Why homeowners don't mind inflation, except when the central bank tries to fight it.

Around 35% of Australian "homeowners" actually own their homes outright, the rest have a mortgage to pay off. For those with a mortgage, such as myself, inflation has a positive impact in that house prices tend to be underpinned by the cost of new houses in the same area - which are in turn linked to inflation. On the other hand, the mortgage principal isn't affected by inflation. Whether you may be paying off the principal over 15, 20 or 25 years, or have an "interest only" loan, inflation won't change the amount of principal owed.

This means that if the value of your home just keeps up with inflation (no real increase in value), over ten or twenty years inflation will have reduced how much you owe the bank (in real terms). For example, our house is valued at around $840,000 and we have a mortgage balance of $490,000 which will remain constant (if we continue to use an interest only loan). If inflation kept running at the current 4% pa or so, our house price would increase to approx. $1.7 million by the time I'm due to retire eighteen years from now, but the amount owed would only be "worth" $242,000 in today's dollars by then. Therefore our equity would have increase from $350,000 to the equivalent of almost $600,000 simply due to inflation.

Unfortunately, higher inflation levels are generally bad for the economy, so the central bank attempts to control it using the fairly blunt instrument of official interest rates, which in turn pushes up the interest charged on variable rate home loans. Although we fixed the interest rate on our investment property, our home loan is at the standard variable rate, so our repayments have almost doubled with the rise of inflation from 2% to 4%. For that reason a temporary spike in inflation would be better for us than a permanent shift to higher inflation rates. If inflation drops back into the RBA's target range of 2%-3%, repayments on our mortgage will trend back down towards the previous rates (although probably not quite as low as before, given the effects of the global credit squeeze), while the real value of our mortgage debt would have taken a permanent hit. Also, our salaries tend to keep pace with inflation, so a temporary spike in inflation would end up making the interest-only repayments a smaller proportion of our pay packet (although it's a bit of a struggle in the interim).

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Rents to rise 10%?

While browsing through an investment magazine at the local library I came across an interesting chart of seasonally adjusted vacancy rates vs. the real (above CPI) rent change. As one would expect, rents tend to rise most when vacancy rates are low, but the relationship was quite precise. As shown in the table below, real rents increase by an additional 2%pa for every 1% drop in rental property vacancy rates:

Real Rent Change......Vacancy Rate
6%....................0%
4%....................1%
2%....................2%
0%....................3%
-2%...................4%
-4%...................5%

Rents tend to just keep pace with inflation if there is an adequate supply of available rental properties (3% vacancy rate), and rents outpace inflation if there is a shortage of properties to rent.

With inflation in Australia currently running above 4% pa and the vacancy rate for rental properties in Sydney dropping below 1% this year, rents should (according to this relationship) rise by around 8% pa.

At some point housing affordability will limit the growth in house prices in Australia - some estimates suggest that Australian houses are currently 30%-50% overpriced. But, with new dwelling construction rates currently well below the rate of increased demand caused by immigration, and the potential for rapid rises in rental yields over the next couple of years, there could be at least one more 'boom' left in the Sydney property market before I retire. When the fixed rate mortgage on our rental property is due for renegotiation in about three years time we may think about selling it and investing the proceeds in our SMSF.

Subscribe to Enough Wealth. Copyright 2006-2008

Forex CFD Trading Update: Jun 2008

My AUDUSD CFD trading on my CMCMarkets account went well during the month of June - about the only thing (financially) that was positive about June 2008. My account balance finished at $2938.81 - a gain of $650.29. I traded less frequently than the previous couple of months, keeping winning positions open a bit longer while the trend continued, and only doing short-term trades while I was watching TV in the evening and could keep an eye on the price action.

I did a bit better using stop and limit OCO orders for positions kept open overnight or while I was at work this month - one useful tidbit of information provided at the CityIndex seminar was to set stops based on the recent market volatility, rather than stick to a set stop of say 13 pips from my order price. The limits were generally set based on recent resistance levels. A couple of times the trends reversed just short of my limit, and I had to take a smaller profit later on (when I was back at my PC), but at other times the limit closed out my order just before the trend reversed, which was very satisfying.

Overall my CFD trading with CMCMarket had produced a net loss of just over $2,000 (~40%) since I started trading in April '07, but this calendar year I've made $1,738.56 net profit, and my net loss for the financial year ending 30 June was only -$290.26. If my forex trading continues to be mostly profitable from now on, I might break even sometime this financial year.

