Wealth Plan

[craft]

Thanks Craft for the numbers. I have sense checked a few key rates assumptions and I can't really flaw any of them. It doesn't mean the next 40 years will turn out the same, but it is a robust basis to believe that the assumptions aren't pies in the sky.

The only thing I have some reservations about is the capital contribution profile. The starting salary for a 23 year old appears too high, as pointed out by Brty. Note the $80k gross salary is before super which implies a total package of ~$87.5k. While ABS statistics suggests that salary income of under 24 years is a lot lower than the average. Sure the % of capital contribution profile can change accordingly but there is a limit to how much that can be done. The other thing of note is whether the numbers (given the lower income of the average 23 year old) allow for the purchase of the PPOR outside super some time down the track. Again, especially the early years when you need to save a deposit, on a lower income, while contributing to the super following this approach. Will it become unworkable?

A quick sensitivity check... if we reduce the contribution in the first 7 years (so up to age 30) by 50%, my model (which is a clone of yours) suggests that the passive income would be closer to $50k than $60k. So even allowing for this, the growth in the numbers are pretty amazing and doesn't really detract the finding of this exercise. The assumptions made are not that heroic... 4.6% inflation is not small, while 0.5% expense is probably on the high side. I didn't think it was doable because I didn't think the nominal return would be 12% (in fact 10.25% is what was used due to your conservatism) and I used a lower salary as a starting point.

Everyone is free to find their own value and utility of money. If you believe spending $2k at age 23 gives you more happiness than $15k (in real terms, not nominal terms) at age 63, then by all means spend that $2k. Just don't complain at age 63 that you wish you knew about the power of compounding over 40 years time. In actual fact, the correct comparison should be whether the happiness of spending $2k at age 23 outweighs the potential struggles you might experience at age 63 without that $15k. My guess is that, if you spent that $2k on smashed avocados at 23, but can't afford to heat your home at 63, there may be some regrets.

looks like we crossed on this post and my last response to brty about the starting wage.

I agree.

 

[brty]

Hi Craft, thanks for the better explanation. I had no difficulty with the growth rates of equities, just the starting amount, so went and found some numbers. I agree wholeheartedly about staying away from bonds though, unless interest rates hit 18-20% in 40 years time, then think again.
I will not be around in 40 years though.

Tech/A's comment...
"You do need to know how to recognise opportunity
(And be in a position to take advantage of it)
You need to know HOW to take advantage of it
Then you need to DO IT!"

This is how I have done things, and I have been studying and investing in markets for over 40 years, so being educated was part of the solution. Also we purchased our first home and paid it off over 6 years, both working full time, but average salaries, just not much spent elsewhere during that time. Our interest rates were 14.5% the entire time.
This put us in the position to take opportunities, some good some bad/poor, but taking opportunities is a plan. Being ready for them is a plan, so yes Tech/A I believe you had a plan, just didn't realise it.

You are not average, neither is anyone else reading this thread. Average Joes and Harrys are not on this forum, they are on FB.

 

[brty]

Just need to add some numbers to my previous post.
My wife started as a teacher in 1980, at $12,500 pa, we still have her first pay advice slip in the files. A starting salary for a teacher today in NSW according to Uni NSW, is $62,282 (2015) but near enough.

Over the 35 years, the wage has inflated at 4.4% pa while official CPI from the RBA has been 4.2% over the same period.
The All Ords started as an index in 1980, at 500 points. At today's level of 5755, it has had an average performance of 6.8% pa, so real gain has only been 2.4% pa for the last 37 years.

It get's worse, over the last 20 years, CPI has been 2.5% pa and All Ords growth from ~2700 to 5755 is about 3.8% pa, only 1.3% pa above inflation.
http://www.marketindex.com.au/statistics

The above page has some very interesting graphs. The divided yield of the All Ords has fallen from 1980 to about 1994, if you take out the 87 bubble and subsequent crash. This was during a period of high inflation and interest rates, with interest rates falling in the early 90's. Since then the dividend yield has been sloping upwards, again if you average out the GFC crash.

Adding the yield to the real growth rate, gives a real accumulation rate of 5%+ over long periods, even allowing for the poor performance of the last 20 years, and before we add franking credits.
Either history is bunk, or we return to a faster growing market over the next 20 years, to keep up with the longer term averages. Every other time the All Ords (or it's reconstructed equivalent) has had a negative return over 10 years or a flatish return over 20 years, the market has had a huge run up in the following decade or 2. This goes back to 1875.

