Saturday, 11 October 2014

Everything you need to know about financial planning (Australian Edition)

Scott Adams, creator of Dilbert, has a one-page summary on everything you need to know about money in his Dilbert and the Way of the Weasel (2002):

Everything you need to know about financial planning

  • Make a will.
  • Pay off your credit cards.
  • Get term life insurance if you have a family to support.
  • Fund your 401(k) to the maximum.
  • Fund your IRA to the maximum.
  • Buy a house if you want to live in a house and you can afford it.
  • Put six months’ expenses in a money market fund.
  • Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement.
With a little translation this is entirely applicable to Australians.  I'll focus on unpacking the investment side but first do some of that translation and highlight some resources for those not on top of the personal finance side yet.  This guide will start out much more prescriptive for those who just want a simple solution before discussing more diverse choices for those who want to exercise them.

There are three levels of investing complexity I'll discuss.  Levels 1, 2 and 3 are not necessarily any better than each other.  Which you should take depends primarily on your goals and level of interest.

  • Level 0: Personal Finance: A pre-requisite before investing
  • Level 1: Investing automatically: I want to retire at the usual age using my super
  • Level 2: I might want to retire before 65: I probably need to save and invest outside super
  • Level 3: I love spreadsheets and want to (try to) optimise

Level 0: Personal Finance:
Before investing, get your house in order.  Paying off your credit cards is a must (and then make sure you have money set aside in advance to cover recurring bills like car insurance and save towards goals like a house deposit or the next holiday).

Having an emergency fund gives you a better chance of riding through life's ups and downs (Scott Pape suggests starting with at least $2,000 before attacking any other goals and then building up to 6 months). Life insurance is indeed particularly important if there are others depending on you.

If you find you need more detail or more support there are lots of free resources out there.  A good place to start is  For someone starting out, Scott Pape's book is good on personal finance (a bit dated on the investment side).  The UK edition is still available to purchase online (the Australian edition is out of print but the main differences are the links and resources at the back, and if you email them they'll send you the corresponding page.  You may be able to find the Australian edition at the library).  Similarly, Dave Ramsey's books are supposed to be good for those struggling with debt (but I wouldn't recommend them for investment advice).

Level 1: Investing automatically:
Once we've got our personal finances under control we can start to think about investment.  For any short-term goals such as a replacement car or a house deposit, stick to high interest online savings accounts (For the last year or so UBank USaver with Ultra has been the highest interest rate product I've found. If you have a mortgage you should use your offset account, so long as it won't tempt you to increase spending).  For "Level 1" let's assume you don't want to have to think about investing and your goal is to retire at normal retirement age.

When Scott Adams talks about funding your 401k or IRA, in Australia that would mean putting money into Superannuation.  For those workers who are not self-employed you should automatically be getting 9.5% of your salary in Super.  If you're under 40 then you've had 8%+ Super contributions for most of your working life.  This is a good start.

At present the maximum most younger people can contribute through salary sacrifice (including the employer contribution) is $30,000 p.a.  That is a lot for most people so if funding your Super to the maximum is out of reach aim to hit at least 15-20% of your salary (so an extra 5.5+% above the current minimum).  If you're approaching 40 and haven't been saving (whether inside or outside Super), or are older still you may need to contribute more than that to achieve your goals.

If you don't want to think about investing but just salary sacrifice (or make an after-tax contribution and use the co-contribution if on a lower salary) into a single fund here are my suggestions until age 55 (closer to retirement you may want to dial down the risk). Choose one of:

If you have a fund offered (or discounted) by your employer compare the insurance offered, fees and asset allocation.  If you're paying close to or more than 1% p.a. (before insurance costs) then it's too much.

If you have a current need for Life and TPD Insurance then I lean towards Australian Super (their costs are currently low and if you are eligible they let you increase the insured amount when you join with less messing around).  If you don't need (much) insurance then the Hostplus fund seems a very good deal.

