Lessons from the ‘rich list’

Most people who are intent on building their personal and business finances know there is no quick road to wealth. While some people dream about their lucky numbers finally being called, others are making every day count. 

Of course, not everyone can make it onto the Forbes rich list, and some individuals rise to wealth largely through privilege and circumstance. However, for many others, their position can be directly attributed to exceptional work habits and a determination to succeed. 

If you’re committed to delivering a serious boost to your finances, then cultivating the techniques favoured by those on the rich list can assist you to achieve your personal and professional goals. 

Having a strong work ethic

The wealthiest and most successful people in the world demonstrate a single-minded commitment to their goals; eating, sleeping and breathing their enterprises. You need look no further than Zhou Qunfei, the world’s richest self-made woman, who started out working in a factory by day and taking accounting classes by night. She proves that determination over a sustained period produces undeniable results. 

Pursue a dream

A number of very prosperous people don’t start out pursuing wealth; they pursue a passion. Consider Bill Gates or Elon Musk, who both conceived an exciting, innovative idea. Passion compels people to continue pushing for their goals. In a society where many people just pursue income, successful people use their knowledge and talent to turn their passion into a revenue-generating venture. 

Setting goals with a long-term view

Innovative ideas require big-picture thinking. The wealthiest people in the world didn’t stop after one success (or failure). They remained committed to their vision and focussed on the long term. Ultimately, individuals who have accumulated significant wealth tend to be entrepreneurs whose determination to ‘win’ motivates them to map out the future and set specific and achievable goals. 

Having support

Jeff Bezos, amazon CEO, has a notoriously rigorous hiring process. Why? Because he understands the importance of surrounding himself with other driven people. Successful people act intentionally to nurture valuable professional and personal relationships, putting time and energy into helping these relationships grow. 

Not being afraid to fail

Sir James Dyson, who literally made his fortune out of hot air, famously said ‘99% per cent of my life is failure’, in reference to the number of prototypes his company makes before they get it right. What he shows us is that failure is an inevitable part of the process and that each failure is an invaluable learning opportunity. Realising that the insights gained from failing have practical applications, successful people continually find inspiration for new ideas and devise ways to execute them. 

Making smart investments

Finally, there are many ways that affluent people go about growing and managing their wealth, and making smart financial investments is certainly a critical component of building capital. Whether you are looking to invest in the share market, a new venture or property, knowledge is power. It pays to do your homework and ask for expert advice where required. 

While, the extent to which your own mindset and habits dictate how successful you are cannot be understated, it’s always good to have an expert in your corner. We’re here to help you maximise your wealth and achieve your vision of success. 

Forbes 2018 top 5

Jeff Bezos $112B
Founder and Chief of Amazon
Attended Princeton and worked at a hedge fund before founding Amazon in 1994. 

Bill Gates $90B
Founder of Microsoft
Now manages the world’s largest private charitable foundation. 

Warren Buffet $84B
Investor
Bought his first stock at age 11. Intends to give more than 99% of his fortune to charity. 

Bernard Arnault & Family $72B
CEO of LVMH
Oversees an empire of brands including Lois Vutton and Sephora. 

Mark Zuckerberg $71B
CEO of Facebook
Dropped out of Harvard to found Facebook at the age of 19.

Longevity Risk in Retirement

Despite narrative to the contrary, a significant proportion of retirees are underspending in retirement out of fear of running out of money. However, there still remains the risk of overspending and running out of funds, not being able to meet costs later in life. Both these scenarios are not ideal and they’re a key driver of why people seek financial advice in preparation and throughout their retirement.

Longevity risk is influenced mainly by three different factors: mortality risk, investment risk and expenditure. How these three factors interact through retirement generally determine whether they will have sufficient funds to see them through their later years or are forced to make do with government aged pensions, regardless of whether this is sufficient to their lifestyle needs or not.

Looking at some of these components of Longevity Risk in more detail, we start with mortality risk. Mortality risk is the chance of death in a given period of time. It can be broken down into two underlying components: Idiosyncratic mortality risk and Systematic mortality risk. Similar to the way that we think of company risk in investing, idiosyncratic risk is the specific risk that a person may die as an individual. Every individual faces the risk of death on any given day that is specific to their own personal situation regardless of how the rest of the population is faring. In the same way that any given company, depending on its specific circumstances, may be exposed to more or less risk than investment markets as a whole. For example, the risk of investing in a tobacco company are quite different to the risks of investing in a bank. So too are the risks of an individual different for a lifetime smoker compared to a vegetarian yoga instructor.

Systematic mortality risk is your life expectancy within the overall population, and it tends to be the greater focus in financial planning when trying to make judgements around longevity. Life expectancy of the whole population changes over time; with advancements in medical technology and a greater understanding of the impact of lifestyle; things like diet and exercise, mental activity, etc. are reflected in continuously changing life expectancies. It manifests in facts like that someone at the age of sixty-five today can expect, based on population trends, to live much longer than just ten or twenty years ago. So, when trying to estimate how long people will live for in retirement, we need to not just take into consideration current life expectancies of populations, but potentially over shooting from advancements in life expectancy as we move into the future.