It's interesting to note that excluding the cost of the 2 pip buy-sell spread incurred on each trade I would already be in positive territory. That's one reason that I'll stick to my CMCMarkets account for forex trading and only use my new CityIndex account for trading Stock indices or commodities - CityIndex spread is 3 pips for trading the Aussie. So far I've dabbled in crude oil and gold CFD trades with my new CityIndex account, and managed to lose around $100 of the "free" $250 provided by CityIndex in just three trades! The minimum gold CFD is a bit too costly relative to the meagre $500 "seed" money in that account, so I'll probably stick to trading the ASX index in the evening - trying to pick the rebound in the ASX that often occurs if the Australian market has been sold down during the day, and the DOW opens positively overnight. We'll see how that theory works out.

I'll start tracking my Index CFD trading results from next month.

Subscribe to Enough Wealth. Copyright 2006-2008

Networth Update: June 2008

Oh, the pain! The pain!

The worst June stockmarket result since 1930.

The worst financial year stock market result since 1982.

Not a good time to have geared investment in the Australian stock market!

During June my net worth declined by $83,111 - that's about one year's gross salary gone in one month. Poof! To put it another way, if I'd shifted all my investments into cash this time last month, I could have quit my job and gone fishing for a year and still ended up better off!

I also ended the month with my net worth dropping below the magic "one million" mark yet again. This time it looks more permanent than the three day dip below $1m earlier this year. At the end of last month I was still hopeful that I might get back to my previous peak net worth by the end of 2008, or at least by the end of the 2008/9 financial year. Now I'll be relieved if my net worth is over $1m at the end of 2008, and I doubt that I'll be setting any personal net worth records before the end of this decade. Considering inflation in Australia is currently running at over 4% pa and that you can get more than 7% return on cash invested in online savings accounts, that is really a rather pathetic outlook. On the other hand, if the stock market continues to drop I could soon be forced to sell off some shares to avoid margin calls - just when everyone else is bailing out of the market and prices have tanked, so things could still get much, much worse. Such is life when things go pear-shaped using "other people's money" to invest in stocks...

The bad net worth result is even worse considering there were several positive factors at work during the month:
* $3,885.50 was contributed into my retirement account (employer SGL contribution and salary sacrifice)
* a $19,130 increase in the estimated values of my share of our house and investment property

My stock equity and retirement account value dropped by a combined total of more than $100,000 during June! I'm running out of exclamation marks!! A small part (around $10,000) of this decline was due to pre-payment of margin loan interest for 2008/9 on one of my margin loan accounts. I applied for interest pre-payment for two of the other margin loan accounts as well, but the pre-payment hasn't appeared in my on-line account details as yet. It's possible that the faxed application forms were not received and processed before 30 June. In that case I may sell off some stocks and reduce the margin loan balances - this would save on the 10%+ interest rate on the loan balances, but would also "lock in" the recent losses if the market rebounded during the remainder of 2008. On the other hand, if there's an extended bear market (for example if there's a global recession in 2008/9) I would be happy to have reduced my gearing even now - pity I didn't do it last month, or in 2007 as I once considered. Even more pity that I let my Index put options expire in Dec 2007 without making more than a token effort to find replacement "insurance" via index put options, warrants, or selling index CFDs.

Property valuations +$19,130 (+2.29%) to +$853,830
Mortgage loans..... -$...165 (-0.05%) to -$365,579
Retirement accounts -$20,404 (-6.66%) to +$285,985
Stocks & other..... -$82,002(-27.92%) to +$211,694
TOTAL NW........... -$83,111 (-7.77%) to +$985,931

My employer's monthly retirement contributions for the months of Feb, May and Jun (a total of approx $11,650) isn't showing in this month's figures as the employer contribution hasn't appeared in my SMSF bank account yet. The payments were only processed in the last few days, so this may create problems with next year's superannuation tax. My SGL and salary sacrifice total in close to the $50,000 annual concessional contribution limit, so the late 2007/8 FY employer contributions could push next year's total concessional contributions over the limit, and make be liable for an extra 30% tax of the surplus amount. I've applied for a private ruling on this matter from the ATO (Australian Tax Office), as I'd like to know exactly how my SMSF administrator should report these contributions in our SMSF tax returns for 2007/8 and 2008/9, and if I'll need to make an application for 'Special Consideration' regarding these employer contributions.

Hopefully this month and the rest of 2008 turn out to be more positive. They say that it's "darkest before the dawn" - I can remember how dire things appeared during the days of the '87 stock market crash, and yet that now appears as a mere blip on the stock market charts.

Subscribe to Enough Wealth. Copyright 2006-2008