Thoughts on the impact of the Coronavirus

My latest thinking on the impact of the Coronavirus is this. I think the RBA will end up cutting interest rates again and will ultimately go to zero. I think the Federal Govt will release a massive stimulus package because of concerns of the economic impact of the virus. However, I don’t think it is going to be as bad as everyone fears. The key figure that leads me to think this is that it appears that children and young people either don’t get it or only get it very mildly. It appears the death rate of ages 0-9 is almost 0% and for 10-39 age group it is 0.2%  

If these figures in relation to younger people hold, I think they are a game changer. Once families realise that children are not materially impacted, I believe they will quickly revert to their usual routines and spending habits. It may also mean schools won’t be closed, weekend sport won’t be cancelled, and the family consumer will continue to spend, travel and go out again as quickly as they stopped. It may mean concern about the economic impact is overblown and that the share market may recover more quickly than expected.

Perhaps more importantly the fact the Coronavirus may lead the Federal Govt to release a big stimulus package could be a blessing in disguise for the economy. Without the Coronavirus I think that the already deteriorating Australian economy would be left to languish without the stimulus it needs. The economy may now get the injection it so clearly needs and by accident, the fears surrounding the Coronavirus may help the Australian economy, recover more quickly from its pre-existing woes than we could ever have expected it to.  

From a portfolio perspective, we are not sellers. We still hold cash and are looking for good opportunities in oversold companies. We would like to deploy this cash sooner rather than later. This is especially true if you are a retiree or long-term investor. Cash is not a particularly attractive asset as it earns you perhaps 1% pa when you can comfortably collect dividends of around 5% pa when invested. If you are a patient long-term investor, the short-term volatility we are seeing now won’t matter much in 20 years, the income you receive does.

Market volatility and Coronavirus (COVID-19)

I’ll make this short but wanted to comment on concerns around the Coronavirus disease (COVID-19)

In relation to the health issue:

• Transmission rate of about 2.6 newly infected from 1 case.

• Fatality rate of about 2.5%.

• The health risk is significant, much more severe than the standard flu, but not as severe as some early concerns.

In relation to the timeline and economic impact:

• It appears that China’s government has enacted measures that have slowed down the spread of the virus there.

• Slowing down the spread of the virus in other populous nations is critical. This is the current concern with new outbreaks recently.

• It will take time for the full economic impact to be understood as Governments react and as people’s daily routines and spending habits change.

In relation to the volatility in financial markets:

• There will be buying opportunities in the coming weeks as markets react further to the situation.

• I would not be in a hurry to add stocks at this point but prefer to be patient and take a wait and see approach.

• I would hold existing cash awaiting opportunities.

How much do you need to retire?

A typical client comes to us with a range of assets that they accumulated in an ad-hoc fashion over time rather than from executing a master plan. Not everyone who is wealthy is financially sophisticated; often they were just really good at what they did. They are usually just really good at running their construction or earth moving business or they’re great doctors or lawyers.

Most of our clients are not financial experts; they wouldn’t need us if they were, but they are smart, and they know the value of getting the right advice to help them optimise their position. I once had a client with $10m ask me if they had enough to retire. As much as it surprised me, it was a great reminder that everyone worries about the same types of things when it comes to retirement:

·         How much do we need to retire?

·         Do we have enough to retire?

·         How long will my money last?

There is not one simple answer because everyone’s situation is different, but these are easy questions to address. In financial terms, the three questions above are all a variation of the same equation, the basic variables of which are income, expenses and capital.

But for the purpose of the general concept, simple numbers are the best place to start. If you require income of $100,000 p.a. to meet your expenses in retirement and a typical investment portfolio produces income of 4% p.a., then you’ll need $2,500,000 in capital.

If you have more capital than this then you’ll be fine. If you have less capital than this then you have a decision to make, and you can either reduce your expenses or you can deplete your capital. There is no right or wrong answer it is up to you. But you need to understand the numbers.

I can’t emphasise enough how important it is to understand the context here and the impact of even the most basic variables. If we change the assumption for the typical investment portfolio in the scenario above to, say, 2.5% p.a., then you’ll need $4,000,000 in capital to generate the income figure of $100,000 p.a.

