet what recommendations the government (or future governments) will take on board. This just adds to the uncertainty surrounding super. I had been thinking that now I am 50 years old, as soon as we buy a house I would start making after tax ("nonconcessionary") contributions to super. This is because once you retire there is no tax on superannuation earnings and it is only 10 years till I am 60 and could withdraw money. Though pre-tax contributions ("concessionary" - actually they are taxed at 15% instead of your marginal rate) are limited to $35k per year, you can contribute up to $150k per year after tax. But if they actually withdraw the advantageous tax status of super and worse still if they end up forcing people to take an annuity instead of being able to access their money as they like then I wouldn't want to put any extra money in super at all. The review recommends making annuities a default option, which people will have to opt out of, but I can imagine it becoming compulsory. So, for now, even when we have bought a house I wouldn't plan on adding any extra non-concessionary contributions to super. And yes I sold Qantas too soon :(

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.

Budget Cuts and Superannuation

Here in Australia we are now in the run-up to the annual federal government budget announcement. All kinds of ideas that might be in the budget are always floated in the run-up. One big one in the last few days is the idea of cutting superannuation tax concessions. Superannuation is the Australian retirement account system. It is very complex due to the nature of the tax regime. At the moment contributions are taxed at 15% rather than at people's marginal tax rate. Earnings of the funds are taxed at concessional rates and there is no tax when the money is withdrawn and once you are in the withdrawal phase there is no tax on earnings either. The latter two concessions were introduced by the previous Liberal government. So the most likely outcome is to remove the concessions for contributions. This will be a further step towards making our system like the US Roth IRA. But we will still be tax fund earnings which is the main contributor to complexity in the Australian system.

Even though obviously it is personally a bad thing for contributions to be taxed more, I think it is a sensible move. Why should high income earners get such a big concession and low income earners none? * It is the easiest way to push the budget towards surplus without raising tax rates or cutting welfare payments. All government departments in Canberra are already getting massive cuts to their operating budgets, but really there just aren't that many public servants in Canberra that this can make a really big difference, especially as in the short-term they are getting redundancy payments. I would be in favor of cutting some of the family welfare payments that the former Liberal government introduced and that Joe Hockey seems to regret, but I can't see Labor doing that.

* Of course you can flip this argument and say we should have a flat tax and super contributions are a good first step towards a flat tax. But that ain't happening any time soon...

Pre-Tax (Concessionary) Superannuation Contributions

After thinking about making after-tax retirement contributions, I thought today - Heh, I'm not even making the maximum pre-tax contributions. I've been making about $A28k a year in pre-tax contributions. Actually, that is supposedly my employer's contribution. In the university sector in Australia, employers contribute 17% on top of the nominal salary to superannuation for continuing (=permanent) employees, as opposed to the minimum government requirement of 9.5%. The maximum pre-tax contributions allowed for over 50's currently is $A35k per year ($A30k for under 50s). So, I just submitted the form to add $100 a week to my contributions. I didn't totally max things out to allow for a year or two of growth in salary before having to submit another form.

By the way, the standard agreement in the higher education sector includes another 8.5% pre-tax contribution from the employee's salary. I already opted out of that, because it would have been over the concessionary limit already when I started in 2011, when the concession limit was $A25k a year. Actually, I already had to withdraw an excess contribution to superannuation last year, which was a hassle, before the contribution limit was raised.

I'm still thinking about post-tax contributions. If I do it, I think I will start small at say $A1000 per month. That is small compared to the limit of $A15k per month :)

Preliminary Monthly Report

Doing the accounts for March this morning... Looks like we hit a net worth of $A600k for the first time, partly because of the fall in the Australian Dollar to $US1.03 this month. But I'm noticing that quite a lot of our investments are hitting all time highs in terms of the profit we have made on them. These are:

CFS Developing Companies Fund
CFS Diversified Fund
PSS(AP) (Snork Maiden's superannuation fund)
Qantas
Celeste Australian Small Companies
Acadian Global Equity Long-Short
Argo Investments
CFS Geared Global Share Fund

Some others are also quite close to peak profit levels. Of course a lot of other investments are still way down from their peak profit level or are underwater... Two common themes among the winners are small cap stock funds and recent investments. Small caps have been doing very well - they usually do at the beginning of the business cycle, which is why we have invested in them quite heavily. Recent investments haven't yet had a chance to lose money :)

Our house-buying fund has reached $A82,973 from $A77,386 last month. The goal is to reach around $A100k.

