Quo Vadis?

If you're aything like me, incorporating the level of risk that you believe you're comfortable with into your asset allocation could still result in unpleasant surprises in the long run.

I've often read that for the long-term investor, time heals all wounds - that is, while equity investments may have large year-on-year variation in performance (a.k.a. "risk"), over long periods of time this variability "evens out" and the long-term performance will display less variation. That is, "risk" decreases over time.

However, I'd recently read a contrary view (unfortunately I can't recall the reference) which stated that time won't decrease the amount of variation (in dollar terms) in your final outcome. This seems to be at odds with the generally accepted view, but in fact it is just a different way of looking at the expected results - concentrating on the variability in the final dollar value of your portfolio rather than in the percentage average return overall.

While it is true that over time the average return will tend closer to the expected long-run value over time, this does NOT mean that in the long run your portfolio will end up with a final value close to what you thought you could reasonably expect. Due to the effect of compounding, over longer time horizons even small variations in average return have a big result.

Even though I was aware of this fact (and have an understanding of the "magic of compounding") it really didn't hit home for me until I ran some simulations of my portfolio (using my current investment mix and projected returns and std deviations loosely based on data from Portfolio Solutions)

It turns out that while the most likely outcome is as I'd expected (around $3 million AUD by the time I retire around 2027), there are several "outlier" scenarios where the end value of my portfolio would be less than $1 million - which is pretty depressing compared to my current net worth and what I could achieve by just investing the entire portfolio in "safe", fixed interest assets! Of course, with my current portfolio mix there is a similar probability that I could end up with over $5 million.

Before we look at the results of my modelling (done in excel) I should point out that it was a bit rough and ready. I had to use guestimates as to reasonable return and std deviation values to use for my "alternate" investments (gold, agribusiness trusts, coins) and "hedge" funds (OMIP series and Macquarie Equinox Select Opportunities). For the other asset types I adapted the values listed by Portfolio Solutions. Because I didn't have any information on covariance between by investments I've lumped all assets of the same class together (ie. All Australian share holdings are lumped together as one total amount, combining my superannuation funds, direct share holdings and geared share fund investments in my model). Hopefully any covariance errors should largely cancel each other out - lumping the like investments together assumes a covariance of "1", whereas they would really have a value slightly less than "1". And the model also generates each years return for each different asset type independantly, based on the asset types return and std deviation values and the amount invested at the start of the year (see this site for an excel formula that can be used for modelling normally distributed returns using mean and std deviation values). This means that the different asset classes have an implied covariance of "0", when in fact some would have a covariance value in the range 0-1 (eg. Australian and International shares), and some of the others would have negative covariance values. According to MPT by having a mix of assets my total portfolio should have significantly less risk than shown in the model. But this is still good as a "worst case" scenario. If I get in the mood I may attempt to calculate return and risk values to use for my Hedge and Alternate investment classes using the monthly unit price data I have for OMIP funds etc.

I think the main take-home lesson from this exercise is to remember that ANY one of the projected scenarios is equally likely to happen, but that you'll only get one bit at the cherry. So you could end up with one of the less likely outcomes - either very good or very bad. While looking at average results and the most likely outcome is useful for planning purposes, if you are taking on increased risk in order to achieve higher returns, you have to have a hard look at what the end result could actually be, and be comfortable with whatever happens. Que Sera, Sera!

Table 1: My current Portfolio Asset Mix

ASSET                           Gearing       Annual               Expected Performance 
Type      PV            % Mix   (Loan)       Addition     LVR     Return   Risk (std dev)
Au Shrs   $595,596.00  34.5%   $262,719.20   $ 8,299.35   44.1%    8.00%   17.00%
Int Shrs  $232,864.00  13.5%   $ 92,572.80   $ 6,453.95   39.8%    8.00%   15.00%
Au Prop   $761,770.00  44.1%   $350,554.00   $13,559.70   46.0%    7.50%   14.00%
Hedge     $ 88,100.00   5.1%   $ 57,620.00   $     0.00   65.4%   11.00%   20.00%
Fixed Int $  2,770.00   0.2%   $    554.00   $     0.00   20.0%    5.00%    3.00%
Alternate $ 44,500.00   2.6%   $      0.00   $     0.00    0.0%    3.00%    3.00%

Excel Formula for calculating a random return from an assets expected return and standard deviation:
Rn = SQRT(-2*LN(RAND()))*COS(2*PI()*RAND())

Figure 1: A plot of two runs of the model showing the degree of variability over time.















