Sitting Down with Strong Money – Your Questions Answered #7

Coffee, Pen, Notebook, Caffeine, Cup, Espresso

Welcome to the latest round of Q&A!  Where I answer a bunch of great questions sent in by readers and share my thinking with all of you, rather than just one person.

Think of this (and all my posts really) as you and I sitting down having a cuppa together.

Today’s topics include getting started with investing, dealing with family pressure to buy a house, optimising for tax, the US stockmarket, and much more!

Remember, nothing on this blog should be taken as personal financial advice.  General thoughts and information only.  As always, do your own research before making investment decisions 🙂

 

Question #1

Hi Dave.  Am I correct in that the dividend returns from the older established LICs are about 4% annually?  As someone just starting out and a long investing horizon, would I be better playing in the small cap space to get better returns, obviously accepting more risk?

 

Strong Money’s Answer:

Yes, that’s correct.  Dividends from the likes of Argo and others are round 4%, which works out to about 5.7% including franking.  Plus growth over time.  Add it together and you get the total return.

It’s possible you get higher returns picking your own stocks.  But that comes with more risk and much higher chance of failure.

Some of us try stock picking and then realise it’s really hit and miss and in the end you probably get the same or better returns with a diversified fund like LICs or an index fund, without the effort and risk of trying to pick the next big winner.

The truth is the pro’s every day are scouring the market looking for the next big winner – so I’ve decided not to bother competing with them!  If you like, perhaps buy some diversified funds on the side, so you can compare your own stock picks and see how you go?

Either way, it’s safer to make stock picking a smaller part of the portfolio, so that if it doesn’t work out, at least it’s not going to slow you down too much in terms of reaching your goals.

 

Question #2

Hi Dave.  My question is whether you think I should purchase a home, or invest in my share portfolio?  I have $200k sitting in the bank at the moment, and I don’t want it there for too much longer.

House wise, I’d be looking at a property around $500k-$600k.  I wonder why I need a house however?  I’ve have had no problem renting for the past 10 years.  And I cant see how it will bring me any closer to being financially independent, in fact quite the opposite.

I have big pressure from my parents and my parents in-law, that believe to their core that it’s a MUST.  And I’m insane to consider another option.  My plan would be to steadily invest the cash into shares over the next 1-2 years, which would allow me to get more comfortable with the market.

Have read nearly ALL your articles as well, which has changed my perspective of a lot of things.  So thank you for that.  What are your thoughts on this situation?  Gary

 

Strong Money’s Answer:

Hey Gary.  Very nice work on the savings, and for reading nearly all my posts – solid effort!

I guess first thing is getting past the family pressure.  Is that something you can shrug off?  For some people it’s too much.  Obviously, I heartily endorse everyone making their own decisions and not succumbing to the pressures from others, no matter what the situation.

Maybe explain you’ll be completely fine without owning a home, as you’ll have enough income from your investments to pay rent plus some left over, rather than tying up all your money in a house.  Tell them the sharemarket isn’t such a crazy place when you’re investing for income rather than betting on speculative mining or marijuana stocks!

This may help, but probably not!  Some beliefs are just too strong lol.  Tell them you’re now part of a different religion/cult – the Financial Independence movement, rather than property 🙂

Obviously you’ve rented long enough to see the pros and cons, so you’re well informed.  There is definitely no rule that says you have to buy a house!  And certainly no way renting will delay your FI plans.  As you said, it could well boost your progress as you have maximum flexibility over costs and location.

I think your plan sounds very reasonable.  There is always the option of pulling your money back out later to buy a house if you change your mind (though keep CGT in mind).

Sounds like you’re happy renting but just looking for reinforcement.  Well, I totally give you permission to forgo home ownership provided you’re going to invest all your spare cash prudently!

Later, when you’re getting lots of passive income and can suddenly cut down or stop work entirely, then you can be an example for your family (and others) of how it’s possible to simply rent, invest and retire very early.  And who knows, maybe it’ll catch on!

 

Question #3

Hi SMA.  Would you have any thoughts about tax and investing in your partner’s name to reduce tax, etc?

I wonder if investing in my wife’s name would be better, as she’s the lower income earner.  Cheers, Pat.