Apart from computing rates of return, I use the monthly accounting to check up on whether all our retirement contributions have been properly made by our employers, whether the fees we are being charged are correct, and whether we have been paid money we are owed. I found that my superannuation provider has been charging around $A100 a month for "inbuilt benefits" since I cut my member contribution to zero in September. This makes no sense to me as there is nothing in the prospectus (PDS) about increased fees if you cut your contributions. It does say that you can't get optional life insurance etc. and in fact the fund refused me the coverage, which I tried to get. So I think they are now charging me for coverage that I don't have. I sent them an e-mail querying this...

Anyway this is how our Australian superannuation accounts are doing:



The green line is Snork Maiden's account and the blue line my current account, both of which we are contributing to. The red is my account from when I worked in Australia previously. I rolled it over into a commercial fund manager and it is invested rather riskily. Hence the big fluctuations. We have now managed to save $100k in our new super accounts.

I'm also still owed money for travel to a conference back last November, and for consulting over the last six months. In the latter case, government budget cuts and local circumstances look like I lost the gig now (right after my security clearance was finally approved at the end of February, but it would be nice to get paid for what I already did! The conference money is also owed by another university. My own employer is actually great at reimbursing money. I submitted a bill for our recent overseas trip this Tuesday and already the money was in my account on Friday!

Performance of Endowment Style Portfolios

In the final post of this series I look at the performance of an endowment type portfolio over the last 12 years. 10% is invested in the CREF Bond Fund and the remaining 90% split equally between the MSCI World Index, the Man-AHL Diversified Fund, the Credit Suisse/Tremont Hedge Fund Index, and the TIAA-Real Estate Fund. As is the case with all the portfolios I've posted here the portfolio is rebalanced monthly. This is the Balanced Portfolio. The Levered Portfolio borrows 45 cents for each dollar invested. In other words, the managed futures and stock portion of the portfolio are geared by 50% (one dollar borrowed for each dollar invested). The unlevered portfolio returns 0.83% per month (10.4% p.a.) with a monthly volatility of only 1.78%. The levered portfolio returns 1.08% per month (13.7% p.a.) with a monthly volatility of only 2.58%. This volatility is roughly half that of stocks or managed futures and the return is more than double what stocks returned in this period. Beta to the stock market is 0.35.

These results look better in the last couple of months than Ray Dalio's All Weather Portfolio, which is one of my inspirations. The reason is that while the AWP only includes "beta sources" the portfolio proposed in this post has 45% of assets allocated to "alpha sources" (i.e. they produce alpha relative to the MSCI benchmark).

Implementing a strategy like this in Australia is probably going to require a self managed superannuation fund (similar but much more bureaucratic than a US IRA) for someone like me with half or more of net worth in superannuation as I haven't found a regular superannuation provider with a managed futures option or for that matter a hedge funds option. Funds like PSS(AP) have some money invested in hedge funds of course, but you can't increase that proportion. You can decrease it by also investing in some of their single asset class funds.

Longer Term Planning

I was rejected for the two jobs I recent applied for. One in Australia after interview and one in the UK pre-interview. So, it looks like we stay in Australia in this city for the moment. It also looks like I will continue in my job next year, but I am seriously thinking about "retiring" at the end of 2019 when I will be 55.

Hopefully, the probate situation is finalized before the end of this year and we can start to restructure our finances. This is what I am thinking to do:

1. We will need to set up a trust account or something less formal for little Moomin for the relatively small amount of money he will inherit. Need to wait to hear what we need to do. According to the will, he won't get the money till he's 23 years old...

