The MONEY WHAT'S HAPPENING Desk

Welcome to the March edition of MONEY WHAT'S HAPPENING.

It seems that volatility in the markets, domestic inflation pressures and another interest rate rise is the diet that we have to have, like it or not.

Have we had one interest rate rise too many? Will domestic lenders raise rates even higher to increase their liquidity or reflect the true cost of money? Have we reached the peak and will interest rates start to fall this year? These are some of the interesting questions that you may be considering.

With international and domestic liquidity concerns and the recent fire sales of landmark financial institutions, these are unsettling and dynamic times, marked by rapid market movements in both directions. Action and adjustment may be required, blind panic won't help and there are always opportunities for the astute.

We hope you will find the articles provided by our clients interesting, informative and educational.

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In this issue:

Hold Your Nerve - Investing Times Newsletter
The CFD Revolution - Safety in the Market
The secret to living without mortgage fees - Australian Property Investor magazine
Financial implications of establishing and running a SMSF - WLM Financial Services Pty Ltd

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Holding your nerve in turbulent times

Volumes have already been written on the recent market volatility and no doubt there's more to come. When the dust settles, be it in three weeks, three months or three years, we will again find out that market volatility has helped uneducated, unprepared investors pass their wealth onto those with a strategic outlook and a plan to match.

Market volatility has tested a lot of nerves in the first few weeks of this year. It has no doubt delivered some sleepless nights to some investors. This is a perfect time then to remind ourselves that, a) markets are markets, b) we can't control them, and, c) we have full control over our own actions/reactions.

Have a plan

A plan is an essential component of being successful. A plan is simply a written record of your time-based goals and the actions you will take to achieve them. The goals, in terms of outcome and timeline, must be realistic. Strategic plans prepared for clients have time-based goals, but they also importantly provide a framework for investment decision-making. A plan gives you the best chance of staying the course in uncertain times because you have a framework to analyse information against your goals before reacting. A good, simple framework is based on four steps: Observe, Orientate, Decide and Act (OODA). If you run this loop when faced with new information, then focusing on your goals you will at least be making rational decisions. Fear and greed are both irrational drivers, so whatever you can do to rid these from your investment decisions it will positively impact your long term return.

Long term investor

There are many plans you might have as an investor. We have seen all of them! But the one plan that continually delivers positive investment results is a long term buy and hold plan that involves buying good quality fixed interest products, property and shares and holding them for the long term. It really is this simple. Long term, passive investors have given themselves the best chance at success because they have let time and good quality businesses compound their investments, while not giving anything away in expensive taxes. They also don't let market noise or fear/greed influence their decisions. One client quote that sticks with us is, "It's taken me 80 years to determine that market volatility really is irrelevant."

Don't be a forced seller

We are still scratching our heads at why people sell assets into depressed markets when they do not have a need for the capital. It simply does not make sense to us to sell a good quality asset when the market is discounting it and you don't need the cash. If you have a sound portfolio structure that ensures you have enough liquid assets (cash/short term fixed interest) to meet cashflow needs, then there is no reason for you to sell a market-linked asset such as shares or property. Unless you are forced to .... In spite of the marketing glitz and the ease at which lenders give money, a margin call is a wealth destroying, serious event. There are certainly some people adjusting their lifestyles in light of recent margin call activity, including in the extreme case, becoming homeless and bankrupt. This is the real risk with a margin loan. You actually give power of attorney to the lender to sell your shares if you can't meet a margin call, and they usually only give you a couple of hours to fix your position. That's why it's recommend that clients exhaust all other finance options, like real property equity, before they consider a margin loan. We then make sure that the actual gearing level of the margin loan remains below 50% - regardless of age, income and insurance protection. We aim to never get a margin call because unravelling a long term portfolio in a depressed market would not only destroy wealth, but also confidence.  We have confidence that markets work over the long term.  A quick glance at the chart below should also reaffirm this in your mind.

Graph: 37 years of market index returns (1970 - June 2007)

Source:http://www.vanguard.com.au/Personal_Investors/Tools_and_education/Calculators_and_tools/Index_chart/index.aspx

This chart illustrates an investment truth - that over the long term, market-linked assets outperform non-market-linked assets.

