Do You Feel You are in a Lower Wealth Percentile Than What the Official Data Say?

People tend to think they are less relatively wealthy than they are. You can check out your perceptions against reality for a number of countries here. I'm not surprised. According to the official statistics we are in the top 4% of households in Australia by wealth. But looking around, it certainly doesn't feel like that could be true. Our house is only valued a few percent above the median for our city. Our car is a 15 year old Ford when it feels like the roads are full of luxury vehicles. But it's not like we are saving like crazy. In 2018, we spent almost all of what we earned from salaries. Apparently, a lot of people feel the same way.

January 2019 Report

In January stock markets rebounded but because the Australian Dollar rose, we didn't gain a lot in Australian Dollar terms. The Australian Dollar rose from USD 0.7049 to USD 0.7274 The MSCI World Index rose 7.93% and the S&P 500 8.01%. The ASX 200 rose 3.87%. All these are total returns including dividends. We gained 0.49% in Australian Dollar terms and 3.79% 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 1.89%. I estimate that the target portfolio gained 1.57% 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. The loss on the apartment is the estimated sale costs.

Things that worked very well this month:

• The China Fund - the fund has announced a tender for 30% of outstanding shares at 99% of NAV. The share price is rising towards NAV as a result. I tendered my shares into the buyback. At least it will probably realise a small capital loss.
• Pershing Square Holdings. This bounced back nicely from December losses and we are now up in this investment.  
• Unisuper. This is after a steep fall in previous months. I continue to be surprised how much higher the beta of Unisuper is compared to PSS(AP). Both are public sector superannuation funds and we supposedly have a similarly aggressive stance in each.

What really didn't work:

• US Dollars - The Australian Dollar rose, especially after the statement from Jerome Powell.
• Cadence Capital - It continues to lose money and is now our third worst investment ever in terms of dollars lost. The fund manager explained that they focus heavily on value stocks and those got trashed.
• Yellowbrickroad...

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. Also, we sold the apartment we inherited.

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 moved AUD 30k from the CFS Geared Share Fund back to the CFS Conservative Fund in my CFS superannuation account. I originally moved this money in October to CFS Geared Share Fund. I made a small profit on the roundtrip trade, but the main motivation for closing the trade was to reduce risk.
• I bought 1558 shares in OCP.AX at AUD 2.07 a share just because they were being offered so low.
• I sold 15,000 shares in PMC.AX and bought 5000 shares in PIXX.AX as the PMC premium to NAV was still high.
• I bought AUD 24k during the "flash crash" and sold them after the Australian Dollar recovered a few cents.
• I bought 1000 shares of PERLS XI as I can't move the Australian Dollars I bought in December to our Australian bank account yet.
• I bought USD 100k of treasury bills maturing in February.
• I bought USD 100k of Santander UK bonds maturing in March. 
• I bought 1000 shares of the gold ETF, IAU.

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

Understanding Increase in Spending Better

I wanted to understand why spending in the 2018 calendar year was up 28% on 2017. The first step was computing a spending breakdown for the 2017-18 financial year. The period is different and the definitions of income and spending are different than in my usual accounts to make it more comparable with other income and spending breakdowns on the web. I now computed the spending breakdown for the second half of 2018 and we can compare monthly spending in this period to that in 2017-18:

Spending was up by 7.5%. So not as dramatic a growth rate. The biggest difference between the two periods, is that in the first period we spent a lot on travel and in the second on health. In fact, the travel spending was mainly in the second half of 2017-18 - i.e. in the first half of 2018. So, 2018 had high spending because of both travel and health spending being up strongly on 2017. The way I usually compute spending and income is to include any refunds for medical spending as income rather than reducing spending by the amount of the refund, which I am doing here. So, that pushed up spending even more. I'm glad I now understand why our spending increased so much.

Another major change is that cash spending was down in the second half of 2018. That was because I had access to the statement for my Qantas Cash card – only the last 13 months is online. In the previous period, I treated all spending on the card as cash spending.

Going forward, I expect medical expenses to be lower this half year and travel expenses to be much lower than in the first half of 2018. Given that, 2019 calendar year spending might be lower than 2018 spending.

Gold

Put my toes into the water by buying a small 0.5% position using the IAU ETF. I've posted about gold previously and it is in our long-term allocation to allocate 6% to gold.

Spending Breakdown

After a discussion with friends at lunch yesterday and some blogposts I read recently, I decided to try to find out what we are spending on. I haven't done this in more than two decades I think. I looked at the 2017-18 financial year so that I can also easily include official income and tax figures in the total. It's all in Australian Dollars of course:

Income is gross income from our tax returns plus employer superannuation contributions which which don't enter taxable income. Income includes salaries and investment income etc.