Figure 2: A plot of the first 32 out of 200 simulations.
















Figure 3: A histogram of the end value of my Portfolio in 200 simulations.

Zero [%] Transfer Offers [Part iii]

My $6000 0% for 6 months transfer offer for my new Coles Source MasterCard arrived safely onto my NAB VISA account - it appeared as a Credit on my NAB account the day after the amount was charged to my Coles Source MC. It was a bit of a shock to see a four thousand dollar credit balance on my VISA account - I usually run up about $1500-$2000 on the card each month and pay it off in full (so no interest charges), so the $6000 transfer means that I can afford to pay an extra $2000 each month off my Citibank RediCredit balance for the next three months. The Citi line of credit account was used to make some tax deductible investments in June (so I get the tax deduction up front), but even though the interest is tax deductible, at 11% it's worth using the free money from the balance transfer for six months. Unfortunately having to do it via a credit to my VISA account means that it will take three months for the entire $6000 to come off my RediCredit balance - so for the six months period I'll save interest on $2000, $4000, $6000x4 - so the average is $5000 reduction in the balance being charged 11% - so I'll save $275 in interest payments. Even after allowing for getting 40% back as a tax refund this means the zero balance transfer offer is worth $165 - for about 1 hour spent filling in forms etc.

I have to make absolutely certain that I pay off my Coles Card balance in Feb (the offer period ends 22/2) otherwise they'll start charging the cash advance rate on the balace transfer amount. I also can't charge anything to the Coles card while the balance transfer hasn't been paid off, otherwise it will be charged interest (any payments come off the balance transfer amount first). But this isn't a problem as I normally charge everything to my NAB VISA card to earn FlyBuys points.

I've now also applied for a Virgin Money Card which has a similar 6 months interest free balance transfer offer. They've approved the application, but I just did the 100 pts identification paperwork at the post office yesterday and mailed copies of some rental and dividend income statements (I had to photocopy 30 pages of dividend statements!). I won't know the credit limit until they process this, but I asked for a $6000 balance transfer to my NAB VISA account - we'll see if this goes through, and when.

As the cash flow benefits of this balance transfer wouldn't kick in for 3 months I'll have to check with NAB how a cash advance on the VISA card would be treated when I have a Credit balance on the account. If I can withdraw the $6000 immediately to pay off my Citibank account, so much the better.

All this balance transfer action is only worthwhile if you can use the amount to save interest on some existing credit balance - but most people would have a home loan, margin loan or similar to apply it to (even if it has to go indirectly, as I've done, by diverting normal monthly credit card payments into the desired loan account). You also have to be able to pull the money back out at the end of the period so you can pay the balance transfer off before it starts costing you interest.

It also wouldn't be a good idea if you needed the credit elsewhere - for example when applying for a home or investment property loan they ask for all your credit card limits - they treat them as existing debt even if you have no current balance, as you could utilise the credit at any time. I don't have to worry as I'm already fully geared in real estate, and have established all the margin lending credit limits that I need.

Trivial pursuits

I must confess, aside from spending time on "big ticket" items (like continual self-education to boost my salary income, reading about investing and trying to inch towards the efficient frontier by tweaking my asset mix and minimising fees) I also like to waste my time dabbling in getting "freebies".

For anyone else who likes getting something for nothing (of course this assumes that your down time would otherwise earn $0 per hour - say watching TV) I list a few of my favourites.

