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Financial Planning

The current low interest rate environment is a worldwide phenomenon based largely around central banks making money “cheap” in order to stimulate economic activity. However this policy has had a significant consequence and that is that the return investors clients can receive on their funds without taking any risk has fallen significantly.

I use the example of a client coming to see us about to commence retirement at age 65, they have $1m to invest and their initial instruction to us is that they do not wish to take any risk with the investment of these funds, yet their expectation is that they want to generate an annual income of approximately $60k p.a in order to live comfortably.

Our response would be that to invest those funds securely the best they could hope to receive would be just under $40k p.a, to which they answer they cannot live the way they wish to on this amount of money. At this point they effectively have two choices, either take the $40k from investment return and supplement it with $20k by drawing down the capital or invest part of their funds into higher risk but higher returning investments in order to generate the $60k. It is a tough choice, but one investors are increasingly faced with.

By drawing part of the capital each year the return then generated from interest each subsequent year will be lower assuming the rate of return stays the same. In which case they will then be required to drawdown even a greater level of capital.

In the current environment leaving your money in cash/term deposits provides security but the return over the inflation rate is minimal and most likely negative if you then have to pay any tax on the interest you receive. Yet the default option of simply investing into equites, especially in what has been a fairly volatile market in recent months, is unappealing to many.

It is important to understand risk works both ways, growth assets such as shares and property based investments carry risk in that their capital value can alter, in some cases quite quickly, however leaving your money in low returning assets such as at call bank accounts or cheque accounts also carries risk and that risk is that these funds lose their real value over time as the rate of inflation exceeds the return that is generated after tax.

It is important to note that not all shares are the same and exhibit the same risk or return characteristics; this is where it can be worthwhile seeking advice. It is also a market where after many years of strong returns from Australian shares via a combination of capital growth, dividend and franking credit this suddenly looks at risk due to a subdued outlook for Australian shares, it is of no value receiving a dividend and a franking credit if the value of your share is retreating and in some case significantly. However it is worth noting there are also investments that we utilise that aim to provide higher levels of return than fixed interest but with much less risk than the overall sharemarket.

When considering these decisions your timeframe is vitally important, if you have an amount of money to invest yet you need all that money in a year’s time to pay off a debt, our view would generally be that the investments main priority is security and return is secondary. If however you have an infinite timeframe, for example as many people do with their superannuation investments, you need to make an informed decision about the level of risk you should take on in order to generate a reasonable level of return.

Michael Lavery
McLean Delmo Bentleys Financial Services