Five shock-resistant personal finance strategies

Astute investors often focus on a few sure fire – or at least shock resistant – investment and personal finance strategies at times like now, when share markets are volatile, investment returns are faltering and the international economic outlook is unsettling.

These simple, easy-to-adopt strategies may enable personal investors to squeeze out extra net returns, reduce risk and increase personal financial security.

And no-frills strategies may help you to concentrate more on long-term personal targets rather than being distracted by day-to-day market movements and often-conflicting investment commentaries.

Here are five strategies smart investors should not ignore:

1. Accelerate your home mortgage repayments

A simple, highly rewarding but distinctly unglamorous strategy is to accelerate repayments on your mortgage.

Take the example of a home buyer with a marginal tax rate of 31.5% and a home loan with a variable interest rate of 7.8%.

Alan Freshwater, co-principal of financial planning group RetireInvest at Bondi in Sydney, calculates that this investor would have to earn almost 11.4% before tax on an interest only investment to equal the benefit of accelerated loan repayments.

A top marginal taxpayer would have to earn about 14.6% on an interest-only investment to produce the same financial benefit as simply increasing repayments on a standard variable home loan – this assumes a 7.8% variable home loan rate.

The reason for this financial advantage is straightforward – mortgage repayments are made from after-tax income.

The accelerated repayment strategy has another outstanding characteristic – it’s effectively risk free because you are already legally obliged to repay your mortgage.

Interest rate researcher Canstar Cannex reports that the nominal interest rates for a standard variable home loan from a big four bank ranges from NAB at 7.67% to Westpac at 7.87%. (You can see this here.)

2. Cut your investment costs

A smart way for investors to improve investment returns – or to minimise losses in difficult markets – is to stop paying excessive investment costs.

Investment researcher Morningstar reports that unlisted share funds concentrating on large cap stocks charge retail investors an average annual fee charge of 1.87% – including commissions paid to financial planners where applicable.

By contrast exchange traded funds (ETFs) and traditional index funds are much cheaper. For instance the Vanguard MSCI Australian Large Companies Index ETF and the iShares S&P/ASX 20 ETF have annual management costs of 0.2% and 0.24% respectively.

Most EFTs listed on the Australian market track the performance of selected indices. (For more information see the ATO’s EFT product list).

More investors are using ETFs or traditional unlisted index funds as the low cost, widely diversified core of their share portfolios and then adding “satellites” of some directly held shares and actively managed share funds.

3. Block out market ‘noise’

“Don’t get pulled left or right by the last bit of investment or economic news that you took into account,” suggests Alan Freshwater of RetireInvest.

He says investors should instead look past the immediate gyrations on investment markets and concentrate on the portfolio’s long-term or strategic asset allocation.

The landmark Brinson, Hood and Beebower study Determinants of Portfolio Performance (1986, 1991) concluded that the asset allocation of investors’ portfolios has a profound effect on their investment returns. The study based its findings on the long-term returns of 91 US retirement funds.

4. Beware of the cash trap

A natural defensive strategy when markets are highly volatile is to build up cash reserves. In that way, investors aim to protect their capital and to position themselves to take advantage of buying opportunities.

The unfortunate reality is that many investors who hold large amounts of cash in their own names are likely to lose all or most of their interest earnings in personal tax and inflation.

Consider an investor with a 31.5% marginal tax rate who decides to hold an extra $50,000 in cash, perhaps in a high-deposit, online bank account paying 6%. The website of InfoChoice shows a 6% rate or higher is obtainable from a few institutions, including the NAB-owned UBank.

After allowing for personal tax and inflation on the capital – assuming an inflation rate of 3% – this investor’s $3000 in interest would have shrunk to just $555.

And if the investor has a 46.5% marginal rate the real return after inflation and after tax is a miserable $105. A top marginal taxpayer who earns a lower interest rate on a cash deposit is likely to lose money on the deal.

Some investors – particularly older ones nearing retirement – are choosing to build-up cash reserves in superannuation as an alternative to holding money in their own names.

Cash held in a super fund is taxed at just 15% during the saving or accumulation phase and is untaxed if backing the payment of a superannuation pension, including transition-to-retirement pensions.

A possible disadvantage of holding more cash in a super fund is accessibility. With certain exceptions preserved superannuation benefits must remain in the super system until members either permanently retire after reaching their “preservation age” (currently 55) or turn 65.

5. Toughen-up your share portfolio

A smart strategy is to create a portfolio of highly reliable, shock resistant stocks that are somewhat insulated from negative investment sentiment.

Ross Bird, head equity strategist for investment researcher Morningstar, says the characteristics of shock resistant stocks include strong reliable cash flows; ability to pay solid, sustainable dividends; good balance sheets; quality management; and successful, non-discretionary core businesses.

Bird says such stocks are typically domestically-based businesses providing essential day-to-day services. Significantly, their financial fundamentals should be cushioned from current economic and investment sentiment.

Bird believes that investors should gain comfort during market volatility from the flow of high sustainable dividends from such stocks.

His favoured shock resistant stocks include Telstra (grossed-up, forecast yield, 13.28%), Woolworths (grossed-up forecast yield 7.14%), APA (unfranked yield 8.7%), Charter Hall Office (unfranked yield 5.5%), Commonwealth Bank (grossed-up yield 9.14%), Westpac (grossed-up yield 10.14%) and NAB (grossed-up yield 10.71%).

Grossed-up yields take into account the value of franking credits.