This can be further complicated when trying to plan for retirement with things like the male/female life expectancy differential, though this difference has been narrowing over time to now being within just a couple of years for individuals at aged sixty-five. But probability still states that roughly one individual in every two couples, is likely to live to age one hundred, despite individual life expectancy only somewhere in the mid to late eighties.

Our next major factor in Longevity Risk, as it relates to retirement planning, is investment risk. However here we are primarily concerned with sequencing of returns, in addition to the actual long-term investment return, as the sequence of future returns, particularly in the early part of retirement, is critical to how long our funds last. The basic premise is that the order of returns that you experience (strong returns or weak returns early on, positive returns up front, or negative) in your retirement years can be more important to the overall result of whether your or not your funds last for your retirement than the actual average rate of return over say a given thirty year period. 

An average return of just six or seven percent can be more than ample for requirements where the first ten years of investing are largely positive, as opposed to the dramatic impact where, with the same thirty -year average return, we experience a high frequency of negative or poor returns in the first ten years.

Under both these scenarios, the long-term, average return can be the same, but the sequence of a poorer first ten years of returns can have a dramatic impact when funding retirement through regular systematic withdrawals from your investment base. Dynamic Asset Allocation can help manage this particular risk, but it can also be impacted and managed somewhat through the use of a Dynamic Expenditure plan, which brings us to the last component of the Longevity Risk; Expenditure.

Expenditure in retirement is not simply a reflection of available funds but can be impacted also from likely lifestyle requirement of retirees. In the past, Safe Withdrawal Rates popularized by William Bengen1 where a withdrawal or expenditure rate generally of four percent (of your retirement savings) has been considered to be a safe maximum. New research, in particular that from the New Zealand Commission for Financial Capability, considers that there are actually three different stages in retirement with different expenditure requirements; an Active, then Passive, then Supported phase.2

The Active stage is the early years of retirement, approximately the first decade, when lifestyle is the main driver of spending, as retirees have the energy and desire to be active. This can reflect itself in additional expenditure on things like travel, hobbies and other types of active endeavors. The following decade can be categorized as more Passive, where there is generally less appetite for activity and spending can commensurately drop. Then for those find themselves in the later stage of retirement; roughly eighty-five plus years of age; support increasingly is required with higher medical and health care costs and potentially aged care needs. Marking an increase again in expenditure needs.

Source: Commission For Financial Capability

Consequently, the interacting requirements in Financial Planning for Longevity Risk in Retirement necessitate an ongoing adaptive approach to plans, where the interaction of life expectancy, investment markets, expected returns and sequencing of returns as well as the changing needs of retirees depending on their stage of retirement, can result in the need for continuous adaptation of an investment strategy.

Other influences that can complicate Longevity Risk in Retirement Planning can be retiree’s desire to leave (or not) a substantial estate to surviving children and whether or the not the spending down of financial capital is allowable part of the strategy (i.e. spending the kids’ inheritance). Does a principal residence form part of accessible funds for the retirement strategy, specifically in later years such as funding aged care needs? The continuing play of these risks, and how we prepare for them, form the basis of Longevity Risk and Retirement Planning for financial planning clients.

1. Bengen W 1994, Determining withdrawal rates using historical data, <http://www.retailinvestor.org/pdf/Bengen1.pdf>

2. Commission for Financial Capability , n.d., The three stages of retirement, Commission for Financial capability, Auckland, viewed 30 January 2018 from <https://www.cffc.org.nz/retirement/thethree-stages-of-retirement/>

Gearing up for growth

Record low interest rates are making it harder for your money to keep pace with the rate of inflation. While it may be a struggle to grow your wealth in such an environment, low interest rates do mean that it is cheaper to borrow. 

So why not take advantage of this opportunity by borrowing money to invest in growth assets such as shares or property? Gearing (borrowing) can be a great way to fast-track wealth creation although it must be remembered that it is a double-edged sword. While using borrowed money magnifies profits, it also magnifies losses. However, by borrowing sensibly and cautiously, and investing in quality assets, the benefits can outweigh the risks. 

As well as boosting your returns, there are also tax advantages because you can offset interest paid on your loan against your income. 

What are your options?

There are a number of ways you can borrow to invest including home equity loans, margin lending, warrants and internally geared managed funds. Each has its pros and cons so it is wise to get professional advice. 
 

Home equity loans

As the name implies, home equity loans let you borrow against the equity you have built up in your home by using a redraw facility or an additional line of credit. 

This method of borrowing is relatively cheap to service as you are only paying mortgage rates of interest. The downside is that you put up your home as collateral. 
 

Margin loans

The second method is via a margin loan where you typically borrow somewhere between 30 to 50 per cent of the value of an asset. The lender will stipulate the maximum you can borrow, called the loan to value ratio (LVR). 