1. Email cash - You can earn a regular 5c per day doing a couple of clicks on their website, occasionally get advertising emails which also pay 5c when you open them and click the link. Most fun is the daily number guessing game which you get to pick 5-7 numbers between 1-1000. If your number comes up you get 200 pts ($2 worth). You can invest up to 10000 pts ($100 worth) in their "eBank" which pays around 15% interest. When you have some pts to cash in you just exchange them for e$ which can be used to buy a real money cheque. Cheques are only available for $30, and there is a 1e$ admin fee. So far I have got about $90 of real cash from this. Makes a good diversion during a tea break or when you're on hold. If anyone wants to join up, go to email cash. Using this link will get me a few pts for a referral ;)

2. FlyBuys - Joining this program is free, and just flashing the card when buying your normal shopping at Coles, Myer, Shell petrol, Target etc. will get you 1 pt per $5. You can earn pts much faster however if you have a NAB credit card. You'll then get a 2nd pt per dollar on such purchases if you pay by CC. You will also get 1 pt per dollar for all purchases using your NAB CC. Obviously this is NOT good if it means you run up CC debt. I always pay off the balance in full during the interest free period (up to 55 days) so my only cost is the annual card fee (about $28 pa). I use my CC for all my regular payments - shopping, doctor, dentist, water, phone, electricity, car rego etc, etc, so I put through about $2000 per month on CC and earn around 6,000 pts per month. You can redeem 13,500 pts for $100 paid off your NAB CC - so I'm getting about $45 value per month for free.

3. Mypoints - a US based email "clicking" program. You can redeem pts for Barnes & Noble gift cards or webcertificates. If you have a US address available to get the gift cards sent to, then you can use the gift card number and PIN number to order B&N books online and get shipped as gifts to the US. Not really worth getting books sent to Australia as the P&H is exhorbitant. If you redeem for a webcertificate, you basically get a VISA debit card number with an available balance. Theoretically you could use this to pay yourself if you have a merchant website - eg. CC payment processing via Paypal. I'll let you know if this actually works out in practice. I tried it once years ago and had trouble "activating" the Webcertificate so couldn't use it, so I've since just redeemed MyPoints for B&N giftcards to send friends and relatives in the US.

Stumbling towards the efficient frontier

The efficient frontier is a nice idea that actually makes a lot of sense - for any particular level of risk there is a maximum expected return that can be achieved. The efficient frontier is found by plotting the risk and return for the universe of all possible combinations of assets that you want to include in your portfolio, and joining the dots of the ones with the highest return for a particular standard deviation.

[graphic from styleadvisor.com]

For a good explanation of this see www.efficientfrontier.com or read this chapter from "Investment Strategies for the 21st Century" by Frank Armstrong [available free online!]

My difficulty is that my portfolio includes more than just equity funds, bond funds and fixed interest - I have direct property investments, alternative investments (agricultural trusts and hedge funds), direct share investments (local and US), and make use of leverage through property and margin loans. Aside from difficulty in calculating expected return and risk values for some of these investments, there doesn't seem to be much analysis of how gearing (the the risk associated with the loans) gets incorporated into modelling of the efficient frontier.

Wikipedia mentions that the use of leverage can actually lift you ABOVE the efficient frontier - but I'm not sure exactly why. To quote:
"An investor can add leverage to the portfolio by holding the risk-free asset. The addition of the risk-free asset allows for a position in the region above the efficient frontier. Thus, by combining a risk-free asset with risky assets, it is possible to construct portfolios whose risk-return profiles are superior to those on the efficient frontier.
* The investor who borrows money to fund his/her purchase of the risky assets has a negative risk-free weighting -i.e a leveraged portfolio. Here the return is geared to the risky portfolio. This combination will again offer a return superior to those on the frontier."

Unfortunately I haven't yet found a more detailed treatment of this elsewhere on the net. Also, in practice, your gearing uses margin loans or home equity loans at 2-3% above the risk free rate, so I'm not sure how this ties in with the presumption of leveraged investments utilizing the risk-free asset.

Any comments or references?

QBE DRP/BSP RIP

I just got notification from QBE that they have more money than they know what to do with, so they're discontinuing the dividend reinvestment and dividend election (bonus share) plans.