2. Almost pay off our mortgage and then redraw it and use it to pay off margin debt and add to a trading account. We can then deduct the mortgage interest from our taxes and it is a lower interest rate than the current margin loan.

3. Set up a self-managed superannuation fund (SMSF) and roll my existing Colonial First State superannuation fund into it as well as contributing AUD 300k for each of me and Moominmama. This would then have about AUD 900k to start with. The reason to go down the road of self-managed super is to be able to invest in managed futures, which are a tax ineffective investment outside super. We would put all our high tax investments into the fund as well as some Australian shares with franking credits to reduce the tax.

4. Scale trading up to full size. At the moment, I am thinking we will need to set up a company for trading. Corporation tax on small businesses is 27.5% vs. top personal marginal rates of 47% +.* My understanding is that you don't need to pay out all profits as dividends and so retained earnings are more lightly taxed. But I will need advice on this. It would also protect the rest of our assets against something catastrophic happening. The company could also be the trustee for the superannuation fund, which would allow us to maintain the SMSF if we left Australia.** These are just my current understandings – obviously I am going to need to get professional advice on all of this.

5. Estate planning. Currently we don't even have wills. This is an area I know little about but will need to deal with. What I want to avoid is the situation we faced with my mother where the government dictated investment policy to us after she wasn't capable of making decisions - despite giving us power of attorney.

* The downside of companies is that they don't get a capital gains tax discount. Individual investors in Australia only pay half the marginal rate on capital gains on investments held for more than a year. But the advantage of only paying 27.5 or 30% tax on trading income rather than 47% tax before investing it in other investments outweighs the discount. If Labor reduce the discount, this will be even more the case.

** You can't be the trustee of an SMSF if you aren't resident in Australia. Using a corporate trustee gets around that. There is a problem in leaving Australia and receiving income through an Australian company as it means we would suffer from double taxation. In Australia, dividends from the company would have attached franking credits so that we would only need to pay the difference between 27.5% and 47% on dividends. But if you live outside Australia in a location where you need to pay tax on foreign income (obviously one reason to move might be to reduce tax...) then we would need to pay the foreign tax on top of the Australian company tax. Investments already inside the company are invested in Australian stocks that pay franked dividends, then the franking credits on the dividends received would mean that the company wouldn't pay net tax on its investment income, so that won't be double taxed if we moved overseas. But trading income would be taxed at 27.5% and then again if paid out as dividends. So, we would need to do a restructure in the most tax-effective way at that point. In an earlier version of this post, I did think about having the company being the beneficiary of a discretionary trust that actually did the trading and then just changing the flow of income. But the trustee of the fund has to pay tax for offshore beneficiaries. So, that doesn't help.

Choosing a Superannuation Asset Allocation

I checked out the "product disclosure statement" a.k.a. prospectus for Snork Maiden's superannuation fund a.k.a retirement account. One interesting point is that under the "superannuation choice legislation" you can opt out of the employer sponsored fund for a private provider but then instead of contributing 15.4% of pay (North Americans with employer "matches" will be envious of this number) the employer may only pay the legally required minimum of 9%. The employee can contribute between 2% and 10%. I am supposing the default is 2% - I will find out when I get to see a pay stub. We will stick with 2% for the moment. 17.4% is a very high rate of contribution as it is. Though when I worked in Australia before our required total employer-employee contribution was 21%!

On asset allocation I am thinking to allocate 90% to the default Trustee Choice and 10% to the "Sustainable Option". The sustainable option is managed by AMP and invests in Australian Shares selected according to various ethical and environmental considerations, both positive and negative. The Trustee Choice is allocated:

Australian Shares: 30%
International Shares(hedged) 22%
Long/Short Equities: 5%
Property: 15%
Cash: 2%
Bonds/Fixed Interest: 16%
Market Neutral Strategies: 10%

This is fairly typical of current endowment or pension fund allocations - 52% allocated to equities, and about 15% to each of hedge funds, bonds, and real estate. For those concerned about management fees they are 0.77% on the Trustee Choice plus an average 0.05% in performance fees and 0.51% for the Sustainable Option. No, there are no index fund options, but I expect a chunk of the Australian and International Share exposures are index tracking.

