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Financial Planning: Long-Term Investing Essay


Compare the performance history of direct property and shares in Australia

Financial advisers who are aware of the long term performance of shares and direct property are better placed to give advice and educate their clients on their investment choice. According to study conducted in the year 2010, direct property has performed better in comparison to other asset classes, by a very narrow margin, against shares in the Australian market (RussellASX report b, 2010,1 ).

In the past few years, return on investment in both shares and the direct property has been relatively equal in a period of the last 80 years (Russell ASX report g, 2010, 1). This performance has influenced by a number of constants such as tax levied on investments and the economic climate at the time (Russell ASX report, 2010, 1).

Results: Before tax but after cost

According to the Russell InvestmentsASX report on long term investing, investments in residential property achieved the very highest return before tax but after costs of 10.4% p.a in a ten year period while shares earned a return of 8.4% p.a before tax but after costs. The same in a period of twenty years residential property earned a return of 9.8% p.a while shares earned a return of 9.7% p.a ( Russell ASX report, 2010, 1).

Australian bonds on the other hand achieved the highest return of 6.4% p.a in a ten year period and in a twenty year period it achieved a return of 8.9% p.a ( Russell ASX report, 2010, 1). On the global scene the real estate investments trusts achieved a return of 5.3% p.a for a ten year period, this was a better performance compared to the local Australian real estate investment trust that achieved a return of 3.7% p.a only.

Results: After tax and after cost

In an after tax and after costs investment in direct property outperformed the other available assets in a ten year period by realising a return of 9.5% p.a in the lowest marginal tax rate whereas at the highest marginal tax rate it achieved a return of 7.9% p.a ( Russell ASX report, 2010, 1). Australian shares, achieved a high result of 8.6% at the lowest tax margin and 6.3% at the highest marginal tax rates all these in a period of ten years.

Over a period of twenty years, shares in the Australian market outdid the other asset classes at both the lowest and highest tax rate margins making a return of 9.9% p.a at the lowest marginal tax rate and 7.9% at the highest marginal tax rate (Russell| ASX report, 2010, 1).

On the other hand investments in direct property as the second best in terms of returns of 8.8% at the lowest tax marginal rate and 7.2% at the highest marginal tax rate (Russell ASX report b, 2010, 1).

According to a research study issued by Australian Stock Exchange and Russell Investments, residential property earned the highest return compared to other assets making a return of 10% p.a and 16% p.a respectively for the ten year as well as the twenty five year period respectively whereas shares made a return of 8.4% and 10.8% p.a over the ten and twenty five year period respectively (Russell ASX report f, 2011, 1).

In the twenty year period shares in the Australian market achieved a higher return of 11.0% p.a whereas investment in residential property in the same period made a return of 10.2% p.a ( Russell ASX report e, 2011, 1).

Australian bonds made a return of 5.8% p.a in a period of ten years, whereas in a twenty year period it made a return of 9.8% p.a, and in the twenty five year period it earned a return of 9.8% p.a in the year ending in 31 December 2010 making it the third best asset class.

In the global scene, global real estate investments trusts performed slightly better than the Australian real estate investment trust by a wide margin ( Russell ASX e, 2011, 1).

Performance : After tax and after costs

Investments in direct property performed much better than all the other asset classes at the lowest marginal tax rate realising a return of 9.2% p.a whereas in the highest marginal tax rate it realized a return of 7.6% p.a in a ten year period ( Russell ASX report e, 2011, 1).

According to a study conducted by the Australian Stock Exchange and Russell Investments, the Australian shares earned a return of 8.6% p.a at the lowest marginal tax rate and 6.4% p.a in the higher marginal tax rate in the ten year period.

Over the twenty and twenty five year period, Australian shares outdid the other asset classes in performance at both the lowest and the highest marginal tax rate ( Russell ASX report f, 2011, 1). Over a period of twenty years shares made a return on investments of 11.2% p.a and 9.0% in the lowest and highest marginal tax rate respectively and over the twenty five year period it earned a return of 11.1% p.a and 8.9% p.a in the lowest and highest tax rate respectively ( Russell ASX report f, 2011, 1).

On the other hand investments in direct property earned a return of 9.2% in the lowest marginal tax rate and 7.7% in the highest tax rate making it the second highest return over the twenty year period. In the twenty five year period it made a return of 10.5% p.a and 8.8% p.a respectively while still maintaining the second highest return over other asset classes ( Definition of Funds, 2011, 7).

Explain the impact of taxation and gearing upon the relative performance of shares and direct property over the long term

According to a research study findings by Russell Investments and the Australian Stock Exchange show that tax makes a notable significance to the final outcome of various investment options available to investors. Australian bonds as well as cash investments are greatly influenced by personal taxation ( Russell ASX report, 2011, 1)a.

Also considered are superannuation calculations. Superannuation is a program intended to cater for an individual’s retirement in Australia. It is a payment made regularly in to a fund by an employee intended to cater for a future pension ( Superannuation, 2011, 1). The report by Russell Investments and ASX shows that investing in superannuation is a good avenue as it provides several and significant tax advantages to individuals compared to investing outside the superannuation (KPMG, 2010, 3). Due to the many advantages of franking credits, there has been less significance on personal taxation in Australian shares return ( Russell ASX report b, 2010, 1).

Also noted in the study by Russell Investments and ASX shows that at the lowest marginal tax rate, tax credit acquired from imputation of an individual’s dividend translates to a greater after tax return (Elsen 2007, 4).