Next we deduct taxes. As franking credits – tax credits for corporation tax paid by Australian companies are included in taxable income, they need to be deducted as we don't actually get the cash.  Then there is 15% tax on superannuation (retirement) contributions. In total tax is 26% of gross income. Next I deduct some financial costs that are deducted from gross income to get to taxable income. There are more of these deductions actually, but some I have included in our spending.

Of the AUD 216k of net income half was spent and half saved.

The big spending items are mortgage interest, supermarkets etc, cash spending, mail order, childcare etc, and travel (flights, accomodation etc). Cash spending includes both spending actual cash and spending using our Qantas cash cards. I haven't gone into the accounts for the latter, though maybe I should. Some of the other spending categories very low compared to the actual amount spent on these because a lot of the spending is in cash. Possibly the most important of these is restaurants. Yes, there is a lot of fuzziness in these numbers because we don't budget and spend a lot in cash.

Am happy to get feedback on how we can save money, though I'm not really into "frugality" for it's own sake. Or maybe you would just like to compare the differences with other posted spending breakdowns.

P.S.
Qantas only provide online statements for the last 13 months. So, I can't now do a breakdown of those accounts for 2017-18. Maybe next year.

New Investment: Santander UK

Bought my first US corporate bond - a Santander UK bond maturing on 14 March. This supposedly gives a yield per annum of about 2.85%, which is more than treasuries of the same maturity. The original coupon on the bond is 4.2575%, so it is trading at a price of above 100. It pays quarterly interest. Fees for trading corporate bonds are higher than for treasury bonds at Interactive Brokers, but I still figured it was worth it.

Santander UK is the result of the merger of three former UK "building societies" - a bit like credit unions. It is owned by Spain's Banco Santander group but is managed separately. The maturity date is before the scheduled Brexit date on 29 March, so I figure Brexit shouldn't affect getting paid when the bond matures. The bonds are denominated in US Dollars not Sterling.

Interesting Paper from GMO on Bursting Stock Market Bubbles and Anti-Bubbles

Here is the paper. Yes, they think that we were in a bubble in 2017 and much of 2018 and the last quarter of 2018 was the beginning of the bursting of the bubble. The problem with the CAPE measure of valuation they use is that it is so backward-looking. If profits are growing fast, CAPE will be high because it uses the average profits of the last 10 years. It has the built-in assumption that profits growth is very strongly mean-reverting.

Likely Political and Economic Scenario for Australia

A couple of days ago I posted a list of all 12 of Labor's proposed tax increases. How likely is it that these will actually be enacted? Labor is unlikely to gain control of the Senate. So, they will need the support of minor parties and independents to push through their program. A quite likely scenario is that there will be a recession in 2020 and the minor parties will be very resistant to raising taxes in those conditions, especially on housing. Or Labor will decide to postpone some of the proposals in reaction to a recession. Then Labor is likely to not be re-elected in 3 years if unemployment is rising etc. So, at this point I would put even odds on most of this agenda being enacted.

How Has Yale Done Since the Financial Crisis?

Just following up on Financial Independence's comment on my post linking David Svensen's 2008 lecture. How has Yale done since Svensen's lecture? It is easy to find out by checking the endowment's annual reports. Yale's financial year is from July 1st to June 30th. The graph shows Yale's total return index against the MSCI, S&P 500, and HFRI, where the others are all calculated on a July to June basis too.

Yale has performed quite well, eventually outperforming the MSCI World Index, but underperforming the S&P 500. Yale's diversification didn't help in the financial crisis. Their returns were just as negative as those of the MSCI and the S&P 500 in 2008-9. By contrast, the HFRI suffered only small losses in 2008-9. The bottom line is that Yale's returns are quite similar to an equity index.

Here is their asset allocation over the years:

Prior to 2013 they didn't report venture capital separately from buyout funds and so "Leveraged Buyouts" represents all private equity in the earlier years. Also, prior to 2009 they didn't report real estate and natural resources separately and so "natural resources" covers both. Over the years they have increased private equity and foreign stocks and reduced real estate and domestic stocks.

The Average Hedge Fund No Longer Produces Alpha

I regressed the excess (above risk free rate) monthly returns of the HFRI fund-weighted hedge fund index on the excess returns of the MSCI All Country World Index (gross returns):

Back at the turn of the century, the hedge fund index had alpha between 5 and 10%. But it collapsed going into the financial crisis and in the most recent 5 year period alpha is -0.17% p.a. Beta is 0.34. The r-squared between the MSCI and HFRI excess returns is 0.86, which is high. So, you might as well invest 34% of your money in global stocks and the rest in cash to replicate the index. Interestingly, a linear trend line rather than an exponential trend line fits the index:

So, it doesn't make sense to invest in hedge funds recently unless you can select an above average fund.

