Thursday 4 December 2008

Shifted my son's cash savings into long-term asset allocation

DS1 had $10,000 he'd earned from two years of doing a paper round sitting in a St George online savings account. It was earning a good rate of interest, and was nice and safe (especially since the Australian government guaranteed bank deposits), but cash isn't a sensible asset allocation for an 8-year old with a very long investment time frame. So, with interest rates rapidly dropping as the RBA cut the official rate by 3% in the past 3 months, and the stock markets appearing reasonable value at current prices, I decided to open a Vanguard investment account for DS1 so he could invest his $10,000 in a suitable index fund. The one we (I) decided on is the Life Strategy High Growth fund, which invests in a mix of the other Vanguard Index funds to achieve an asset allocation of:

Asset Sector ..................... Fund ... Target
...................................Actual . Allocation
Growth Assets
Australian Shares ................43.5% ....44.0%
International Shares .............28.9% ....29.0%
Australian Property Securities ... 5.2% .... 5.0%
Int. Property Securities (Hedged). 5.6% .... 5.0%
Int. Small Companies (Hedged) .... 3.8% .... 4.0%
Emerging Markets Shares .......... 2.9% .... 3.0%
Total Growth .....................89.9% ....90.0%

Income Assets
Australian Fixed Interest ........ 4.1% .... 4.0%
Int. Fixed Interest (Hedged) ..... 6.0% .... 6.0%
Australian Cash .................. 0.0% .... 0.0%
Total Income .....................10.1% ....10.0%

The fund has a fairly high fee (0.9%) for an index fund, especially compared to the US Vanguard funds, but there are fee rebates for larger investments, so you pay 0.6% fee on amounts between $50,000 and $100,000, and a reasonable 0.35% for amounts over $100,000. If DS1 continues to use this fund for investing as he gets older it should be a reasonable investment vehicle for his non-retirement savings.

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Anonymous said...

You could also try an exchange traded fund that tracks the ASX's overall progress.

Anonymous said...

What are the tax implications of this account?

At what rate is it taxed and whose name is it in?

Thanks. said...

The account is in my name 'As Trustee for' DS1. His tax file number was provided, and the distributions (reinvested) will by declared as income on his tax return. As the amount invested all came out of his bank account that only contains "earned" income (eg. from his paper round), income from the investment of "earned" income is also deemed to be "earned" income (from a child tax point of view). This means that the distribution income will be included in the total of "earned" income listed on his tax return, so it will end up being taxed at the "normal" tax rates rather than at the punative "child" tax rates (which apply to unearned income). As his total "earned" income (from this investment plus his weekend busking) will be below that tax-free threshold (~$8,000), he should have little of no tax due on this investment.

BTW, his 'unearned' income (eg. birthday gift money from his great-aunt and grand parents) is put into a different bank account, and he uses that money to invest into his retirement savings account (RSA) each year. Depending on changes to the superannuation rules, some years a $1000 personal contribution into his superannuation account results in a co-contribution from the government. Putting his "unearned" income into superannuation moves it into a concessionally taxed environment, and stops him from accumulated enough "unearned" taxable income to be subject to the high "child tax" rate (around 65% I think).

Bear in mind, I'm no expert on taxation, so this could turn out to be a misunderstanding of the relevant tax rules, as explained in the ATO's
"tax pack" and website (I guess we'll find out if/when he gets a desk audit). said...

Angus - the reason I chose the Vanguard High Growth Index Fund is that it's diversified across several asset classes in proportions that I think are pretty close to the "efficient frontier" for an ungeared investment with a risk level suitable to someone with the investment time frame he has (20-60 years). It's asset allocation target percentages will mean that his investment is automatically rebalanced. Investing in a stock index ETF woyld mean having to administer a mix of several investments to achieve a similar asset allocation, and annual manual rebalancing of his investments. Tax returns would also be more laborious with calculation of realised capital gains and distributions from multiple investments, rather than a single annual tax statement from Vanguard.

Anonymous said...

Thanks for that long reply. I'm thinking about something similar for my kids. At the moment their money (gifts) is in an ING account in my wife's name so it attracts less tax, but I'm thinking of putting it in a VG Fund (also in my wife's name, for tax purposes).

I can't start a Super account for that as they have never been employed.

Just on the Vanguard note -- I have been complaining to about the relative poor functionality of their website when compared to the .com website. Have you noticed the vast differences and have you emailed or contacted VG in this regard at all? Thanks.