There is an "Aggressive Mix" that cuts out the bonds, slightly reduces the hedge funds, and increases straight equity exposure to 70%, but I prefer to go for more diversification.

Defined Benefit vs. Defined Contribution

The major decision I need to make in response to receiving my job contract is which type of superannuation (retirement) scheme to join. Yes, we have a choice between defined benefit and defined contribution (or accumulation in the Australian jargon). Defined benefit is mainly based on your average salary in the last three years that you work for a university that is a member of the Unisuper fund (indexed for inflation) and the number of years that you contribute to the fund. So here the main risk is career risk. This option performs best for someone who will work their whole career at Australian Universities and get promoted to professor or dean right at the end of their career. In defined contribution you have both a career and a market risk but much more of a market risk. An important benefit of the defined contribution is that you can rollover your benefit into another superannuation fund - i.e. it is portable - while the defined benefit is not.

When I previously worked at an Australian university we initially had no choice and were all in a defined benefit scheme. Then when we were given the choice of switching to defined contribution I did it immediately as I didn't expect to stay in the Australian university system in the long-term. After I left the university I rolled my super into Colonial First State. That was all going well until some unfortunate investment decisions last year.

Given my great career uncertainty at this point it seems obvious to go for the defined contribution scheme. But I will do a proper analysis and report back with the results.

The Unisuper scheme has, on top of a massive 17% employer contribution, a required 7% contribution from the employee's nominal salary. To balance things out, and given our higher income now, I will start 7% "salary sacrificing" (pre-tax employee contribution) for Snork Maiden too. Her employer contributes 15.4%. As her salary is higher, it seems fair to me to go for the equal percentage salary sacrifices.

BTW I'll see no gain from salary sacrificing this tax year as my marginal tax rate is 15% which is the same as the superannuation contributions tax.*

* In Australia retirement contributions are usually taxed at 15% going into the fund. You can choose to make employee contributions pre- or post-tax. Post-tax ones don't attract the contributions tax but obviously you pay your regular income tax on them. If your marginal tax rate is above 15% (as most people's is) then it seems like a no-brainer to go for the pre-tax contribution known as "salary sacrifice".

February 2019 Report

In February stock markets continued their rebound. The Australian market rose especially strongly. The Australian Dollar fell from USD 0.7274 to USD 0.7106. The MSCI World Index rose 2.72% and the S&P 500 3.21%. The ASX 200 rose 6.32%. All these are total returns including dividends. We gained 3.18% in Australian Dollar terms and 0.90% in US Dollar terms. So, we underperformed the markets. This is not surprising given the weight of cash and bonds in our portfolio. Our currency neutral rate of return was 1.94%. I estimate that the target portfolio gained 3.08% in Australian Dollar terms.


Here again is a detailed report on the performance of all investments:

The table also shows the shares of these investments in net worth. At the bottom of the table I also included the Australian Dollars return from foreign currency movements and other net investment gains and losses - net interest and fees.

Things that worked very well this month:

• CFS funds - they all did well. Future Leaders continues to outperform Developing Companies.
• Our two UK listed stocks - 3i and Pershing Square Holdings.
• Medibank. It continues to bounce back nicely though we only have a very small posiiton.
• Unisuper made the largest gain in dollar terms, though we are still below the peak value last year.
• Many investments hit new profit highs including PSS(AP), Generation, and Hearts and Minds.

What really didn't work:

• Yellowbrickroad... I exited this investment at 6.5-6.6 cents per share following the release of the Royal Commission report. I should have gotten out much earlier. The shares are now suspended as the company has not filed its interim financial report. They are still working on writing down their assets... The last price they traded at was 5.4 cents.