All of Labor's Tax Increases

The Labor party is at the moment likely to win the next federal election in Australia in May. Labor has become increasingly left wing in recent years and has a long list of policies to raise taxes. This is, I think, a comprehensive list:

1. Abolish Liberal plan to raise the top tax threshold to $200k: This was supposed to happen in 2024. The top tax bracket will still cut in at $180k (about USD130k) where it has been for many years. Bracket creep is pushing more and more taxpayers into the top bracket. This will affect us if I am still working then. If I'm not, probably my taxable income will be lower.
   
2. Raise the top tax rate: Add 2% to the top rate to raise it to 47%. With Medicare that is 49%. This will immediately raise our taxes.
   
3. Abolish plan to eliminate 37% tax bracket: This also was supposed to happen in 2024, so may not affect us except to the extent of how many franking credits will get used up offsetting our taxes, if I retire by then.
   
4. Repeal already-legislated tax cuts for companies with turnovers of between $10 million and $50 million: Small businesses pay 27.5% corporation tax and larger companies 30%.  The government wanted to extend the low rate to larger companies. This is unlikely to directly affect us.
5. Reduce the long-term capital gains tax discount to 25%: The discount is now 50%. This will have an immediate impact on us as we have run out of accumulated tax losses. OTOH existing investments will be grandfathered. It makes it more attractive to incorporate and pay CGT of 27.5% instead of 37.5%.
   
6. Abolish refundability of franking credits: Since 2000, if you have excess tax credits from Australian companies beyond those that offset the taxes you need to pay you can get a cash refund. I did benefit from this once or twice soon after we moved to Australia and my income was low. This will have a big impact on superannuation funds in pension phase that have zero tax to pay and possibly even in accumulation phase if they have a lot of franked dividends. It will affect lower income self-funded retirees with money outside superannuation too.  Some listed investment companies (closed end funds) are already paying out special dividends to get franking credits out of the fund and to investors before the end of the financial year. On the other hand, I don't think these funds will radically restructure due to this proposal. I don't think it will have a big impact on us as I've planned to put the least tax advantaged investments like managed futures into our planned SMSF. And I expect we would be in the 32.5% tax bracket when retired. If I retire at 60 say and start a superannuation pension we could use franking credits inside our SMSF to offset Moominmama's superannuation earnings tax liability as she is 10 years younger. And then maybe we could add Moomin to the superannuation fund :)
7. Abolish negative gearing: This is the ability to deduct investment costs beyond the earnings of an investment from other income. This mainly applies to property investors who mostly lose money in Australia in the short run, hoping for a long-run capital gain. We don't negative gear so it shouldn't affect us. Wealthier property investors who also own shares or other investments will be able to offset their losses in property against dividend and other income. So, like many of the Labor measures they mainly hit lower income investors...
   
8. Tax discretionary trusts as companies: These are trusts that have multiple beneficiaries and can alter what earnings they stream to which beneficiary on a year by year basis. Actually, they are proposing to tax trust distributions at a minimum of 30%. So, it's not like a company which pays 27.5% tax in the case of a small business and then distributes franking credits. I don't see any justification for allowing this kind of tax dodging. However, I think they should just require all trusts to be unit trusts with defined shares and everyone sharing in all income. These operate just like unlisted managed funds (mutual funds). I think most discretionary trusts will just do this if it's allowed.
   
9. Reduce annual non-concessional superannuation contributions to $75k: This would mean it would take us more years to make all the non-concessional contributions we want to make and means I probably should already get one in this financial year.
   
10. Reduce the threshold for 30% superannuation contributions tax to $200k: Currently the threshold is $250k. The threshold includes employer superannuation contributions, so this will definitely affect me.
    
11. Remove the right, already legislated by the government, of superannuants to make catch-up contributions when their super balance is less than $500,000: I don't think this is probably a big deal. It will mean stretching contributions over more years.
    
12. Reduce ability to take tax deductions for additional concessional superannuation contributions: People will need to have 90% of their income or more from sources other than employment to do this. I don't understand why concessional contributions for employees are limited to salary-sacrificed contributions and you can't make more concessional contributions unless you really aren't an employee. The Liberals tried to fix this anomaly.
13. Limit tax free pensions to $75k per year: Currently you can transfer up to $1.6 million into an account to fund a tax free superannuation pension. At a 4% initial withdrawal rate (required rate for under 65s) that is $64k per year. At 5% (65-74 y.o.) it is $80k per year. So, Labor's proposal is not that restrictive. However, if the $1.6 million earns a lot more than that a year, it will be taxed a lot more than at present.
14. Limit deductions for tax advice to $3,000 per year: I am assuming that this won't apply to companies or superannuation funds, just to individuals. In which case, it isn't a big deal.

I think most people are probably aware of one or two of these but don't have a good idea of the extent of the proposed tax increases. A big question is whether Labor will have sufficient control of the Senate to pass all these measures.

David Svensen Lecture at Yale

Svensen is the manager of Yale's endowment. He also gives occasional lectures at Yale.

My investment strategy is strongly influenced by endowment investors like Svensen.