 

Strong Money’s Answer:

Generally, it does make sense to put the shares in the lowest income earners’ name.  But keep in mind, you’ll be living on this portfolio one day so it makes sense to have at least some in both your names.

One option is to build up the portfolio in one spouse’s name first.  Then down the track, start investing in the high earner’s name.  That way, you’ll end up somewhere close to owning half each and will put you both in lower tax brackets when you retire early!

Also, franking credits tend to go a long way to cover the tax owing, so the tax isn’t as painful as many assume.  Remember, you’re still making more money (by investing) than before, so higher tax is just part of that.  A gold-plated problem I guess? 😉

 

Question #4

Hello.  I’m fairly new to the FIRE movement but I’m a massive fan.  I want to start buying LICs and ETFs, however I just wanted to know what are the best ways to make regular contributions?

Obviously trying to avoid brokerage fees etc., is it best to accumulate funds in a high interest bank account and then buy shares quarterly or similar?  Thanks, Paul.

 

Strong Money’s Answer:

I don’t think there’s a perfect answer to that question, Paul.

I like to invest every month or two, despite brokerage costs.  The reason is that it becomes a habit and builds momentum on a regular basis.  So every month your portfolio and future passive income increases, which is a great feeling and can provide more motivation to save and keep investing.

On the other side, waiting a few months to invest might mean you have a larger amount and will maybe start questioning whether it’s a good time to invest or not.  Then, your mind can start playing tricks on you.

Either option is fine, just make sure brokerage costs are 1% of your purchase or less.  So if you’re paying $10 brokerage, try and make sure you’re investing at least $1,000 at a time.  If you prefer to invest quarterly and save on brokerage, then go for it.  The main thing is to get started, keep saving and adding to your portfolio!

 

Question #5

Hey Dave.  I landed here from Aussie Firebug, you guys are both very knowledgeable.  I want to start my FI journey (only just discovered FI but always hoped to at least semi retire by 40 – I’m 26 now btw).

So far I’ve invested all my money in real estate (around $120k).  But moving forward, I like the idea of LICs and ETFs.  I’m suffering really badly from analysis paralysis.

I have a large sum of money (for me) to invest (around $60k), but cant decide between investing it all now into some LICs and maybe 1 ETF, or picking one a month and investing say 25% in each.  Cheers, Sam.

 

Strong Money’s Answer:

Hey Sam.  Glad you found your way here!  By the way, great job getting started.  At just 26, you can definitely hit your goal of being semi-retired by 40!

This is quite a common question.  Firstly, you want to keep it simple.  So if you like both LICs and index funds, maybe have one of each.  No need for a large group.  Some of us have a bad habit of over-complicating things (hand up here!).

So if you choose two holdings, you could simply take turns in purchasing each.  If it helps, invest $5k-$10k per month until its gone, rather than all at once which might be stressful.  And try not to overthink it.  Just get started and keep moving forward.

 

Question #6

Hi Dave.  Have you heard of factor investing?  Vanguard has started an actively managed ETF with factor investing called ‘Vanguard Global Multi-Factor’ – VGMF.  Thoughts?  Thanks.

 

Strong Money’s Answer:

I can’t profess to know much about this area (though aware of the concept).  I probably wouldn’t invest in it personally.  These funds typically cost more, have higher turnover (less tax-efficient), and are fancier ways of trying to beat the market.

If you’re trying to beat the market (I’m not), as far as active ETFs go, it’s probably not bad.  Keep in mind, some funds close down if they don’t get enough investors so that’s something to consider with a new fund like this.

Personally, I prefer to keep it simple and stick with boring funds which have already been around a long time (man, is there an echo in here!?)

 

Question #7

Hi.  I’m very happy to have come across your blog!  I found a post of yours on debt recycling and now I have started from the beginning and will read a post or two each day until I have read everything.

I’d love to hear your thoughts on a relatively new LIC ‘Plato Income Maximiser‘.  It pays a monthly dividend and is invested in the Plato fund which has been a well-managed fund for a number of years.  Benny.

 

Strong Money’s Answer:

That’s awesome, I appreciate the dedication Benny!

Plato is interesting, but I’m just not sure about it at this stage.  The manager has only been around about 8 years which is not long at all.

