Hi Keith,
Okay this is a
good response . . . many questions:
Keithj said:
I’d rather see a Nett IP yield quoted instead of 4.5% gross. There doesn’t seen to be any account taken of IP expenses.
I have allocated 4.5% GROSS yield to the property portfolio and
OFFSET this with holding cost expenses. (IP expenses)
Also, wherever I have mentioned the 4.5% yield I have mentioned that the
passive income stream will be used to cover the property expenses.
Keithj said:
Buffers – you mention buffers quite a bit (it gave me a nice warm fuzzy feeling).
Can you elaborate on what you mean by buffers?
How liquid are these buffers ?
Are these buffers ever likely to disappear just when you need them most ?
Buffers will be held in a variety of ways:
- LOC / Offset account: cash earning the same interest as the current interest rate. This is stable, liquid and CG fluctuation will not affect it.
- Cashbond: Annuity delivering regular after tax income and guaranteed for the term. This is stable, liquid and CG fluctuation will not affect it. Also the annuity is commutable should you need the full balance. This income will be directed into other assets of which the Offset account above is one of the choices.
- Share fund without a margin: Money housed in the share fund is liquid (1 week) and can also serve as a buffer, whilst accruing CG and creating distributable income. If there is a decline in CG, then the buffer will decline by the same percentage. The choice is guaranteed lower return in cash as above, or fluctuating higher return as in shares.
- Share fund with a margin: Exactly as above except for double the return. (The margined amount.) Note that when capital needs to be withdrawn, then the margined portion should be reduced proportionately.
You will notice that as the return goes up, so too does the risk. Each investor will choose a buffer /s according to their individual risk profile.
You should still be feeling nice, warm and fuzzy.
Keithj said:
Why did you start off with examples of 1% CG, why not start with –7%?
This is not for a particular year;
this is the long term average.
You personally might well wish to plan for a long term average of -7%:
In this case you would
plan accordingly and not hold any CG investment assets and rather hold all your assets in cash. (Or gold ?)
Each according to their own . . . make your own pick.
The long term averages suggest 7% or greater. (
These long term averages include disaster times too.) You spoke of the fact that the WTC is no longer there: This is a subject very dear to my heart, having worked there for some years. Well, despite that disaster, the chaos caused volatility to the extent that I personally returned 24.25% in shares that year and Property in Aust was double digit too.
The most important aspect remains: Risk for Reward . . . choose what makes you comfy. Income wise and SANF wise.
Keithj said:
So can you give us some scenarios with volatile growth rates eg Japan, 0% average for 20 yrs and Hong Kong – down 57% over 7 yrs, and some other more likely scenarios, eg Bris 0% for 10 yrs until 2000
Hmmmm, I thought the full presentation actually spelled this out . . . I shall have to read it again.
No Growth = No Spend:
So maybe there would be no CG and therefore no Equity to spend.
In which case one would have to
rely on the passive income. (Just like in the conservative model) This income will be made up of: Rental income, Dividends, distributions.
Now you mention Japan, Hong Kong and Brisbane:
Diversification says you should spread your investment around, so for local property whilst Brisbane was flat, Sydney and Melbourne were booming and a spread of property through these three cities would have averaged greater than 7% in these years.
I can’t talk for property in Japan and Hong Kong. Did this property have the necessary Land Content? Were the properties purchased with Rental Reality?
As far as shares go: it is very easy to spread a portfolio around internationally.
In the case of Japan and Hong Kong, even though property markets may well have been in decline over a long time period, their equity markets certainly didn’t lack volatility.
The higher the volatility, the higher the distributions would be with DCT.
The point is the spread of assets and income classes lowers the risks and you would be hard pressed to show me a return of such a diversified spread, even through bad times, that would not have exceeded the cash rate!
Conservatives are relying on the return on cash as being their savior?
What was the cash rate and long term bond yield in Japan throughout the 20 years?
Keithj said:
What would be the maximum margin loan LVR allowed by the margin lender, for a fund that returns 10% consistently?
And why do you suggest gearing up to 50% in retirement?
Maximum margin loan LVR = 70% (On Navfund)
I recommend a 50% margin, (Aggressive Category will go higher) because this allows for a 40% market decrease. (By comparison Sept 11th dropped the market by -14.7%.)
Oh and in that year the realized profit (Distribution) was 17%.
Keithj said:
How volatile would you expect the distributions of such a share fund to be?
Very stable actually:
It all has to do with the volatility of Blue Chip shares in a given year. Surprisingly this volatility level (The amount that shares rise and fall between peaks and troughs) is very stable. The volatility will be much higher at times of chaos, which makes for greater distributions.