Cash reserves

How much cash is enough depends on your lifestyle.  But it's more than a factor of what you spend.  You ought hold enough cash to meet at least three months of living expenses, but you should also have cash reserves to meet an emergency and to sustain you through a bear market.  There's no rule, but generally, every investor should hold around 5% of their portfolio in cash and three years of living expenses in fixed interest.

The following table shows why:

Source: Vanguard

So have a plan, be prudent with margin lending (if you have to use it at all), hold some cash and make rational decisions within your framework.  Do this and you will become wealthier than the average bear!

Angelo Veschetti - Extract from Investing Times Newsletter – February 2008 edition

Investstone Wealth Management - Financial and Investment Advisers - www.investstone.com.au
Publishers of "Investing Times" newsletter. Visit the Investing Times online - www.investingtimes.com.au 

Contracts for Difference - The CFD Revolution

CFD stands for Contracts for Difference. The idea is that, instead of outlaying the full purchase price for a share, a trader can enter an agreement (or contract) to settle the difference between the buy price and the sell price. As security for this agreement the trader pays a security deposit or margin.

To illustrate, if I wanted to buy 1,000 shares of BHP, it would cost me $35,700 based on the closing price of $35.70 on 18th March. Imagine I think that the price will go to $40.00. If it does I can sell my 1,000 shares for a profit of $4.30 per share, a total of $4,300. This is a return on my investment of 12%.

CFDs allow me to undertake the same trade with much less capital. Instead of buying the shares I merely gain the right to control them. I do this by paying a deposit to my CFD provider. The value of the deposit will be fixed by the provider, and varies between different stocks. For the purposes of this example, let us assume that for BHP it is 10%. So rather than outlaying $35,700 for my 1,000 shares, I can buy 1,000 CFDs of BHP for 10% of that, or $3,570. And I do not have to write a cheque for this; it will be withheld from my account with the CFD provider until the trade is completed, at which time I will get it back again, plus any profit or minus any loss.

In our example above, my $4,300 profit now becomes a return of 115% on my initial investment of $3,750.

What costs are involved in trading with CFDs? Firstly, the CFD provider will charge brokerage. Typically, this is at a rate of between 0.02% & 0.05%, calculated on the full size of the position, as if I had bought the shares (ie. $35,700 in our example above). Secondly, because I am effectively borrowing the value of the shares so as to control them without having to buy them, I will have to pay interest, which is calculated daily, again on the full value of the position ($35,700). The interest rate is based on the Reserve Bank rate plus 1% to 3%, again set by the CFD provider.

It is also important to remember that when a dividend is declared, the holder of CFDs will receive the dividend, just as you would if you owned the shares. This may seem like a good thing, but remember that the share price will generally fall by the value of the dividend, so the net effect is nil. Now this is not a problem when you own shares for investment, as you have a longer-term perspective. But because of the interest component, CFDs are more effective for short-term trading purposes, so this impact is more significant.

Another big advantage of CFDs is that they enable a trader to sell short. This involves selling stock at one price with the aim of buying it back later at a lower price. It should be of interest to many people given the moves in the stock market over the past 5 months. There are restrictions on short selling of shares which make it very difficult for the average trader, but CFDs can be traded short (sell first then buy later) just as easily as they can be traded long (buy first and sell later).

Let me illustrate with a recent example of BHP. Throughout February and March, BHP has traded in a range between a level of price resistance and a level of price support. On seeing the market fail to reach back to the top level and open lower on 7th March, you could sell short CFDs and buy them back on the 11th when it closed near to the support level, expecting that it might move up again the next day.

As you can see, there are many advantages to the trader who can make use of CFDs. But it is important to recognise that alongside the advantages are always potential risks. The most powerful advantage of CFDs is the leverage they provide. But just as leveraged products can increase profits, they can also magnify losses, as many people with margin loan accounts have discovered recently.

Therefore the most important thing is to have a trading plan and to educate yourself about the market. Learn how to trade with safety and manage your risk. Then you will be ready to take full advantage of the amazing opportunities offered by CFDs.