The strategy for high stable income sounds good, but the fund is very high turnover (about 200% from memory).  This means they only hold stocks for around 6 months.  They tend to buy and sell around the dividend dates to create lots of income and franking.  They also aim to do it in businesses which have good outlooks etc so they do keep growth in mind.

Honestly, I’m just not sure how it will fare over the next 30 years.  The yield is high, but the fees and risk are higher too.  Compare this to the more established low cost LICs, who are long term focused, simply collecting and passing on dividends – it’s all very predictable.

I guess my thoughts are, it could be a good fund, but I’m not convinced.  The fund seems very reliant on franking credit refunds remaining in place… maybe not a great idea.  Really more of a trading company than an investment company.

I prefer to be in funds which are long term investors, not trading around dividend dates.  But if desired, this fund is best suited to people paying zero tax, given the high yield focus and franking.

 

Question #8

Hi Dave.  Excellent blog for a newbie like me to start thinking about FIRE.  I have a question about index funds.

I am going through all Vanguard ETFs , and one – VTS (Vanguard US Total Market) – has consistently performed 15% per annum.  Why have you not considered VTS?  Any thoughts please?  Thank you.  Aaron.

 

Strong Money’s Answer:

Good question.  Logically, we would choose the investments with the highest returns, right?

Unfortunately, it doesn’t quite work like that.  15% per annum is an extremely high rate of return and over the long term is not sustainable or realistic to expect.  The US has just had a fantastic run since about 2009, when that ETF was created.  That in itself doesn’t make it a great choice – it’s simply a point-to-point measurement.

Interestingly, if you look at a similar US index fund managed by BlackRock called IVV, it shows very poor returns.  4.8% per annum since 2000.  Likewise, this doesn’t make IVV a poor investment – it’s simply a different point-to-point measurement.

I know it sounds strange, but neither result should sway you in your choice of whether to invest or not.  All that matters is what happens from here.  You’re not investing in the past, you’re investing in the future.

Both funds are a low cost way to invest in the US stockmarket, and a fine choice for long term investing.    I simply choose to invest our personal money into Aussie investments, with our super allocated entirely to international shares.

An important point here is that after a period of high returns, comes lower returns.  Now, I’m not at all forecasting disaster for the US (or anywhere really), but that’s the way these things usually work.

Interestingly, the US and Australia have delivered very similar long term returns, which you can see here and here – we tend to take it in turns of bigger upswings and downswings.  Hope this provides some context on markets and long term expected returns.

 

Question #9

Hi Dave.  Thanks for all your blog posts.  I enjoy reading them.  I’m a late beginner (almost 40) to the stock market.

Got a question regarding investing in VAS.  At the moment it’s trading over $80 per share.  To live off the dividends at some point in the future, I’ll need to have significant savings to invest in VAS.

Am I correct in saying that?  In this case I might as well stick with lower priced shares like BKI and AFIC.  Your thinking on this will be much appreciated.  Regards, Angie.

 

Strong Money’s Answer:

Hi Angie.  This is a super common question.  Believe it or not, the share price of different options is largely irrelevant.  Let me explain…

Company A’s shares are worth $1 each.  It pays a dividend of 4 cents – this is a yield of 4%.  Company B’s shares are worth $100 each.  It pays a dividend of $4 – this is a yield of 4%.

One is no more ‘expensive’ than the other.  However much you invest in each option, you’ll receive the same level of dividends on the amount you’ve invested… 4%.

On average, VAS will have a similar yield to those LICs you mentioned even though the price of each share is much much higher.  Hope that makes sense!

 

Question #10

Hi Strong Money.  Loving the wealth and substance to your blogs and conversations.  Keep
them coming!

I’m trying to get my head around figures on debt recycling and the potential benefits of having DSSP/Bonus Share plan with AFI and WHF.  What are your thoughts on…

Having a line of credit to start debt recycling and investing in those LICs which offer DSSP so it isn’t touched by any tax, though the interest still reduces your taxable income?

Obviously you would need to be able to service the loan and make the repayments but is this the only drawback?  Cheers, Jake.

 

Strong Money’s Answer:

Hi Jake.  Great to hear you’re enjoying the blog!