Keep contributing 15-20% and ignore the ups and downs in the balance until age 55.  Once you're closer to the point where you'll need to access the money it may be worth looking for a financial advisor who can help understand the interaction between Super, taxes and age pensions. The industry funds above can refer you to a fee-for-service advisor or the information you can get from them over the phone or via your own online investigation may be sufficient.  You should make sure you're comfortable with the level of risk you're taking and may want to dial it down in the lead-up to retirement.

Level 2: I might want to retire before 65
The details of the Super system changes fairly frequently and rule changes understandably worry people.  It's not worth being too paranoid about it.  Just make sure some of your savings are outside Super if you think you'll want to retire before "retirement age".

If you want to retire around 65 my best guess is that Super will be the most effective way to save and invest.  If there's a chance you'll want or need to retire earlier then Super is still great for the later part of your retirement but you may not be able to access it at the start (for most people, at time of writing, the Super "preservation age" is currently 60 and there are rumours of it eventually increasing to 65.  I wouldn't expect people currently close to retirement to be impacted though).

2.1 The simple approach
If you are looking to retire a few years earlier (or at least have that option) but don't want to add much complexity here's the simplest approach:

  • Figure out your likely annual expenses in retirement
  • For each extra year of retirement before 65 save towards an extra amount equal your expected expenses in an online savings account.  For instance if you want to retire at 60 a reasonable target is five times your annual expenses.  
  • [If you want to retire much earlier you should probably add a bit more complexity with some stock index funds outside super (see below).  This will hopefully mitigate the risk of inflation.]
  • Keep saving in Super as above (or more, if you can)
If you have a mortgage, paying more off or putting more in the offset account is even better (so long as you don't redraw or use large chunks of the offset account for casual spending money).  While you have a mortgage prioritising that will likely be more financially effective than the other financial investments below.

    2.2 A bit more complexity
    Follow Scott Adams' advice modified for Australian conditions.  After setting aside our emergency funds and money for expenses coming over the next few years in an online savings account, for the investments outside super the lowest-fee all-in-one option I've found is:
    • Colonial FirstChoice Wholesale Multi-Index Balanced
    The fund automatically rebalances to 70% shares and 30% bonds and cash periodically. With this option you can set up a regular investment plan to automatically invest monthly.  You can also reinvest the distributions automatically (although you'll still need to pay taxes on the distributions).

    An alternative is the Vanguard® LifeStrategy® Growth Fund.  The fees are higher for the first $50,000 but are lower after that point.  If you're looking at investing for the long-term and expect to have over $100,000 invested long before retirement age then this may actually be a more cost-effective option.

    I'd like to mention investment bonds as another alternative here if you're investing for 10+ years in the future and in a high tax bracket. But if you use them, make sure you understand the product, don't pay more than 1% p.a. in fees and don't pay a percentage commission to an advisor.  They can be a bit complicated in the rules that apply so be even more careful if you go down this path.  A low-cost option with a similar balance of 70% growth assets and 30% defensive assets is the Austock Life Imputation Bond using the Dimensional Multi-Factor Growth Portfolio as the investment fund.

    2.3 Lower costs with some more complexity
    If you're willing to face investing in individual funds, for the savings outside super,
    • Invest 70% in stock index funds
    • Invest 30% in a high-interest online savings account (or an Australian bond fund)
    For Australians, the best high-interest online savings accounts currently pay more than the expected yield of Australian Government bond funds, with a government guarantee up to $250,000 per person per bank and without any of the costs.  It may not always be the case that these have better expected returns than bonds but at the moment it's a good deal.

    For the stock index funds if you're investing more than five thousand dollars per year in stock funds consider using Exchange Traded Funds (ETF).  These are purchased through an (online) brokerage just like regular Australian shares.  If you don't want to think too much about it a "good enough" option is:
    If you're a fan of them you can replace the Australian Shares ETF with an old-school listed investment company like AFIC, Argo or Milton.  To keep costs down invest at least a few thousand dollars at a time (saving up in your online savings account). Also, rebalance using new money (invest new money and dividend payments into whichever fund has the lower balance to try to keep the relative proportions of different investments stable).