No reason why people should not choose the best of both worlds. 9.5% is compulsory super, put it into a long term industry super fund. The 7.2% from existing savings should also be put into a LIC like AFI or ARG for the Harry and Sally Average, as it gives them options in their 40's and 50's outside super, but will not be enough to retire on by itself, unless only 5 years or so before 'official' retirement age, whatever that might be in 30-40 years time.

 

[Triathlete]

While I agree on how the model and all assumptions have been put in place which was what was first discussed.....It would be interesting to know how many would be comfortable to leave their total retirement account in 100% equities once they stopped working or stopped contributing to the fund...??

 

[tech/a]

Your of course right brty
I'm a big picture person.
I employ meticulous people
To take care of the finer details.

I've found long term planners ( so far without exception)
Find it impossible to accept wrong assumptions.
This leads them into making poor decisions.
Even worse those decisions play out over years.

Personally I think one of the best traits you can learn
Is recognising a wrong assumption or decision as fast as you can
And staying wrong for as short a time as possible.
This includes being on the wrong side of a great opportunity.

 

[craft]

Your of course right brty
I'm a big picture person.
I employ meticulous people
To take care of the finer details.

I've found long term planners ( so far without exception)
Find it impossible to accept wrong assumptions.
This leads them into making poor decisions.
Even worse those decisions play out over years.

Personally I think one of the best traits you can learn
Is recognising a wrong assumption or decision as fast as you can
And staying wrong for as short a time as possible.
This includes being on the wrong side of a great opportunity.

No problem with your third paragraph. But no reason you shouldn't plan.

First couple of paragraphs are just typical tech/a ego driven wank. Hopefully people can see through it otherwise this thread is also futile.

 

[kid hustlr]

Craft,

Don't lose faith - I've walked into work this morning and filled out the form to salary sacrifice 5% of my wage so there's been an immediate effect on me.

Can we talk detail?

Do you have a Super Fund which allows direct ETF exposure you can suggest? I had one suggested to me but there's an admin fee of $400 a year which on smaller balances is quite influential. How bad is it to use an industry super fund which objective is to track to the ASX300 until the balance is large enough to move into a different option?

Secondly, can you explore Triathlete's point about the possible draw down? This is was I was getting at to - I'm picturing Nan & Pop watching there super fall 15% in a month and panicking.

 

[craft]

While I agree on how the model and all assumptions have been put in place which was what was first discussed.....It would be interesting to know how many would be comfortable to leave their total retirement account in 100% equities once they stopped working or stopped contributing to the fund...??

This is an important question.


If your capital is not large enough to fund your income requirements from yield alone then you will have to draw down capital to fund the shortfall. If you have to draw down capital you have volatility risk which means 100% equity is not suitable. The reason being that despite equities having by far the best long run return it also has the greatest volatility which means sequence risk comes into play. Drawing down capital in large down years, especially early screws everything.


Recognising sequence risk arising from most people having not enough capital and hence subject to volatility risk – the pretty standard solution is to go to bonds/cash – to give you liquidity during equity volatility. This liquidity position should really be short term to match the near-term requirement for liquidity. Problem is short term cash has a terrible return which hastens the speed you have to draw down capital.


The worst thing that seems to be happening is that people seem to be hearing the advice to have some liquidity when they are short of capital, but then in an attempt to improve the return on that liquidity they push out the credit risk and /or the duration attributes and it’s a really bad time to be doing that - they are unwittingly opening themselves to capital loses in their supposed secure asset.


If you have got the time and inclination – build your capital to a point where you can sustain the volatility in the cashflow from Equity and staying 100% invested puts you so far in front. Its like a paradigm shift from potential poverty at 90 to intergenerational wealth.


For some reason Australians would be more inclined to see the logic of staying invested in growth assets via residential housing, leaving it to their kids and living off the rent in the meantime. Yet unlevered housing is a much inferior asset class to equities both in net yield and capital gains. Meaning you would have to have much more capital for the plan to work, than using equity as the asset.

 

[craft]

Craft,

Don't lose faith - I've walked into work this morning and filled out the form to salary sacrifice 5% of my wage so there's been an immediate effect on me.