To download a FREE Investment Know How book courtesy of Safety in the Market click here

Here are five ways you can reduce your initial and ongoing mortgage costs that you may not be aware of.  Mamta Grewal

Getting a home loan and sticking to the defined boundaries of the contract is like signing a pre-nup. If things go wrong down the track, you and your financier have decided upfront who gets what in the event of a split and you agree to that contract when you sign up. You try your best and hope none of those conditions will ever apply, however, over the life of a 25-year loan we can all be tempted to stray occasionally and that's where bank penalties kick in. The secret to a long and happy partnership with your mortgage lender is to read the fine print. That way you should be fully versed on the consequences of inattentive behaviour and can even work towards avoiding, or at least minimising, bank fees and charges. Here we suggest five ways you can reduce the initial and ongoing costs of your home loan.

1. Investigate a portable loan

Portability means simply that you can pick up your loan and carry it with you when you move houses. In the past, a housing loan was secured by a particular property and if you wanted to sell that property and move, you had to take out a new loan for the new property. A portable loan now allows you to sell your old property and buy a new one while keeping the same loan. Naturally, the new property would have to be valued at the same loan-to-value ratio (LVR) of your existing loan. However, shopping around for a loan that's portable will save you the hassle and extra costs involved in finalising an old loan and starting afresh.

2. Avoid lenders mortgage insurance

It's no secret that the higher the LVR you borrow at (usually greater than 80 per cent), the more likely you will be required to cough up the lenders mortgage insurance (LMI). The cost of LMI varies from bank to bank, depending on the underwriter's view of the level of risk associated with the loan. Ideally, of course, a 20 per cent deposit sees you avoiding LMI completely. But that's easier said than done. For a property worth $300,000, you'd need to save up a $60,000 deposit which is a tall order. However, borrowing in excess of 80 per cent LVR would mean an additional cost of up to $5000 as LMI. The market is now recognising this difficulty, particularly for property investors, and we're seeing variations on product offerings that help overcome this, in particular the "Guarantor Option". It's now possible for a guarantor to help with the purchase by contributing the 20 per cent deposit. Around 70 per cent of the 374 variable loans on the CANNEX database allow for this flexibility. Even though the guarantor option seems attractive because it eliminates the cost of LMI, it's not without its pitfalls. As the name suggests, a guarantor puts up part of the equity in their home as a security for the new loan. In the event that the borrowers are unable to make repayments, the lender has the ability to call up the debt, so make sure you read the fine print first. Another way of avoiding LMI is to look for banks and non-bank lenders who offer a maximum LVR of 85 per cent before the borrower is forced to pay LMI. In recent times banks like Westpac have begun to offer loans with a higher than average LVR of 85 per cent without attracting the additional cost of LMIs.

3. Shop around and negotiate

Upfront fees such as the application fee, settlement fee and valuation fee could cost you between $100 and $1500 depending on who the lender is. The best way to pay the lowest price possible is to negotiate. Some banks are happy to waive the application fee, but add it as a deferred establishment fee which they'll charge should you pay out the loan in the first three to five years (which is the average exit fee period). The average application fee is $625 so it's a worthwhile saving but you need to be sure you're staying with your current lender beyond the timeframe when the deferred establishment fee applies. Remember that the lending institution wants to retain your business, as competition these days is fierce. A great place to research and compare rates is the internet. Before deciding on a loan, shop around and do your homework on all products available.

4. Don't pay for what you don't need

If you don't need branch access or face-to-face financial service, consider online mortgages as these offer the best savings. It may sound daunting for first homebuyers, but it may be an attractive option for experienced borrowers who understand mortgage products quite well and are able to make decisions without advice. Homepath, a subsidiary company of the Commonwealth Bank, has been offering online mortgages since 2001. It was followed recently by Virgin Money, OneDirect (a subsidiary of ANZ Bank) and MyRate. How do online mortgages stack up against bank branch mortgages? The nominal interest rates available on online products are generally lower than comparable products offered through traditional banking channels.

5. Plan ahead

In your eagerness to get your home loan "up and away" you may tend to ignore the bigger picture. In order to avoid paying certain bank fees including switching fees (fees charged to change to a different loan or interest rate within the one organisation) and deferred establishment fees, ask yourself these questions before jumping in:

Am I comfortable with my level of borrowings? Am I stretching the budget just a bit or am I being realistic about my situation? Banks charge fees for being late in making periodic payments. This may be added on to your loan amount. You don't want to pay an average fee of $20 every month on top of penalty interest rates as high as 2 per cent over your nominal interest rate payments.