With regards to dipping into capital in retirement, people tend to fall into two camps; those that are petrified of spending any of their capital and those who are petrified that they won’t use it all before they die. My philosophy here takes into account real life, not just the financial side. When you’re 65 maybe you live for another 30 years, maybe you live for 2. But I’ll say this, life is short, and I have not yet seen anyone get healthier and more active as they got older.

The reality is that your first 10 years of retirement are going to be your best, so make the most of it. If you are 65 and have $3,000,000 in capital and you spent $50,000 from your capital to have an amazing holiday every year for 10 years does it matter that at 75 your capital has reduced to $2,500,000? Probably not. What if you don’t make it to age 75?

Obviously, the above scenarios are basic and don’t take into account specific circumstances, but the overriding concepts and philosophy still apply. For our clients we complete sophisticated financial models that include a range of assumptions around returns, inflation, tax structures and scenario planning to ensure they are prepared for the future and have peace of mind. Certainly, if the three questions at the start are keeping you up at night then it’s probably time to get that type of advice and start planning properly.

What if Labor wins the election?

Australian Federal Election 2019

The battle between Bill Shorten and Scott Morrison is not likely to overwhelm us with charismatic and inspiring speeches. Rather, it’s likely to be the political equivalent of a street fight. In short, I suspect Shorten wins because Australians vote leaders out if they annoy them, rather than vote a leader in. The Liberal party leadership issue annoyed a lot of voters.

Another important trend is that times have changed in the era of social media, and people are generally more progressive in their thinking than in the past. A good example of this is the same-sex marriage vote where roughly 70% of the population voted for it . Go back 20 years ago and it’s probably 70% against. This is the case in relation to many issues and many of the old heads on the conservative side haven’t picked the change in the community’s view. It will be a close fight and a lot can happen between now and then, but it appears the election is Bill Shorten’s to lose at this point. 

What does this mean for our clients? Many of our clients have already raised concerns around the upcoming federal election. Specifically, the concerns raised relate to some of the policies the Labor party have proposed in relation to property (negative gearing and CGT) and dividends (franking credit refunds). These are attention grabbing policies, but also typical of parties testing the pre-election market or appetite for these types of policies.

Negative gearing: The potential removal of negative gearing is far more nuanced than politicians seem to understand. This is not a strategy of wealthy property owners. The wealthy property owners actually have little to no debt. They have paid their properties off. This is a strategy of people on good income, using debt to try and build their wealth – that’s a lot of people. But here’s the thing, removing negative gearing doesn’t just impact those people, it also impacts those who aspire to buy an investment property in the future. That is a lot more voters than many appreciate and why I’d be surprised if it gains real support. In fact, I think it’s hard to find a group of voters that will actually support this proposed change. Let me know if you can think of one.    

Franking Credit Refunds: Another key proposal relates to removing the refunding of excess franking credits. Many people have investment portfolios that result in dividends with franking credits attached (tax already paid by the company) that offset the tax from their overall income. Where people have franking credits in excess of the tax owed, they receive a refund. The proposed change would now result in those refunds being lost, impacting self-funded retirees in particular. However, it’s worth noting that before the year 2000 that was how it worked. Back then portfolio construction included detailed consideration of the total income and total franking credits received so that franking credits were not lost or at least could be well managed. I would expect this to again become an important management strategy for investors. 

Superannuation: Regularly changing superannuation rules effectively undermines the integrity of the superannuation system. Both sides of politics are guilty of this because they don’t appreciate that to have confidence in the system people need to feel that the goal posts won’t move. But it is inevitable that politicians look at the massive pool of money within the superannuation system, crunch the numbers, and see that even a small percentage change will result in a windfall of billions of dollars. So, they always propose changes, usually to make the system ‘fairer’ because who would argue with a fairer system, right? But everyone has super now, and they don’t want the government touching it, so when this happens the voter outcry causes them to shelve the proposal.

In conclusion, I would be surprised if these policies actually become law in the form initially flagged. Typically, significant changes that impact a lot of people are met with voter outrage and are shelved, diluted or grandfathered all of which result in minimal real impact for those initially targeted. We are watching these developments closely and planning ahead.