Bonds mostly had negative returns. When you buy a corporate bond you have to pay the interest accrued since the last interest payment to the previous holder.

We moved towards the new long-run asset allocation:*

The main driver is continued movement of cash from my US bank account to Interactive Brokers where I am buying bonds before eventually transferring some of the money to our Australian bank accounts when the broker allows. The increase in rest of the world stocks is mostly due to updating the allocations of various managed funds for their current allocations. We are near the long term allocations for each of the stock categories and real estate. We are overweight cash and bonds and underweight commodities, private equity, and hedge funds.

On a regular basis, we also invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. Other moves this month:

• I bought USD 300k of corporate bonds and USD 100k of treasury bills matured. Our monthly bond ladder now extends to September.
• We sold 569 China Fund (CHN) shares back to the company at 99% of NAV in the tender and then bought 669 in the market for a lower price.
• We sold out of Yellowbrickroad (YBR.AX) at a big loss.
• I made a quick (losing) trade in gold futures (Included in gold above).
• We switched our choice of option in the PSS(AP) superannuation fund to "balanced" from a mix of "balanced" and "aggressive".
• I switched from Geared Shares to Imputation (leveraged and unleveraged Australian shares) in my CFS superannuation fund.
• At the end of the month I also switched to the balanced option in the Unisuper superannuation fund.

So, there was a big deleveraging/derisking theme that will continue. There are no capital gains tax implications to shifting the super funds, so I am doing them first.  We can still switch from the "Geared Growth" fund to an unleveraged version.

* Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged funds.

Risk Reduction

I switched $A13,750 from our holdings of Colonial First State Geared Share Fund to the CFS Conservative Fund in my CFS Superannuation account. This effectively sells the units I purchased in July and September 2008 for a small profit. Even so, the value of our holdings in this fund in this account has still gone up this month at this point. Our allocation to large cap Australian stocks will be about constant this month and still well overweight and leverage will be down by just over a percentage point. Still this is a small step towards risk reduction without going overboard in any way :)

P.S.
I'm actually going to let the risk allocation in Snork Maiden's accounts drift up going forward. I increased the allocation of future investments in superannuation account in the "sustainable" (=Australian shares) allocation to 20% from 10%. The actual current allocation is 11%. I'm also going to tweak the allocations in her non-superannuation Colonial First State account. But I'll blog about that more when I actually make a move there. My accounts have gotten overinvested in risk and hers under, so we'll move them towards each other.

Income Replacement Rates of Mandatory Retirement Schemes

The table is from a paper by Richard Disney presented at a conference on taxation held as part of the Australian tax policy inquiry. It shows the percentage of income replaced by mandatory retirement programs at different levels of average earnings. The Australian data includes both the means tested age pension and the 9% superannuation guarantee! The two together are estimated to replace only 52% of average earnings. Australia's outcomes are very similar to those of the US which only has one mandatory program: social security. With Australia's government worrying about the tax benefits provided to superannuation and raising the age of eligibility of the age pension to 67, you can see just how unsustainable the US program must be. I won't even talk about some of the European schemes :)

Bottom line: You probably need to save more than the 9% superannuation guarantee.

April 2020 Report

This month saw a rebound in the stockmarket and in Australia the rate of new COVID-19 infections and deaths fell to near zero (and zero in our city) after peaking in March. The local state government had said that schools will remain closed for all of the next term, which ends in early July. But yesterday, their resistance to re-opening weakened. I am working for home and our university campus also will be mostly closed over this period. So, it is hard keeping up with everything - full time job, co-parenting two small children, and keeping on top of our finances. At least I am already set up to work from home comfortably and have converted part of the office I share with Moominmama into a mini-classroom complete with whiteboard I brought home from my campus office...

My main scenario is still that the stock market lows will be at least be retested. Only in 1987 really was there such a steep fall in the market that did develop into a longer bear market. And even then there was more bouncing along the bottom than there has been so far. This is probably like the March-May 2008 rally. The bullish case is that government's and central banks are pouring so much money into the financial markets and broader economy that this time it will be different. On the other hand, though people are comparing this period to the Great Depression, I think there is no chance that stock prices will fall as much as they did then because of all the government action.