Aside from having to send in my bank details (again!) so that dividends can be direct credited, I'm not too fussed. DRPs used to be a good deal in the days when they were issued at a discount to the prevailing share price, but they were always a pain to keep track of for CGT calculations (even more so under the old indexation method). These days they're mostly issued at the prevailing price, so you don't get much benefit apart from saving brokerage fees. A few companies round UP to the next whole share, which can be great value for small shareholders with only a couple of thousands shares in the company - getting 8 shares instead of 7.13 can boost the dividend yield substantially.

However, this will affect my sons holding in QBE shares. He was in the Bonus Share Plan, so he didn't get any dividend to declare on his tax return (but he would later pay CGT on the entire value of the BSP shares when sold, as they are deemed to have had zero cost basis). Now he'll be getting taxable dividends to include on his tax return. Luckily he will be under the income threshold where paying the exhorbitant 'child' tax rates cuts in, and he'll get the franking credits refunded, so it's not all bad news.

Zero Transfer Offers [cont.]

My first attempt to do a 0% balance transfer from my new Coles Source card was a flop - apparently a Citibank Redicredit account is not acceptable.

I'm a bit unhappy that the customer service dept. had sent out a letter on the 11th confirming that my transfer request had been processed, but then ever informed me that it had been reversed. (I only found out when I checked my account online this morning).

Anyhow, I tried again this morning - this time with a transfer to my NAB VISA credit card, which I use for paying all my rates, bills etc. (I get lots of Fly Buys. points that way, without any extra spending). As I put through around $2000 per month on this card and pay off the balance in full each month, a $6,000 transfer from the Source card will mean I can pay $2000 extra off my Citibank LOC account for the next three months. I used the LOC to fund some end of tax year deductible investments, so the interest is tax deductible, but it's still worth reducing the outstanding balance by using the 0% transfer money.

When the 0% offer period ends in Feb '07 I'll just pay it off with some spare funds I have sitting in an HSBC Serious Saver account.

We'll see if the balance transfer works properly this time...

If it does, Virgin Money is currently offering a 0% balance transfer for new customers, so I may have a go at that one next. As I've already got all my Margin Loan limits and home loans established, it doesn't matter if I have a few extra credit applications on file.

A random walk down George Street

Had a nice, cheap evening out tonight. Vanguard Australia had arranged for Dr. Burton Malkiel to give a talk in Sydney. There was quite a good turnout, and the setting was great - in the Ballroom of the Westin Hotel in Sydney.

If you've read his famous book "A random walk down wall street" (and the Vanguard product brochures) there was nothing new in the one hour session. But the professor is a very entertaining speaker, and it gave my wife a quick overview of efficient market theory and how it suggests index funds are a good 'core' choice for your portfolio.

Afterwards I bought a new copy of the book, and had it signed by the Author. I also got to ask the Vanguard officials how come the US parent has low, low fees (around 0.25%) while the Australia version starts at 0.9% and only gets cheap (0.35%) for amounts above $100,000 that are invested in a single fund. With Dr. Malkiel predicting single digit returns are likely in the future, an extra 0.5% fee off your 9% total return will have a big impact over time. The suits from Vaguard said that the Australian Fund is smaller than the US one, but that they were "looking into" the fees. I won't be holding my breath. In the US "no load" funds can only charge a certain maximum for advertising before they can't call themselves "no load" - here there's no such rule, so I think the current Vaguard Australia customers are paying for the companies growth strategy.

All in all, a very economical and enjoyable night out.
ps.
Total costs (2 persons)
Lecture - free
Parking - $4 at Pyrmont (a healthy walk through Darling Harbour to the city)
Entrees and drinks before - free
Dinner afterwards - $17 (OK, it was actually 2x take-away)

total = $21.00!

Esanda online savings account is no more...

Well, it had to happen. With the proliferation of online savings accounts all offering the same high interest rates, some of them are struggling and going under.

I'm not too fussed as I also have an ING direct online account which I tend to use more anyway. The Esanda one gave me $25 when I opened the account - the main reason I opened it. Probably a lot of other folks did the same thing.

