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Keeping Your Money Clean

Keeping Your Money Clean

Opening a bank account and buying and selling investments are not such simple processes as they were a few years ago. Now you must provide formal photo identification such as a passport or driver’s licence, proof of address, and, if you are transacting a large sum of money, evidence of how you came to have the money. For family trusts, each trustee, including independent or professional trustees, must provide this evidence as well as a copy of the trust deed. While this can seem like an invasive process, especially for elderly investors, it is all for a good cause. New Zealand’s financial system has such a good international reputation that it is a target for criminals wanting to ‘clean’ the proceeds of crime. In the interests of keeping our system clean, financial institutions and financial advisers are required to check identification and source of funds and report suspicious transactions to the Financial Intelligence Unit. Some would say this all seems a bit unnecessary, however each year around 10,000 suspicious transactions are reported. Criminals can go to extreme lengths to clean money, including a process called ‘layering’ where they spread their funds through many small transactions to avoid suspicion. It’s not just hardened criminals who are involved. Think of all those tradespeople who do ‘cashies’ and then spend or invest their money without declaring the income. Tax evasion is just as much a crime as theft or fraud.

Later this year, the range of entities required to comply with anti-money laundering legislation will be extended to include lawyers, accountants, real estate agents and businesses selling big ticket items such as luxury boats. Buying property is a popular choice for criminals – it is estimated that around 30% of money laundering activities are conducted through property transactions. Perhaps that explains our property prices!

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Investing for Children

Investing for Children

Parent and grandparents often want to set aside funds for their young children so they can be used to help further their later education or for some other worthwhile purpose. Here are some useful tips on how to do it in the best possible way.

First, consider the investment time frame. When is the earliest point you would wish the child to have access to the funds? If there is at least a five year time frame then some of the funds should be invested in assets that will grow in value over time, such as shares. For a shorter period, more stable assets such as term deposits may be more appropriate.

Putting funds into KiwiSaver is an option, however, the funds will only be accessible if they buy a first home, reach the official retirement age, leave the country or suffer hardship. There are diversified funds with investment profiles similar to KiwiSaver but which are not locked in. These funds are invested in a mix of fixed interest, property and shares.

Use the investment as a way of teaching your child about saving for the future. Review it with them once a year or so, and as the years go by explain more about how it works. They may choose to add more funds of their own to achieve a particular goal they have in mind.

Take heed that later in life, your child may enter into a relationship and, if you have invested a large sum on their behalf, you may wish to get advice on protecting it from a relationship property claim.

Given that student loans are generally interest-free, your child may be better to keep their funds invested through their study years and use them as a deposit on a home or to set up a business.

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Keep Your Cool in Uncertain Times

Keep Your Cool in Uncertain Times

The world is full of uncertainties. How will Brexit play out? What effect will Trump’s outlandish statements and policies have on the global economy? Where is the New Zealand dollar heading? Will interest rates keep rising? In amongst all these uncertainties and more there is a large bunch of people wondering if their retirement funds are in jeopardy and whether they will be stuck in the workforce for much longer than planned. The reality is; there is no such thing as certainty (other than with regard to death and taxes); there are only degrees of uncertainty. So when it comes to making good financial decisions, a key skill is learning how to manage uncertainty.

There are natural instincts that come into play. Some people react to increased uncertainty by becoming highly cautious, some aren’t bothered at all, and some see uncertainty as an opportunity to make gains by taking risks. How you respond to uncertainty will have a significant impact on your financial outcomes.

The coming year is shaping up to be a very uncertain one. The key to being a successful investor is to learn to overcome emotions and make sound investment decisions based on objective analysis. An objective approach starts with determining your goals and the time frame for achieving them. If you have long term investment goals, don’t get distracted by short term changes in the market. Review your attitude towards risk and ensure your investment strategy is a good fit. Find the right balance between risk and return so you can achieve your goals while taking an acceptable level of risk. Stay diversified. Markets can change quickly, and moving all your investments into one asset class increases your risk.

Confident investors have a long term plan that they stick to. Just keep calm and carry on!