Sorry to be the bearer of bad news, but debt used to purchase shares using those special plans will not be tax deductible.  You have to be earning taxable income from your investments to claim interest costs, and those don’t qualify, as no taxable income is earned.

A full tax deduction and no taxable dividend income… too good to be true I’m afraid!

If you saw my post on debt recycling, you’ll see there’s lots to consider, but it can work well for some people.  I wouldn’t worry about tax too much – if going this route, there won’t be much tax to pay anyway as interest costs will likely be similar to your dividend income.

But if preferring to keep it simple and not use debt then those Bonus Share Plans are decent options for tax-effective accumulation.

 

Notes

I really hope you guys found this Q&A interesting!  I always try to include a range of questions which will benefit a good chunk of people – things that come up often in our little community.  This way there’s hopefully something for everyone!

As always, you can get in touch with me through my contact page – I do my best to reply to everyone.  Until next time, have a great weekend and thanks for reading!

16 comments

  1. A great read as always
    I had thought VTS was the aussie version of Vanguard’s Total Stock Market Index Fund Investor Shares (VTSMX) which started in 1992. VTSMX has returned 9.69% since inception, after such strong growth post GFC yield is running at around 1.74% though
    Here’s hoping Perth Property starts to recover soon also to boost the coffers

    1. Thanks Baz. Well it is, yes – VTS is the version we can invest in, but rather than act as its own index, it invests into the US listed fund. IVV on the other hand is managed from Australia and there are no tax forms to fill out. The only other difference is VTS is ‘total market’ with thousands of companies – IVV is simply the S&P500 (so 500 companies). Both are fine options in this amateur’s view!

      Haha yes… Perth looks alright based on a few fundamentals but we’ll have to wait and see.

  2. Hi Dave ,
    l feel l have to encourage your readers to take the simplest route possible as you continue to expound upon the thesis of remembering the principle of Occam’s Razor !
    For example , and for the record of my own journey , had l invested in the pure and best of the LICs at the beginning of my investment journey and held on until now , l would now be at least four times better off !
    The brokerage fees and CGTs are real killers of capital over time !
    Best wishes , Ramon .

    1. Hey Ramon, thanks for reinforcing the point on simplicity. It’s something that takes a while to sink in sometimes (definitely took me a while, and still have to remind myself!).

      Also that’s an interesting conclusion you’ve come to. It’s always useful (though sometimes not enjoyable) to go back and see what we could have done better 🙂

  3. Hello again Dave and Everyone …
    Forgot to mention Bell Potter’s review of the whole LIC situation [ on a monthly basis l believe ] on their site , just google it . l find it informative and useful . They do not push a line of bull dust . lt can be found in firstlinks.com.au , also .
    Take it easy , but not too easy [ your slogan ] .
    Cheers , Ramon .

  4. Just another thing to think about regarding Jake’s question…

    I am looking at debt recycling in to AFI, and while it is leveraged, take the dividends and use them to offset our home loan. Once the home loan debt is cleared, the dividends will be used to pay off the investment loan. Through that period, while there is debt being used for an investment that is paying dividends, I will be able to claim a tax deduction on the interest. Once that loan is paid off, we will either switch the AFI shares to DSSP and have them continue to grow capital while not attracting income tax, or if we are close enough to FI, we will quit and live off the dividends 🙂

  5. Hi Dave,

    great to see the blog is still going – and congrats on participating in the live Q&A panel. I definitely understand your trepidation there, but that’s really awesome that you followed through with it.

    Just wondering if you have considered investing internationally in ETFs? It seems like it would remove some concentration risk associated with investing only in Australia. I’m definitely guilty of home country bias, but considering that Australia makes only ~2% of the world market cap and Aussies invest ~75% of their money locally, I’m starting to have second thoughts.

    It doesn’t seem overly difficult to work out the cheap and expensive markets in the world either, the cyclically adjusted P/E (CAPE) ratio seems like a good way to gauge things. Taking the US an example, which has a CAPE ratio of 30 (after averaging 17 for the last 100 years), it seems the odds would be tilted in your favour by avoiding this market as the expected future returns are low – buy low, sell high. Whereas by investing in Russia or Turkey (CAPE ratios of 7 and 9 respectively), the odds would seem to be stacked in your favour.