    If you can kickstart your savings a bit ($5,000 starting minimum) but want to be able to invest in smaller amounts periodically, do the same thing with Colonial FirstChoice Wholesale Investments:
    • Half in Colonial First State Wholesale Index Australian Share 
    • Half in Colonial First State Wholesale Index Global Share
    Like the Multi-Index Balanced fund you can set this up for automatic monthly investing. You could also use their Wholesale Index Australian Bond fund or even the similarly priced Wholesale Australian Bond fund to replace the high-interest online savings account.  As a helpful commenter pointed out, this will be beneficial during times of falling interest rates but will give lower returns when interest rates are rising.

    If you really don't want to have to think about where to invest your share allocation, for about twice the price you can use an all-in-one investment (keeping the online savings account for your stable bond-like assets). Two all-in-one investments that are worth your consideration are:
    The one cautionary note when separating out your share investments from your fixed interest is to keep in mind your appetite for risk.  Global share markets can drop quickly and substantially.  To date, in the US, UK and Australia they've always recovered in the longer-term.  But if seeing your available wealth fluctuate will impair your ability to sleep well at night, seek out strategies to help.  One I'm familiar with is to lower the percentage you put into shares and know that you always have the online savings account component safe. Another is to use more conservative all-in-one funds instead of separating out the cash and shares which will smooth out the fluctuations you see (but likely add some expense).  Options to consider in this case include the Colonial FirstChoice Wholesale Multi-Index Conservative, FirstChoice Wholesale Multi-Index Diversified or FirstChoice Wholesale Multi-Index Balanced.

    Level 3: I love spreadsheets and want to (try to) optimise
    If you've come this far you're really heading towards the domain of asset allocation.  If you don't want to get any more complex then call it a day with one of the simpler approaches. Keep in mind there's no guarantee a more precise asset allocation or asset location will actually lead to better results.

    A starting point is one of my posts on Asset Allocation.  However if you really want to make a (positive) difference with a detail-oriented approach it's important to learn more about the history, theory, psychology and business of the market.  My favourite book covering these is The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein.  A good free resource online is  You'll also need to figure out how best to apply the usually US-focused  (or Canadian) resources to Australia.  I'm not a tax expert and can't give tax advice. But I can point you in the direction of resources I've found useful and rules-of-thumb to consider further.  Some of my thoughts are below:

    • Learn to think of all your savings and investments which are for a single goal (e.g. retirement) as one whole.  Psychologically separating your resources in Super and outside Super limits your ability to optimise, particularly in terms of taxation.
    • Due to preferential tax rates, depending on your particular tax situation, it may be advantageous to hold more of your defensive assets in Super (franked dividends, foreign tax credits and capital gains discounts all work similarly inside and outside super for shares, while cash and bond interest tends to get a better tax treatment in super for those on average or higher incomes). Similarly, consider where you put any diversified property allocation for taxation purposes.
    • Diversify across asset types (cash or bonds and shares) and diversify internationally.
    • The Vanguard 2014 Index Chart and Index Portfolio Calculator can give you an idea of how different assets have performed historically.  But when they say "Past performance is not an indication of future performance", it's not just a line.  For example, with government bond (fund) yields currently close to 3%, expecting the 8.5% earned on average since 1970 is unrealistic.
    • The enemy of a good plan is the dream of a perfect plan.  Find a plan you can stick to for the long term.  On average, constantly adjusting your portfolio is a costly game.  And allocating that last 2% to small cap frontier emerging market value stocks will have far less impact on your overall results than the basic split between fixed interest assets like cash vs. more volatile, higher expected growth assets such as shares.