When announcing the closure they informed me that their parent company (ANZ bank) has already opened an ANZ online account for me! But I'll NOT be taking up their kind offer to activate this account by taking in 100 pts of ID to an ANZ bank to open a regular bank savings account with them - they charge $5 per month in fees!

As the ANZ online account ONLY works with an ANZ bank account, it's not really competitive with ING, which lets you link to ANY existing bank or credit union account that you have.

pfblogs.org

Well, if you write a blog you obviously want to be read - so pfblogs.org seems a good idea.

I'm not so keen about the need to pay $2 a month if you want to be a "friend" and get a better ranking in the blog posts listings - apparently you used to just have to give them a mention and add a permanent link to become a "friend".

They also have a commercial (with ads) version pfblogs.com - I would have expected THAT one would be the one to charge to become a "friend"!

Tax time blues

Well, it's that time of the year again. I did my wife's tax return last weekend (using eTax) and she got her refund deposited into her account on Friday! I've now started the annual grind of doing my taxes. Once you've done your own return a few times, it's fairly straight forward, just need to check on any relevant changes and spend the time to add up all dividends, deductible expenses etc. Well worth a couple of hours effort to save the cost of a tax preparer.

As a wage slave my return is fairly simple, but having some direct share investments can be a headache when you sell them and have to report for the Capital Gains Tax item - especially if you've acquired them in odd lots via DRPs and maybe sold some of your holding previously. I used to enter all trades and dividends into Quicken, and it was great for being able to select which lots of a share to deem as being sold. However, I haven't had time to keep Quicken updated since I married in '99, so I've had to manually track through all trades for shares I've sold to calculate capital gains info the last few tax returns.

Hopefully now that I've started using Quicken 2006 I'll be able to add in all the info for my current holdings over the next few months.

Net Worth

Much of investing performance comes down to patience and a long-term outlook. Overtrading will kill you with fees (but your broker will love you), and trying to time the market is almost guaranteed to reduce your performance. However, I still enjoy monitoring my net worth, and it lets me feel like I'm "doing something" when all my investments are in place and just need to be left alone.

I've just started recording my net worth info using www.networthiq.com. I already I track my networth daily using a spreadsheet (data from various online accounts daily). I used to use Quicken, which was great for budgeting and handling the calculations for Capital Gains Events (ie. share sales) as it handled individual lots very well. But since getting married and starting a family I didn't have the time to keep Quicken regularly updated, so I've had to manually do CGT calculations at tax time each year.

I've installed the 2006 version of Quicken (it was free with last month's Money magazine), and so far I'm keeping up to date. Entering 20 years of share transactions will be this years major project! I'm still working out how to record my property and mortgage info in Quicken, but getting it to only count half of these values in my networth report (I only want MY networth, and the property investments and mortgages are in joint names with my wife).

I also want to write some PERL scripts that will automatically login to all my online accounts and grab the relevant daily information and display in one place - this will save me logging into half a dozen accounts each day!

Anyway, although it's a bit redundant I'll update monthly data from Jan '03 to the present into NetWorthIQ over the next few weeks so it can be easily displayed for this blog. I'm not sure that it will be of any practical use to anyone, but in the Blogosphere I think having an 'Open Wallet' gives you cred. It's always nice to know where someone writing about investing is 'coming from'.

For those with kids

Just thought I'd jot down some notes about what I've been doing regarding my son's finances. He's turned 6 and is already quite money-wise. He enjoys earning some money busking at the Art Gallery with his recorder, and used to do a local paper round [with a lot help from dad the taxi service/heavy lifter]. As all his basic living expenses are taken care of and $3 per week pocket money, he manages to save 100% of his earnings! At his age and net worth he'd definitely be classed as a PAW (nb. see the millionaire next door for a great read and to find out the difference between PAWs and UAWs)

There whole area of money and kids can be quite complex here in Oz - especially as there is such a low threshold for 'unearned income' (around $1400 pa) beyond which a massive marginal tax rate of around 66% applies!