I don't usually talk about monthly spending, but this month we only spent AUD 4,300. This doesn't include mortgage interest, which is now treated as an investment expense. Still, it is the lowest monthly spend in a long time. Including mortgage interest it would be AUD 5,800, which is the lowest since July 2017.

The Australian Dollar rose from USD 0.6115 to USD 0.6524. The MSCI World Index rose 10.76%, the S&P 500 12.82%, and the ASX 200 8.78%. All these are total returns including dividends. We gained 4.02% in Australian Dollar terms and 10.98% in US Dollar terms. The target portfolio is expected to have gained 2.93% in Australian Dollar terms and the HFRI hedge fund index gained  4.79% in US Dollar terms. So, we strongly out-performed these latter two benchmarks and beat the MSCI by a little. Updating the monthly AUD returns chart:

Here is a report on the performance of investments by asset class:

The returns reported here are in currency neutral terms. Small cap Australian stocks and hedge funds performed best after terrible performance in March. Hedge funds and bonds contributed most to the total return.

Things that worked well this month:

• Gold
• Hedge funds rebounded. In particular, Regal Funds and Tribeca Global Resources.

What really didn't work:

• Virgin Australia. The company went into voluntary administration and unfortunately I'm still holding USD 25k in face value of their bonds. 
• Though it only lost AUD 142, I was surprised by the poor performance of the PSS(AP) superannuation fund (balanced option). This is the main public service superannuation fund for workers who joined the service in recent years. With stock markets and corporate bonds rebounding strongly and a roughly even balance between Australian and foreign assets it must have lost big in real estate or hedge funds to post this result. Unisuper (the universities superannuation fund) gained almost 7%.

We moved further towards our new long-run asset allocation. The share of hedge funds rose most while the share of bonds fell most:

On a regular basis, we invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Other moves this month:

• General Motors and Anglogold bonds matured, releasing USD 72k plus interest. I bought USD 15k of Woolworths (Australia) bonds, reducing net exposure by USD 57k.
• I shifted USD 16k from the TIAA Real Estate Fund to the TIAA Money Market Fund. I am concerned that the direct real estate investments the fund holds will be written down soon.
• I bought 4 September out of the money put options on the S&P 500 E-Mini futures as downside insurance in case the market lows are retested or worse.
• I bought AUD 25k by selling US Dollars.

Government Response to Henry Review

The government will do three main things - raise the compulsory employer superannuation contributions to 12% from 9% of salary over time, reduce the corporation tax from 30% to 28% over time, and introduce a 40% mining rent tax. For the latter state royalties already paid can be credited against the tax. The first of these moves was actually ruled out by the Henry Review. The second is more timid than the Henry Review (they proposed 25%) and the latter probably more aggressive. No bold tax reform is planned.

The first move will have no effect on Snork Maiden or me as our employers already contribute more than 12%. The second is rather marginal. The latter move could have negative effects on stock prices to the degree that a lower rate of resource tax was expected.

There are quite a few other provisions but I see them as being more minor. Superannuation taxes are unchanged as is the $A25k p.a. cap on concessional contributions for under 50s. Over 50s will be able to contribute up to $A50k p.a. if they have less than $A500k in super.

P.S.

"The Henry review recommended abolishing the tax on super contributions and halving the rate of tax on fund earnings to 7.5 per cent, neither of which was adopted by the government."

P.P.S.

It seems that they meant to abolish the super contributions tax and instead tax super contributions at normal rates. So yes that would be a move towards the Roth IRA model. The government just ignored this of course (like 136 other recommendations).

P.P.P.S.

The Review actually proposed a 20% "offset". This means that people on the 15% bracket would pay -5% on super contributions and people on 45% would pay 25% on super contributions. But, the full contribution would actually go into the fund. So this would have effectively increased the superannuation guarantee to 10.575% from 9%.