I expect the distributions to be 10% at the low end and 18% at the high end as per normal long term volatility.
10% to 14% should be the norm. Currently this year we are performing at about 14% distribution (10%+ first 3 quarters) and this has occurred NOT because the market is going up, but rather because of volatility in energy stocks.
Keithj said:
Also take into account a DCT strategy would be buying heavily the more the market fell.
Basically this question represents a lack of understanding of DCT. (No disrespect meant here
) The Navtrade system certainly buys in a market decline for value and sells on a market increase for profit. It is the number of profitable trades (Sale for profit based on previous low purchases) that dictates the distribution and this is DCT. When the market is low we may well be 100% in shares, but this doesn’t stop the trades which are short term fluctuations. The converse applies that we could be 100% in cash when the market is over valued, but the trading (DCT) continues.
Financial year 2001/2 is a good example of DCT working well:
Market decline = -6.7%
DCT = 24.25% (17%+ distribution and 7%+ unrealized gain.)
Keithj said:
. . . can you give examples using lower risk LPTs returning say 8% (with & without gearing and assuming they grow with CPI), cash returning a guaranteed 5.25% with no CG, low volatility LICs returning 5% with 7% CG. Also any comments on the volatility of each asset class and why you haven't made it an option?
Of course I could have given examples of every class of asset!! (
Wasn’t the presentation long enough? )
I referred to the use of many of these investment classes and suggested that they would lower / raise the risk profile and that each investor should choose accordingly.
It is easy to work out the outcomes at the different percentages . . . perhaps you might like to volunteer to present this to the rest of us.
Keithj said:
. . . but what about -
* the risks you perceive
* what is the assumed worst case scenario
* what buffers are required
* exit strategies employed as attitude to risk changes
* any adjustments that may be necessary if worst case scenario happens
* is any active time/effort required (in retirement) to monitor/adjust anything
This was all covered!
- Perceived risks: the market goes up or down so spend accordingly.
- Buffers: as set out above and amounts to match SANF
- Exit strategy as risk changes: move asset classes about, more towards lower returns to lower the risk and more towards higher returns to increase the income.
- Adjustments and worst scene / best scene!! scenarios: The buffers should see you through it all. If they do not, then it is highly probable that even the most conservative approach would not have sufficed either. (0% cash rate in Japan for many years). On the other hand when it is working really well (Best scene scenario) then you buy the boat and Ferrari that the conservatives can only dream about.
- Active effort: Sure there is . . . one should always actively monitor their portfolio no matter how conservative / aggressive it is. If this is a hassle get a good planning organization to do it for you. (I can recommend you to one that specializes in DCT )
Keithj said:
Have you considered approaching it with the end in mind?
Sure have, but I consider a percentage risk assessment to be
too subjective in outlook. I have always found that clients find
real figures in today’s dollars easier to understand rather than probabilities.
Keithj said:
You have chosen to put 50% as cash & leave 50% in Residential IP returning 3%. Didn't the previous chapter use 4.5% gross yield?
I at all times mentioned 4.5% Gross and 3% net. I also always pointed out that where I used 4.5% gross that the passive income will need to pay the expenses, so it’s the same thing. However to make things clearer so that we could clearly understand what the income from an unencumbered property portfolio is, I used 3% net. (Or else some might have thought that the gross rental return of 4.5% was net income result.)
Keithj said:
It’s easy for everyone to be blinded by the fact that on average they’ll have an extra $113,750 pa mostly tax free. However, some years they’ll have nothing (that is absolutely $0,zilch, zero) & some years they may have many times that. This is volatility. Can you explain volatility relates to this outcome?
Not entirely true: there will not be some years of “absolutely $0,zilch, zero”, there will
always be the passive income generated by the portfolio that is not of a CG nature. (Rent, dividends, distributions and interest on cash)
Volatility is GOOD!! (For CG)
- It creates value opportunity with shares. - To buy and sell
- It creates value opportunity with property – To lock in value in your LOC / Offset account when the valuers think the market is high and to use this locked in value when the market is actually low.
Volatility can be bad for your income stream:
You can risk manage (overcome) this risk by:
- Sufficient buffers
- Guaranteed income streams (Cashbond)
- Diversification: rent, dividends, distributions, interest, LPT’s . . . and however many you might choose. (Note: Distributions are dependent on Volatility so this creates a great balance amongst the other income methods)
I think this is enough: I find discussing this topic very
rewarding, but at the
risk of severe typing cramp.
More questions? (Come to a structure course
)
Regards,
Steve