    I'll add to this list and the resources below as I realise things I missed but, since most of my posts are about the more granular details, I wanted most of this post to be more helpful for those who don't want investment to be so complex.  As always, feedback is greatly appreciated.

    Further reading
    If You Can: free booklet by William Bernstein (US-oriented but the same principles apply)
    A valuable free guide (again US-oriented)
    Helpful places to discuss asset allocation and get input from others are the forums:


    1. "For Australians, the best high-interest online savings accounts currently pay more than the expected yield of Australian Government bond funds, with a government guarantee up to $250,000 per person per bank and without any of the costs. It may not always be the case that these are better than bonds but at the moment it's a good deal."

      Good point about the government guarantee. However keep in mind that compared to bonds, cash gives little benefit during times of sudden deflation. I guess you have to weigh up taking more money now versus having a deflation hedge.

      1. Thanks for the feedback. Maybe I should consider highlighting the all-in-one balanced fund more prominently? I'm concerned about costs over the long-term though, particularly for people who probably won't rebalance frequently (so in a recession which corrects itself the benefit in times of reducing interest rates will likely cancel out with losses when interest rates increase again).

        Cost-wise it's a tricky balance. The cheapest 70/30 Balanced fund is 0.69% p.a. We could get slightly cheaper with Colonial using their Wholesale Index Australian Bond fund or even the similarly priced Wholesale Australian Bond fund (0.4 and 0.45% p.a. respectively). The available Australian bond ETFs are pretty illiquid, sadly.

        For the asset allocators out there, I agree bonds are probably a good idea but favour holding them in Superannuation. For example Australian Super have a low cost, consistently well-performing Australian Fixed Interest option.

    2. btw - I'm also a big fan of Adams' financial plan. It says so much with so few words. It stands up fine alone, or forms the base for going into as much detail as one likes.

    3. Sorry yes I was thinking of ETFs. You're right, Australians have a love affair with property, shares and "max saver"-bank accounts, and so fixed income products tend to be thinly traded (although they have seen a surge in trading volume over the last two years).

      Having said this, the spreads during "regular" markets are quite competitive, and I'd argue that liquidity is primarily of importance when you are looking to acquire cash when an asset class is tanking. For bonds this would be a time of high inflation, so it comes down to whether you'll need your money at that time (eg is your company likely to restructure during times of high inflation). I think for most people though, if they needed money they should be able to sell some of their stocks or property, which tend to overperform in an inflationary environment.

      In other news, what are your thoughts on AAA.AX as an alternative to money in a high interest bank account. I know you lose simplicity (everyone knows how interest in a bank account works) but was wondering whether there were any other reasons to favour a traditional bank account.

    4. The main challenge using the ETF AAA is that individuals can often get better rates with no fees and lower risk using an online savings account.

      At a quick glance I suspect SMSF's can't do any better at-call, that's probably the largest market for it. In Super there are better term-deposit rates if it is a long-term cash allocation.

    5. Dear superannuation freak. Whats your opinion on ing living super? I opened an account coz of the low fees but I think id feel more comfortable with sizable sums in a fund with more of a bricks and mortar presence in Australia..cheers

      1. The main factors (for me) for ING vs. Industry Funds were:
        -Size of balance
        -Insurance needs
        If I recall, for me the break-even on investment and admin fees alone was about $30,000, above that the industry fund choices were cheaper for me.
        Insurance was also more expensive.

        I think they're a fine choice for someone starting out with a small balance, when the amount you save will likely have a much bigger impact than your returns. Later in life I've found better options for my needs.

    6. Thanks for the excellent blog resource!!

      I went through a similar exercise earlier in the year to review my finances and super. I seem to have found many similar resources and reached similar conclusions towards low cost index investing...

      At the end of it I shifted my super into sunsuper (since I wanted to tweak my allocations of the various index options). And also helped my folks change theirs into Hostplus balanced-index (they were in the default balanced option). I also had been long-term regular investing in retail managed funds with fees around 2% and decided to sell all of those and reinvest into a mix of VAS/VEU/VTS and ASX blue chips.

