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 INVESTING |
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Smart Investing
Debt the dark cloud on the New Year’s horizon
22 June 2007
Robin Bowerman
The start of a new year is always a good excuse for celebration and a time of reflection. And the first week of the new financial year promises to be a good week.
For a start most Australians will be a little better off thanks to changes in tax rates announced in this year’s federal budget. For people on average incomes it will be worth between $10 and $20 a week extra in take- home pay. It is impressive that Federal Treasurer Peter Costello can now claim that 80% of taxpayers are either on or below the 30% tax rate.
There are plenty of other reasons to welcome in this new financial year with a cheer. We officially welcome a new, simpler super regime at a time when super funds are on track to deliver a fourth year of double digit returns.
The Australian sharemarket index has delivered a whisker more than 29% in growth so far this financial year and over three years is up 27.5%. International shares look a little less bubbly but are still in double digit territory gaining 11.4% this financial year on an unhedged basis; if the currency impact was hedged out the international market index is up 24.7%
Combine that with the drop in volatility in share markets and it has indeed been a golden period for investors. But a little reflection can be sobering.
For a start the increase in household debt as measured by the latest Reserve Bank data is clearly something that should be a concern. Interest payments now represent a record proportion of household income at 11.9%. That is the highest it has been in 30 years and is a clear reflection that people are comfortable taking on more debt. Credit card hit a new record high at $2139 a person which is more than 8% higher than a year earlier.
At times of record levels of employment that possibly is less of a concern but it is a timely reminder that any interest rate rises will have a real impact.
The strength of the dollar is a good news/bad news story. For people travelling overseas and our importers it is good. For people with investments in international markets who have not hedged the currency exposure it means the returns fall as the dollar rises (and vice versa).
So what will happen to the tax cuts that begin appearing in pay packets from next week? Let’s face it a couple of extra cappuccinos a week or a jump in the petrol price will see the tax cut easily absorbed into the weekly discretionary spending pattern and by the time the election rolls around it may be a case of: Tax cut? What tax cuts?
So what would happen if you finally got around to setting up that regular savings plan and put the tax cut to work over the long term?
Consider someone who has $5000 to invest and decides to put $100 a month into a regular savings plan versus someone who invests $5000 at the same time but makes no further contributions.
If we assume an 8% market return after fees then our initial investment without any further top ups will turn into $8866 by the end of year 10 (assuming all distributions are reinvested and without taking into account investor taxes or inflation). But for the person who puts Mr Costello’s tax cuts to good use and contributes regularly each month the payout figure at the end of 10 years is a much more interesting $25,069 (assuming all distributions are reinvested and without taking into account investor taxes or inflation).
Now there is nothing magical about that apart from disciplined savings and letting compound interest do its job but sometimes in this sophisticated financial world when we can trade shares at the press of a button it helps to remember that the simple approach can work very effectively even when we are talking about modest amounts of money.
Alternatively a debt reduction strategy where you add $100 a month to your mortgage or credit card repayments may make even more sense. The only magic ingredient required is the discipline to do it regularly.
Whatever your views, you can discuss this article - or any of Robin's articles - on our message board Your 2 Cents.
Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia and the former managing editor of Shares and Personal Investor magazines. To receive this column by email each week go to http://www.vanguard.com.au/ and register with smart investing.
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