Can we talk detail?

Do you have a Super Fund which allows direct ETF exposure you can suggest? I had one suggested to me but there's an admin fee of $400 a year which on smaller balances is quite influential. How bad is it to use an industry super fund which objective is to track to the ASX300 until the balance is large enough to move into a different option?

Secondly, can you explore Triathlete's point about the possible draw down? This is was I was getting at to - I'm picturing Nan & Pop watching there super fall 15% in a month and panicking.

I think we crossed again - answering Triathlete as your post come in - if that's not adequate let me know.

The only super fund I'm at all familiar with has an indexed growth option that costs 0.17% as opposed to 0.5%+ for every other option - but it also has a weighting of some indexed bonds in there so its not completely ideal, but better than all the other managed options offered. Whilst at amounts under what makes a SMSF viable where you can access ETF's directly it would be O.K. I'm also aware of some super funds offering direct share options but don't know how much this costs. I will put up my costs shortly on SMSF so a breakeven for viabilty on this option can be explored - maybe others can answer the what is available in superfund question.

 

[Triathlete]

This is an important question.


If your capital is not large enough to fund your income requirements from yield alone then you will have to draw down capital to fund the shortfall. If you have to draw down capital you have volatility risk which means 100% equity is not suitable. The reason being that despite equities having by far the best long run return it also has the greatest volatility which means sequence risk comes into play. Drawing down capital in large down years, especially early screws everything.


Recognising sequence risk arising from most people having not enough capital and hence subject to volatility risk – the pretty standard solution is to go to bonds/cash – to give you liquidity during equity volatility. This liquidity position should really be short term to match the near-term requirement for liquidity. Problem is short term cash has a terrible return which hastens the speed you have to draw down capital.


The worst thing that seems to be happening is that people seem to be hearing the advice to have some liquidity when they are short of capital, but then in an attempt to improve the return on that liquidity they push out the credit risk and /or the duration attributes and it’s a really bad time to be doing that - they are unwittingly opening themselves to capital loses in their supposed secure asset.


If you have got the time and inclination – build your capital to a point where you can sustain the volatility in the cashflow from Equity and staying 100% invested puts you so far in front. Its like a paradigm shift from potential poverty at 90 to intergenerational wealth.


For some reason Australians would be more inclined to see the logic of staying invested in growth assets via residential housing, leaving it to their kids and living off the rent in the meantime. Yet unlevered housing is a much inferior asset class to equities both in net yield and capital gains. Meaning you would have to have much more capital for the plan to work, than using equity as the asset.

Nice reply Craft.....The other point I was going to make was also about the chances that should their be another financial crises and a person/s is in equities the chances that companies cut their Dividends or in an extreme case suspend for a year or two, but we now know we would need to sell down some holdings to tie them over....I guess we just need to cover these scenarios as well...

 

[craft]

Just need to add some numbers to my previous post.
My wife started as a teacher in 1980, at $12,500 pa, we still have her first pay advice slip in the files. A starting salary for a teacher today in NSW according to Uni NSW, is $62,282 (2015) but near enough.

Over the 35 years, the wage has inflated at 4.4% pa while official CPI from the RBA has been 4.2% over the same period.
The All Ords started as an index in 1980, at 500 points. At today's level of 5755, it has had an average performance of 6.8% pa, so real gain has only been 2.4% pa for the last 37 years.

It get's worse, over the last 20 years, CPI has been 2.5% pa and All Ords growth from ~2700 to 5755 is about 3.8% pa, only 1.3% pa above inflation.
http://www.marketindex.com.au/statistics

The above page has some very interesting graphs. The divided yield of the All Ords has fallen from 1980 to about 1994, if you take out the 87 bubble and subsequent crash. This was during a period of high inflation and interest rates, with interest rates falling in the early 90's. Since then the dividend yield has been sloping upwards, again if you average out the GFC crash.

Adding the yield to the real growth rate, gives a real accumulation rate of 5%+ over long periods, even allowing for the poor performance of the last 20 years, and before we add franking credits.
Either history is bunk, or we return to a faster growing market over the next 20 years, to keep up with the longer term averages. Every other time the All Ords (or it's reconstructed equivalent) has had a negative return over 10 years or a flatish return over 20 years, the market has had a huge run up in the following decade or 2. This goes back to 1875.