      I wish I came across your site earlier, it would have been a big help ! One of the challenges as you've noted a lot of these resources (Bogleheads, etc) are US centric and it takes some translation to apply to Australia.

      Just to share where I ended up : For high level AA in my sunsuper, I am using (age-10) in FI/cash and (110-age) in growth. For the more detailed level AA, I then split the defensive part into FI, FI - Index and Cash (33/33/34%). For the growth part, I split AU share index, Int. index unhedge, Int. index hedge (45/35/20%).

      The decision to hedge or unhedge the Int. shares allocation is something I found little guidance on, and also one of the only things I couldn't see much in your blog about on first reading. My thinking was around the issue of home bias and the lack of diversity of the ASX. Basically I wanted a higher portion of Int. shares than usual mix e.g. (Int/AU around 40/60%), but without the excessive exchange rate exposure. Therefore adding some hedged Int. gave me a way to compromise these factors and access a higher allocation on better diversified international shares, without excessive currency risk.

      Will be interested in any thoughts/feedback and once again commend you for the very informative and useful blog. Adrian

    7. Love the approach you have taken with different levels of complexity. I remember myself progressing through these stages as I read more and became a more sophisticated investor. I think allowing people to see a clear prescriptive plan of the big picture is refreshing. For most people I’ve spoken to, apathy seems to be their main problem. They know they should take more interest but don’t know where to start and feel intimidated or just disinterested by the financial industry. I really like Scott Pape as the Barefoot Investor who is making personal finance accessible to the masses.
      You mention level 0 as the ‘getting your house in order’, and I totally agree you should first be building from a solid base of spending less than you earn. First fix the leaks in your bucket, before you try to fill it up! However I would argue that you should take an interest in superannuation at this level. As the Superannuation Guarantee is compulsory for working Australians, whether they like it or not they are invested in the stock market, so at the very least they should avoid wasting hard earned money on high fees. Switching to an index tracking fund in your super is a simple and effective way to save thousands. For such a little amount of effort the rewards are huge! You mention some great low cost funds provided by HostPlus and Australian Super and I think it’s interesting and unfortunate that these are not the default balanced funds that most customers will be dumped in and never question! They really should be.
      You mention paying more than 1% is too much, I would go further and say that anything over 0.5% is too much and in fact preferably a lot lower. The Grattan Institute found the best indicator of future performance was low fees. This insightful advice makes choosing a super fund as simple as comparing fees. Easy.
      Good advice about seeing fee-for-service financial advisor once closer to retirement, this is one place where a misstep can be very costly for example whether to buy an annuity or remain invested for income.
      For your simple approach to retiring early I agree that paying down the mortgage and owning your own house outright would probably be hard to fault, especially with the joy of being mortgage free! For the remaining investments I think generally you’d be better investing in a low cost index fund if you have more than 7 years till you want to retire rather than cash savings though. With interest rates so low and likely to stay low for a while I’d be worried about the effects of inflation on cash in the bank.
      Good point on the investment bond, this is something I’ve recently been looking into. Generally having the returns tax free after 10 years trumps the higher fees you have to pay and you make a good point about not using an advisor, they seem to take a big fee 3.3% initially and 1.1% ongoing, which would probably cancel out the tax benefits!
      Thanks for a great blog and some really detailed and I suspect time consuming investigation. Australian’s need more unbiased straightforward advice like this, keep up the good work!


    8. Thank you, thank you, thank you. As said above, wish I'd found this earlier. I've been groping my way toward the conclusions outlined in this post, particularly as regards investing outside super - relying as best I could on Bogleheads, Garth Turner at Greater Fool and some others,, and trying to map them back to Australia

      Had no confidence in my decisions though. Ie, I really would prefer to use high interest savings as against a bond fund for the 'defensive' allocation, and/or to make use of investment bonds for the tax advantages. You've done a sterling job.