If markets fall, your LVR will rise and if it rises above a certain level you have to pay extra money to rebalance your borrowing. This is called a margin call and may be requested at short notice, forcing you to sell some of the investment quickly (and at a bad time) to meet the call. 
 

Warrants add leverage

Warrants, which are traded on the Australian Securities Exchange, give you exposure to an underlying asset for a portion of the price without the need for margin calls. 

As a result, a warrant gives you leverage which means small changes in the value of the underlying asset result in larger changes in the value of the warrant. This magnifies gains and losses. 

There are many types of warrants, each offering a different level of risk and leverage. Warrants can be on individual shares or on exchange traded funds which offer greater diversification. 

The maximum you can lose is the amount you paid for the warrant. As the borrowing is non-recourse, you can walk away and only be liable for the loan. 

Gearing made simple

The simplest alternative is to let a professional handle the borrowing for you with an internally-geared managed fund. The advantage here is that you don’t need to take out a loan yourself, risk your home as collateral or face a margin call. 

Such funds are for investors seeking capital growth rather than income and should be viewed as a long-term investment as the funds are generally more volatile than the sharemarket in the short term. 

You can also gear up your selfmanaged super fund with a limited recourse loan. The rules are complex so it is vital that you receive the right advice to make sure you comply with superannuation laws. 

By adopting a borrowing strategy that aligns with your risk profile, you can turn today’s low interest rates into tomorrow’s gains.

Counting the cost of education

A quality education is a lifelong resource and a powerful launching pad for young Australians. But with education costs rising at more than twice the rate of inflation, it’s more important than ever to plan ahead for the investment you’re making in your child.i

Grandparents may also like to help their family by investing money for the future school and university costs of their grandchildren. This is becoming increasingly common with 29 per cent of grandparents wanting to draw down on their super to pay school fees.ii This can be done in the grandparent’s name or the child’s name, depending on your individual circumstances.

The actual cost of your child’s (or grandchild’s) education will depend largely on whether they are enrolled in a public, systemic (e.g. Catholic) or independent private school.iii

The ASG survey found that the cost of private education in metropolitan areas – from preschool to year 12 – ranged between $360,000 and $550,000. Private schools in regional areas are slightly more affordable.

In contrast, Melbourne public schools, even at 12 percent above the national metropolitan average, will still only set you back $75,000. Regional areas, again, cost less on average at $50,000. These estimates include the ‘voluntary contributions’ in lieu of fees that most public schools ask for.

Systemic schools, such as religious and other alternative institutions, sit between the two extremes. Here the national metropolitan average is an estimated $230,000 and $172,000 for regional areas.

Of course, fees aren’t the only cost you need to budget for. There are the traditional outgoings of uniforms, books and extracurricular activities. It’s also becoming increasingly common for schools to require students to purchase laptop or tablet computers.

ASG estimated that in 2016 families were spending an average of $1000-$3000 on these ‘extras’ per child every year. It was also found that these costs increased as the student aged, whether they were private, systemically or publicly schooled.

And let’s not forget the cost of higher education. An undergraduate degree currently costs between $6000 and $10000 each academic year, depending on the course chosen.iv Most students choose to defer payment via a HECS-HELP loan, but many families would like to help their children or grandchildren pay some or all their fees upfront to avoid a large student debt.

Where students live away from home, parents may also need to factor in the cost of student accommodation and other living expenses.
 

Explore your savings options

Like any major investment, the sooner you start saving the more options you will have. You could open a dedicated savings account, but the interest rate is unlikely to keep pace with inflation. Here are some popular strategies for long-term education savings:

• Education Funds. These are specifically designed to lock money away for your child’s education. They offer some attractive tax concessions, but there are restrictions and fees to consider.
   
• Term deposits. Are simple and virtually risk free, but interest rates may not keep pace with inflation.
   
• Managed Funds. You don’t need much money to get started, you can make regular contributions and you get the benefits of diversification and professional management.
   
• Insurance Bonds. Like a managed fund, these offer a diversified investment menu but with additional tax advantages. Earnings are taxed inside the bond at the company rate, which may be less than your marginal rate. If you withdraw your money after 10 years, all investment earnings are tax free.v

Investing in a child’s education is a long-term commitment, but the satisfaction that comes from knowing you have given them the best possible start in life is priceless. Call us if you would like to discuss an education savings strategy for your child or grandchild.
 

i Trading economics, http://www.tradingeconomics.com/australia/inflation-cpi

ii http://www.smh.com.au/national/education/grandparents-stumping-up-for-private-school-fees-20160225-gn3hst.html

iii https://www.asg.com.au/doc/default-source/Media-Releases/Planning-for-Education-Index-2016/ASG_EdCosts_SchoolCosts_2016_NAT_Metro.pdf

iv http://www.gooduniversitiesguide.com.au/Support-Centre/Funding-your-education/Degree-costs-and-loans/Commonwealth-Supported-Places#.WCtxAOErKRs%20

v https://www.moneysmart.gov.au/investing/complex-investments/investment-and-insurance-bonds