A reduction of the impact of personal taxation on Australian Real Estate Investment Trust returns has been due to tax deferral of a determined portion of the trust distribution ( Russell g, 2010, 7)

The result of personal taxation on investment in direct property has also been of less significance as a result of capital gains tax discounting rule ( Russell, 2010, 7). Expenses on direct property has been deducted from taxation has an impact on personal taxation ( Russell ASX report, 2011, 1).

Discuss reasons why some individuals strongly prefer direct property over shares and whether these can be supported by facts

Whether to invest in shares or direct property has been an argument in Australia for a long time. A recent study by ASX shows that 41% of Australians own shares either directly or indirectly. This is further encouraged by the government initiative, of compulsory superannuation guarantee in the year 1992 ( Russell ASX e, 2011, 4).

Investors in property argue that property is better as it is more stable compared to shares and also has a great chance to grow and achieve great returns on investments. Those who invest in shares argue that shares and funds make a better investment owing to the potential for growth, flexibility and liquidity.

ASX estimates that over six million Australians own shares either directly or indirectly through avenues like managed funds (ASX, 2008, 1). In some instances it is the professional financial adviser who introduces investments in shares to a client as an investment strategy but it is the reverse in direct property investing.

One common thing that drives investments in direct property is the perception that property is safer and a less vulnerable option. The global financial crisis proved that not even the property market is immune to risks (Russell ASX report g , 2011, 4).

Whereas many investors are undecided over which option to invest in, it has slowly emerged that shares are more volatile compared to other asset classes and this is a direct opposite of the property market.

Investing in property

Many prefer to invest in the property market because of the perception that it has some level of stability. This perception emanates from the notion that since property is not traded everyday there is less speculation hence reduced volatility. This is rebutted by the fact that the market is continually influenced by external factors that affects pricing (IFSA, 2007, 3).

Direct property is tangible therefore one can keep checking from time to time. One can also earn returns from it by renting it out or from capital gains in the sale of the property. Property is also viewed as an asset for growth ( Russell ASX report, 2011, 4).

Another factor that affects pricing is liquidity. Direct property is not as liquid as shares. The process of selling property is tasking and lengthy. It is not easy to dispose property as it is shares ( ASX, 2008, 7).

Another factor that affects direct property is the issue of maintenance costs. These costs are largely forgotten by investors when it comes to realising capital gains. Many get caught up in realising the capital gain forgetting expenses such as maintenance, renovations and their own time as well.

Another issue not to be forgotten is the buying into an area of growth. Adequate information about the area one intends to buy property in, amenities in the locality, support services and so on. It is in such grey areas that investors employ the services of professional financial advisers.

Investing in shares

A share is the most basic unit of ownership in a company. Owning shares in a company entitles the shareholder to a proportionate share of the company distributed as dividends and are a potential capital gain upon the sale of the shares.

Investing in shares exposes one to the performance of companies. If a company grows and makes then the shareholders earn dividends ( International equity investing, 2011, 3 ). Dividends earning in the recent past has been higher than earnings from rent in direct property investments.

The world over the share markets are highly volatile, they are constantly changing and this may not resonate well with all investors. Some investors tend to be risk averse while others are risk takers.

Examine how financial advisers can help clients create a well diversified portfolio for their clients that contains both shares and direct property

In managing investments risk and return are closely related, this requires financial planners to closely monitor investments. The Modern Portfolio Theory (MPT) advocates for diversification as the preferred style in order to spread risks across different asset classes ( Sunguard, 2010, 2). Financial planners manage risks so as to insulate investments from shocks in the economy ( Sunguard, 2010, 4).

In an effort to provide good financial advise financial planners do so by identifying and quantifying financial goals then proceed to create realistic and tax efficient portfolio custom made to suit each investors needs ( Sunguard, 2010, 5). Asset allocation and diversification are important elements in portfolio creation and risk management (Robinswood Financial, 2011, 3). Financial advisers begin by analysing a client’s need for investing and assessing the client’s tolerance to risk and cash flow ( Sunguard, 2010, 5).

Another factor that influences the creation of a portfolio is liquidity of the investment. Time limit factor, investors with short term investment plans should look into investing in more liquid investment options (Sunguard, 2010, 7).

References

Definition of funds. (2010) The Association of Real Estate Funds.

Elsen, M. (2007), The tax effects of Australian share fund investments. Web.

IFSA Guide, (2007). An IFSA guide to understanding managed investments.

International Equity Investing. (2011) Debt, Mortgage, Loan.

KPMG Global Tax Services. (2010) The Impact of of tax treaty trends in the Asia Pacific funds sectors.

Robinswood Financial. (2011) Strategy: Portfolio Diversification.

Russell InvestmentASX. (2009) Long-term Investing report. Share Ownership Study 2009.

Russell Investments ASX. (2010) Long-term Investment Report. Comparing 10 and 20 year performance of various investments to 2009.

Russell Investments ASX. (2010) Long-term Investing Report – Compairing 10 and 20 year performance of various investments to 2009. Web.

Russell Investments ASX. (2011) Report. Long-term Investment Report-Compairing 10, 20 and 25 year performance of various Investments to 2010.

Russell Investments ASX. (2011) Long-term Investing Report – Compairing 10 and 20 year performance of various investments to 2010. Web.

Russell Investments ASX. (2010) Long-term Investing Report – Compairing 10 and 20 year performance of various investments to 2009. Web.

Sunguard Solution For Wealth Management. (2010) Managing Risk Through Diversification, Perspective and Data Aggregation.

Superannuation. ( 2010) What is Superannuation. As at 2108-2011.

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