    It seems like a good and simple way to improve returns, and reduce risk. Have you got any thoughts on this approach?

    1. Thanks for your support David!

      It’s a personal choice of course, currently we’re invested about 15% or so internationally through our super, which will increase over time. I went in-depth on this topic here. There are some genuine reasons for overweighting your home country which have been written about plenty by Vanguard etc. Most diversified funds end up somewhere around 30-50% Aussie shares that I’ve seen, rather than 2% in line with our market size.

      I’m not the type of person who would feel comfortable investing for the long term in handpicked countries like Russia/Turkey etc based on the fact that they look cheap. I want to invest in things I feel I understand and can have confidence in over the very long term (in Australia for example, and developed markets). I’m pretty happy being heavily invested in Australia given the shape of Oz versus other countries (the fundamentals look good to me). But that could be wrong, so international shares in super are a backup plan.

      No doubt it’s possible to outperform by making some successful picks here and there of out of favour ETFs, but it’s not my style and I’d bet it’s probably harder than it seems! Think about it: if they look cheap and everyone can see they’re cheap… why are they still cheap? Likely their outlooks and fundamentals aren’t great. Likewise the US and it being ‘expensive’ for many years despite everybody saying so. Why does it keep going up? Likely good fundamentals and solid earnings growth.

      Markets can stay cheap or expensive for a very long time, so it makes sense to invest where you have conviction in what you’re holding. But if that style of investing suits you then it may well work out nicely. Hope these thoughts make sense 🙂

      1. Hi Dave

        Your comments definitely make sense given your goals, and if you are comfortable investing that way then that’s the way to do it. Most investing plans work out pretty similar over the course of a few decades anyway from what I’ve seen.

        I think the pivotal moments in any plan will come about when there are big drawdowns in a portfolio. I haven’t seen that in my investing career yet, so it will be interesting to see how things play out when there are 50, 60, or 70% drawdowns on net worth.
        I am leaning towards the view that the best way to limit drawdowns is by diversifying across markets – and it’s easy to get exposure to 1000+ companies by investing in multiple international ETFs.

        I read pete wargent’s blog religiously which is how I came across this style of investing, he has been blogging about it recently. But if you’re interested there is a guy called Meb Faber who has some great (free) ebooks out on this topic…

        Anyway keep up the great work with the blog 🙂

  6. Hey Dave

    Love the questions and love the blog even more, catch up every month with you all the way from Ireland.

    Whats your thoughts on Sol.asx. I know its not a LIC but as a dividend growth investor a think its one that ticks a lot of boxes would be great to hear back.

    1. Thanks for tuning in from Ireland Alan, that’s awesome!

      I like Soul Patts and used to own it actually. It’s a bit higher risk given it’s more a conglomerate than a diversified LIC, but it has a great history and is well managed. The dividend stream has been pretty incredible too. I may do a review of it at some point – it’s on the list!

      1. Thanks for the feedback, have been keeping an eye one this for quite a while now and with it down a fair bit for its highs I think am ready to take a bite of this one.

        As you say its more a little more risker especially with there investment in the coal industry (am confident TPG will come good) but management is sound and dividends history is up there with the best on the on asx. Would be great to see a review on it and think it would be really beneficial for your readers.

        Cheers

  7. Hi Dave

    So after reading your blogs, I am planning to buy into VAS over a period of time. From your experience, can you comment if I use an investment loan to buy into the ETF, is the interest on the loan tax deductible on the dividend income? Following on from that, if I choose to have the dividend income reinvested into VAS, is the dividend income considered taxable income? Lastly, do you know if any interest paid in the financial year is not claimed in a deduction, does it carry over to the next financial year?
    I know an accountant should be able to answer this, but I don’t have an accountant for now. LOL

    1. Hi Allan. Thanks for reading the blog!

      Yes if you use an investment loan to buy dividend-paying shares like VAS the interest is tax deductible. Even if you reinvest your dividends, you still need to declare this income in your tax return, so yes it’s still ‘taxable income’.

      And yes, I believe if you have unclaimed interest relating to an investment from previous years, you are allowed to claim it the following year. But my understanding is you do this by making an adjustment to your old tax lodgement, rather than adding the extra interest to next year’s return. I’m no accountant either by any means! But I hope that helps.

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