A couple of good things that you might not be aware of
1. Gifts don't count, so little Johnny doesn't have to include pocket money, xmas money from Grandma etc. on his tax return (you HAVE applied for a tax file number of his behalf, haven't you?)
2. Beware of investing too much in stocks etc. on his behalf - if he gets more than $1400 in dividends etc. he'll pay a fortune in tax (it's to avoid you putting all your money in your kids names to minimise tax). Anyhow, these days superannuation is such a good deal that you'd be better socking spare money into your super than your kids investments. If he does invest in shares, select those that have a Bonus Share Plan (so they don't issue dividends) would be a good way to accumulate more shares without earning taxable income. There will be a larged capital gain when he eventually sells the shares though - the Bonus Shares have a zero cost base.
3. EARNED income is treated entirely differently to unearned income - normal adult tax rates apply, so, basically earning $5,000 a year on a paper round didn't make him liable for any tax. Also, any interest or dividends on EARNED income that has been invested is also taxed at the normal adult rates - so make sure you he has separate bank accounts, Chess share HIN etc. My son has one St George Happy Dragon account where he saves his pocket money etc., where the interest will be considered unearned income, and he also has a separate Online banking account which is ONLY used to receive his paper round wages by direct payment. Any interest on this account can be thus be included when calculated the earned income total for his tax return.
4. He has a so-called "child super" account used for retirement investing in his name. Superannuation is another way to invest that avoids any issues with high taxation - super is only taxed at 15%, even for kids. The Macquarie account he uses is invested in a 50/50 mix of International Equities and Geared Local Shares - which is quite risky (volatile) but should give high returns over his long,long investment horizon (54 years till retirement!).
5. He also has second PERSONAL RSA (retirement savings account) with AMP so he can make personal undeducted contributions into superannuation and be eligible for the annual government "co-contribution". For each annual personal undeducated superannuation contribution of $1000 he receives the $1500 as a government co-contribution! A pretty good immediate return of 150%!

What goes up...

Well, the Reserve Bank has done to expected and raised interest rates by 0.25%, and talk has now turned to anticipation of another increase in November.

Of course, no-one really knows what will happen - just before the previous rate rise the consensus opinion of the "experts" was that rise would be the last. Reading the commentary in the financial press is a bit like watching a herd of cattle stampeding this way and that.

In reality, interest rates are not particularly high, now just approaching the level they peaked at in the last rate tightening phase, and probably not likely to go much higher. With the US economy slowing and the Chinese economy overheating, it's quite possible that in another year we'll be fearful of a resources-bust lead recession!

Anyhow, with housing construction at very low level, vacancy rates dropping and prices levelling out in the eastern states, it's probably a good time to start looking around if you intend to buy a rental investment property before the next housing boom starts.

Personally I'm a bit over-weight in property, with a large home loan balance outstanding (variable rate) and a considerable outstanding mortgage remaining on an investment property (which is on a five year fixed rate interest only loan). But it's still interesting to look at how unit prices are tracking in the suburbs of Sydney - some recently completed units near Epping Station caught my eye. If the price is right these may be attractive once the new rail line through Nth Ryde is soon completed.

Money for blogging?

While blogging about wealth creation, it's natural to ponder the possibility of making some revenue at the same time. When I joined blogger.com I was offered a sign-up to Google adsense. Theoretically, when lots and lots of people start reading this blog, some will click on the google ad links, and I'll get paid a pittance.

So far? In 12 days I recorded 30 page views, with a *huge* spike of 8 hits the day after I mentioned this blog in a post to mymoneyblog. However, there hasn't been a single click yet, and while google doesn't advertise the payment rate I expect it's in the order of cents per THOUSAND clicks, so I certainly won't be getting get rich that way ;)

However, there are lots of other methods that *could* earn revenue from a blog - see How to Make Money with Your Blog Site for some of them.

Over time, I may try some of the ideas from this blog and see if any of them work in practice!

Meantime, the most important thing will be to blog something that is interesting enough for you to come back regularly and read ;)