No reason why people should not choose the best of both worlds. 9.5% is compulsory super, put it into a long term industry super fund. The 7.2% from existing savings should also be put into a LIC like AFI or ARG for the Harry and Sally Average, as it gives them options in their 40's and 50's outside super, but will not be enough to retire on by itself, unless only 5 years or so before 'official' retirement age, whatever that might be in 30-40 years time.

Thanks for your post.

Capital growth of 1-2% above inflation is about historical norm for equity markets and it makes sense from an economics perspective. Companies retain capital to fund nominal GDP growth which is made up of Inflation, Population growth and productivity. Productivity gains typically get shared with the labour that implement and use the new capital - Labours share wont show up in an increasing market value. Just leaves part productivity and population growth above inflation to produce "real" capital gains and even some of those gains are diminished through issuing more shares rather than internally financing.

I don't have a problem with people not choosing to use super. Just be mindful that you are going to need more contributions or an above market return to get the same outcome because of the tax implications to the real return figure. Salary sacrificing $5,000 into super means you are putting $4,250 to work after contribution tax. That $5,000 taken in hand after marginal tax leaves you only $3,275 to put to work if your income is below 87K, above its lower still. Taxation on the cashflow that you need to re-investment along the way has the same effect - but its even worse because the savings income will be added to your wage and push you into higher marginal brackets.

 

[craft]

Nice reply Craft.....The other point I was going to make was also about the chances that should their be another financial crises and a person/s is in equities the chances that companies cut their Dividends or in an extreme case suspend for a year or two, but we now know we would need to sell down some holdings to tie them over....I guess we just need to cover these scenarios as well...

Yes dividend volatility and whether we can live with it is the absolute key to deciding if 100% equity allocation is appropriate as I see it.

Fortunately we have lived through a recent stress point in 2008 so we have a recent example of an extreme to study, to see if we can hack the dividend volatility that caused. Maybe even allow for a worse case scenario - but don't skim over the question. you don't want to find out you can't hack it and have to start drawing capital to suplement your income at the market lows

 

[tech/a]

First couple of paragraphs are just typical tech/a ego driven wank. Hopefully people can see through it otherwise this thread is also futile.

Its personal experience.
What?---- its your way or no other?

After you've presented your suggestions Ill present mine.
People can do what they wish. Who knows I may take on
board some of your stuff.

Personally I think an integration of the Two once I present my
suggestions would be hugely beneficial.

But I'm talking more about sustainable excess cash generation FIRST
Without it your going to struggle living let alone saving for a retirement
you may not even make! or indeed want!.

Ill wait.

 

[craft]

First couple of paragraphs are just typical tech/a ego driven wank. Hopefully people can see through it otherwise this thread is also futile.

Its personal experience.
What?---- its your way or no other?

After you've presented your suggestions Ill present mine.
People can do what they wish. Who knows I may take on
board some of your stuff.

Personally I think an integration of the Two once I present my
suggestions would be hugely beneficial.

But I'm talking more about sustainable excess cash generation FIRST
Without it your going to struggle living let alone saving for a retirement
you may not even make! or indeed want!.

Ill wait.

Well get on with it – Nowhere Have I said a long-term plan for wealth should be the exclusive plan considered. Actually, I think I may have said I encourage adding an active string to the bow with even more ambitious goals.

You haven’t shown anything of detail or substance yet, just a lot of how good am I and a lot of white–anting other plans because you don't seem to understand the power, efficiency and simplicity of the ideas.

If you have got any substance – show it. I’ll consider it. But I’m afraid my consideration of your contribution so far is; No detail ego wank fest.

Actually, I think a lot of what you are saying so far is dangerous and potentially leads to where you said your father ended up. Unless you get lucky. But maybe I'm just misinterpreting your posts.

Happy for you to think of my contributions the same! This thread is not about you or me. It will hopefully be about sharing substance and detail for people to consider.

 

[Ves]

Hi craft, are the calculations purely based on 100% Australian equity exposure? Any idea what the historical pre-tax yield (including foreign tax credits) for international equities is in an ETF like VGS (or vehicle following the same index construction)? From memory it's something like 2.5%-3%.

 

[craft]

Hi craft, are the calculations purely based on 100% Australian equity exposure? Any idea what the historical pre-tax yield (including foreign tax credits) for international equities is in an ETF like VGS (or vehicle following the same index construction)? From memory it's something like 2.5%-3%.

