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Thursday, 19 January 2017

Adapting William J. Bernstein's book "If You Can" for Young Australians

After dabbling with stock picking and then fund/fund manager picking (and not doing very well at either), I eventually arrived at the same sort of conclusions as William J. Bernstein - pick a suitable asset allocation and invest via low-cost 'index' funds. He recently published a nice small volume of investment advice for 'Millennials', but it is a bit too 'US-centric' (eg. 401K plans and so on) to be immediately applied by young Australian investors. With that in mind, I decided to have a look at how the principles expressed in Bernstein's book could be employed by my sons when they start a career and begin to think about saving and investing.

In a nut-shell, Bernstein's advice for (US) Millennials is simply to:
* save 15% of your (pre-tax) salary annually, and invest it.
* invest it in equal proportions in: domestic stock market index fund, international stock market index fund, and domestic bond market index fund.
* rebalance each year to maintain equal proportions in these three asset classes.

For Australians, the tax system provides substantial benefits for investing inside superannuation. And 9.5% of salary is directed automatically intro superannuation via the 'SGL' (superannuation guarantee levy) for most employees. This can be 'topped up' to the 15% target by arranging to have another 5.5% (or more) of salary directed into superannuation via 'salary sacrifice' (bearing in mind the $30K pa 'cap' on concessionaly taxed contributions (SGL+SS))

However, for Australians, the plan's assumption that half of retirement income needs will eventually come from 'social security' isn't correct, as our 'aged pension' system is both means and assets tested (and while the US social security system in underfunded, our aged pension system is completely unfunded - relying on current tax payers to pay for the aged pensions of retirees -- not a great situation given the aging population and shrinking proportion of taypers:retirees). So perhaps the required rate of savings for Australian Millennials needs to be a bit closer to 30% of salary than 15%. (But this isn't quite as bad as it seems, given that US workers also have around 7.65% deducted for social security and medicare).

Now, in terms of how to invest those savings in the proportions suggested by Bernstein, one could invest in the Vanguard 'growth' index fund, which has the following 'target' (strategic) asset allocation:

35% domestic stocks/property:
Vanguard Australian Shares Index Fund (Wholesale) 31.0%
Vanguard Australian Property Securities Index Fund (Wholesale) 4.0%
35% international stocks/property:
Vanguard International Shares Index Fund (Wholesale) 24.0%
Vanguard International Property Securities Index Fund (Hedged) (Wholesale) 4.0%
Vanguard International Small Companies Index Fund (Wholesale) 3.5%
Vanguard Emerging Markets Shares Index Fund (Wholesale) 3.5%
30% fixed interest:
Vanguard Australian Fixed Interest Index Fund (Wholesale) 12.0%
Vanguard International Fixed Interest Index Fund (Hedged) (Wholesale) 12.0%
Vanguard International Credit Securities Index Fund (Hedged) (Wholesale) 6.0%

nb. Fees: 0.90% on first $50K, 0.60% on next $50K, then 0.35% on balance over $100K.

This is fairly close to the recommended three-way equal split, and would not require any rebalancing as the fund automatically maintains the asset allocation within a fairly tight band. Some of the growth asset allocation is into 'property' rather than shares, but over the long term that should not have much impact on overall return, and may add some additional diversification benefit.

Alternatively, Australian investors could invest in the relevant Vanguard listed ETFs to get the desired asset allocation. Some examples:
VGS: MSCI World ex-Australia
VTS: CRSP US Total Market Index
VUE: FTSE All-World ex US Index
VAF: Bloomberg AusBond Bank Bill Index
VSO: MSCI Australian Shares Small Cap Index
VLC: MSCI AUstralian Shares Large Cap Index
VAS: S&P/ASX 300 Index

However, while the management costs are low (0.05% - 0.30% pa), there may also be a cost to purchase the ETFs via a broker (eg. CommSec), which would rule out making multiple, small purchases on a regular basis. One disincentive to moving out of the 'growth' index fund and into a mixture of ETFs is that some capital gains might be realized (although the rate of capital gains tax is fairly low within a SMSF).

Once DS1 is old enough to become a member/trustee of our SMSF, I'll add him to our SMSF and arrange for his current 'retail' superannuation fund balance to be 'rolled over' into our SMSF. Our SMSF doesn't quite have the asset allocation recommended by Bernstein - it has around 4% invested in cash (in an ANZ V2Plus account paying a silly 0.75%) to provide a 'float' for any SMSF tax bills, and the rest is invested in the Vanguard Lifestrategy 'High Growth' fund. The fund is around 90% invested in 'growth' assets, and only 10% invested in fixed interest. By the time DS1 finishes uni (he is only doing his HSC this year, and plans on doing a 5-year 'double degree' and possible then a 1.5 year masters) and has substantial superannuation contributions flowing into our SMSF, both DW and I will be close to retirement, so we may review the SMSF asset allocation at that time. Once the bulk of the SMSF is in 'pension mode' any capital gains tax implications arising from moving out of one Vanguard Fund into another will be insignificant.

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