Do I intend to stay in this property for long? The shorter the period, the more likely you'll pay the exit penalties associated with a loan. From the lender's perspective, the longer you take to service the loan the more interest it earns. In a traditional mortgage a large part of the interest cost is recovered in the early years of the loan. As interest is calculated daily on a diminishing balance, naturally, the early years of the loan bear more of the interest cost burden. If you think you might exit or refinance to move to a better property in the first four years it might be worthwhile shopping for a loan that has no or low exit-period penalties, as these fees could be as high as 2 per cent of the original loan amount.

Am I happy with a basic variable product or do I really need the offset and transactional account? Am I likely to make extra payments and need the redraw facility? Redraw facilities may be available with a basic product, however there may be a limit to the number of free redraws. Choosing a product that suits your needs to start with may well avoid paying switching fees later. There are a few factors to consider such as: can I live off a credit card and use my extra repayments to cover the cost once a month? Do I need unlimited free withdrawals to pay other debts or living costs? If you start off with a basic variable product with limited redraw facilities and then buy an investment property which requires payments fortnightly rather than monthly, you may end up paying extra for each additional redraw you make. It would be wise to put all your salary into your principal mortgage and make fortnightly withdrawals for the investment loan and monthly ones to pay off your credit card. You may think of switching your basic variable loan to a standard variable which has more flexibility in terms of an offset transaction account and redraw facilities. Be aware that this will cost you an average switching fee of $300.

Mamta Grewal - Mamta Grewal is a financial analyst with financial services research group CANNEX.

© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission.

The Financial implications of establishing and running a SMSF

The ATO advise that there are many issues to consider before making the commitment to establish a self managed superannuation fund (SMSF), such as:

• The financial and time burdens of operating a SMSF.
• Your responsibilities as a trustee to comply with the legislation.
• Determining whether you have a sufficient amount of money to contribute to the fund to make it viable.

You should also ensure you have the appropriate combination of asset levels, investment diversification and expertise to manage the fund successfully.

It has been generally accepted that you should have at least $200,000 in the fund to start it off as well as making the costs of operating worthwhile. With inflation, more recently this figure has been slowly increasing towards $250,000.

The costs and administrative requirements in establishing and maintaining a self managed superannuation fund include:

• Establishing the superannuation fund, including formulating a trust deed (costs can run from $500 to over $1,000), appointing trustees (if a trustee company is to be formed the cost can be between $750 and $1,200) and ensuring the settlement of property.
• Preparing and keeping accurate accounting and administrative records for the fund (accountants or accounting services generally cost from $1,000 upwards, depending upon the fund assets, transactions, complexity, number of member accounts, pensions, etc.).
• Appointing an auditor and ensuring you have an annual audit completed for the fund every year (fees from $1,200 upwards, depending upon the complexity of fund).
• Lodging a fund income tax and regulatory return, which includes a supervisory levy of $45 each year.
• Lodging annual superannuation member contributions statements outlining the contributions made into the fund (this function may be included in accounting fees).
• Completing the relevant eligible termination payment statements.
• Costs of brokerage if you invest your money in listed shares.
• Costs of dealing with a real estate agent if you purchase property through a real estate agent and have the property managed by a real estate agent.
• The option to engage a financial planner, investment adviser, stock broker, etc. to assist with your investments.
• The costs of education if you are an inexperienced investor and you want to make your own decisions on your investments.

The ATO also warn prospective SMSF trustee/members that:

1.  It is illegal to establish or use a SMSF to gain improper early access to superannuation.

2.  SMSFs must be maintained for the purpose of providing benefits to members upon retirement, or to their dependants in the case of a member's death before retirement.

It is important to understand there are severe penalties for trustees who misuse the fund's superannuation benefits and who do not comply with the relevant legislation.

As with any area of your financial affairs, consider all aspects and seek advice from professional advisers.

Laura Menschik
Director and Authorised Representative
WLM Financial Services Pty Ltd.
CERTIFIED FINANCIAL PLANNER TM - SMSF SPECIALIST ADVISER TM
Visit the WLM Financial Group online wlm.com.au

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