For the exercise it was Australian numbers only. Costs/Benefits, Pro's/Con's of diversifying internationally(currency hedged or unhedged) with a passive long term equity approach would be an interesting topic if somebody wanted to persue it.

 

[McLovin]

Yes dividend volatility and whether we can live with it is the absolute key to deciding if 100% equity allocation is appropriate as I see it.

Fortunately we have lived through a recent stress point in 2008 so we have a recent example of an extreme to study, to see if we can hack the dividend volatility that caused. Maybe even allow for a worse case scenario - but don't skim over the question. you don't want to find out you can't hack it and have to start drawing capital to suplement your income at the market lows

View attachment 72074

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You got any charts on dividend volatility? I seem to recall in 2009, dividends were cut across the All Ords by about 30%. If my memory is correct, that's a pretty big fall in income for someone targeting an income stream of 75% of the average wage. They wouldn't want any unanticipated expenses rearing their head at that point.

 

[kermit345]

I'm pretty much living this scenario at the moment. I'll explain my position and how that might guide your assumptions etc further.

I did a uni double degree at uni which took 4 years and started full time employment when I was 22 (I'm now 30) on a starting wage of $40,000. Its important to note that I work in country SA and so starting wages or just wages in general are quite different between each state and capital city v country which I'm not sure if thats something you wish to consider in your assumptions. Anyhow from day 1 of employment I started investing into shares however with nobody to really learn from I made the mistake of buying small cap tips quite a bit or buying stocks I thought were undervalued but actually weren't etc. I've made my fair share of mistakes and learnt from them too but wish I'd had the knowledge back then about the simplicity of ETF's or just purchasing larger stocks like the banks. Anyway I don't want to harp on about the stock picking side but lets just say I burnt some capital in the early days but have improved quite a bit since then.

Fortunately over this 8 year period I was able to live at home and save a lot of money - I own my car, I've paid off a block of land (building now) and accumulated capital in equities to the point that I now have $120k of shares with a $30k margin loan. Essentially I'm bang on where craft has said a 30 year old needs to be however i've done it outside of super rather than inside of super.

The issue now becomes paying off my house. Being a single guy essentially all the funds i've directed to equities in the past will now be going towards paying off the house. My salary has only increased to a little about $60k but should grow some more over the next 5 years as I take on clients and more responsibility within the business. However the issue becomes that it becomes increasingly difficult to invest that amount anymore towards the future when repaying a mortgage as well - particularly when you're single.

I'm still planning out how i'll attack the next stage as the property will be finished within the next 8-10 weeks and i'll be living in it. Will take some adjustment to see how much I can still potentially invest (I fear i'll be lucky to do maybe $100-$200 a fortnight which about $70 a fortnight will only cover margin loan interest).

I hope that gives a bit of an overview of a form of the average joe, which is where it becomes difficult for craft with assumptions etc. Couples typically have a greater ability to invest funds but then if kids are involved sometimes they have even less capacity then a single person. Then you get the differing wages between states etc as I mentioned earlier and it becomes a difficult task to measure the average joe.

Fire away if you have any questions that I can maybe help with in terms of my experience. As I said earlier definitely wish I had someone to tell me when I started that I could just progressively invest in a broad market ETF re-investing the dividends and I honestly feel i'd have at least an extra $20-$30k today.

 

[tech/a]

Seriously??

When your finished.

The wank fest you mention is an attempt to
show that someone without a degree in finance or
working in a financial background can achieve extra
ordinary results.

While that is very upsetting for you craft it maybe
very encouraging to others out there without your acumen.

 

[craft]

You got any charts on dividend volatility? I seem to recall in 2009, dividends were cut across the All Ords by about 30%. If my memory is correct, that's a pretty big fall in income for someone targeting an income stream of 75% of the average wage. They wouldn't want any unanticipated expenses rearing their head at that point.

Here is a dividend chart back to 1974 - Yes it was a 30% odd fall in 2009



However with a long term view you shouldn't have been relient on 2007ish dividend levels to support your plan as things were obviously extended on a historical basis. In other words the fall occured from elevated levels - not from the level you should have your plan based on. Lots of the falls that scare people are from elevated levels and they seem to forget you would have substantialled squirelled away a lot of nuts in the summer before winter hit.