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Personality and Investment Decisions

personality-and-investmentPersonality and Investment Decisions

People who find themselves suddenly having to make significant investment decisions often feel overwhelmed, confused, or even afraid. They fear making costly mistakes which could jeopardise their financial futures. In most cases, fear stems from lack of information, understanding or experience which undermines confidence in making the right decisions. These emotions can bring about the very thing that is feared – that is, costly mistakes. Learning to invest is a bit like learning to ride a bike. When you first get on a bike, never having ridden before, your fear of falling off means you ride slowly with your feet ready to touch the ground, so you are much more likely to fall. Once you learn to proceed confidently with your feet firmly pushing the pedals, you have a quick, smooth ride with a low risk of falling.

Fear can lead to procrastination of decision making, or inertia. The cost of not making an investment decision or delaying it is the opportunity cost, which is the investment return that could have been achieved if the decision had been made earlier. Fear can also lead to panic decisions after an investment has been made, which can result in actual loss or in opportunity cost.

On the other hand, some investors are over-confident which means they take on high risk that can lead to disastrous consequences. Somewhere in between are those investors who stick to a narrow range of investment options they are familiar with and who lack the confidence to step outside that range. This means their investments can lack diversification resulting in increased risk or opportunity cost.

Investors often behave irrationally, without logic or reason, driven  by emotion. In the words of author Jason Zweig, “Investing isn’t about beating others at their game. It’s about  controlling yourself at your own game”.

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It’s About Time

its-about-timeIt’s About Time

It’s about time, or, to be more precise, it’s mostly about time. That is the answer to the question on most investors lips, which is ‘How should I invest my money?’ The next question to ask should be ‘How long do I want to invest my money for?’ Your investment time frame is one of the key ingredients in deciding how best to invest your money. The problem is, many inexperienced investors don’t understand the connection between time and investment.

Your investment time frame is the time after which you will need to access the amount of money invested in order to spend it. This is not to be confused with the time after which you will need to spend the income from the money invested. Many people approaching retirement have the mistaken belief that their investment time frame ends at the age of retirement. If things go according to plan, you will still have money invested the day you leave this earth. That could be thirty or so years after you retire. Your money will be mostly used up, but gradually. While every dollar you spend has a different investment time frame, it is more practical to consider three investment time frames – short term, medium term and long term. Money allocated to each of these time frames should have a different investment strategy. Money required in the short term needs to be invested mostly in stable assets, despite the lower return, to avoid the risk of loss. Funds for the longer term should be invested in assets which will grow, albeit with volatility, to get a good return. Funds for the medium term should be a balanced combination of the two.

Investing in this way gives the opportunity for a good return while making sure funds are available when required.

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What Investment Income Really Means

Investment IncomeWhat Investment Income Really Means

When it comes to managing investments, a big source of confusion is the relationship between income, return, cash flow and capital. These four things come together make investments grow and to provide funds for the enjoyment of life. Different approaches are needed depending on what your financial goals are.

When people say they want a good income from their investments, what they usually mean is something completely different. If they are growing their wealth, they really mean they want a good return. Return is the total sum of income and capital gain. The return from a rental property is the sum of the net income received and the change in the value of the property. For shares, it is the dividends paid plus the change in value of the shares. On the other hand, investments such as bank deposits don’t change in value and their return is simply the interest income. If your goal is to grow wealth, a higher return can be achieved by investing in assets which change in value.

At a point in time, usually retirement, the goal changes from growing wealth to providing funds to enjoy life. At this time, when people say they want a good income from their investments, they really mean they want good cash flow. Cash flow is the total sum of income and capital drawdown. Investing for cash flow is not the same as investing for income and opens up the possibility of investing funds for both income and capital gain. They key issue is to manage liquidity – that is, to ensure that money (either income or capital) is available when required. Retired investors should not be constrained by living on the income from capital; they should use capital as well as income to provide the money needed to enjoy life.

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Understanding Market Volatility

Market VolatilityUnderstanding Market Volatility

Volatility in the share market is both a threat and an opportunity. It is a threat for people who don’t understand it and an opportunity for those who do. It is something to be welcomed. Without volatility there would be no capital gain. There is a natural process at play in market cycles called ‘reversion to mean’. Simply put, this means that share prices follow a long term upward trend, around which prices will be higher or lower in the short term, but will always head back toward the trend. When prices get too high or too low, there will be a trigger which points them back in the direction of the trend. Market cycles can take some years to play out, and investors who have spent a long time in the market have a greater understanding of this principle and how it works. The more crises an investor has successfully lived through, the easier it is to put emotion aside and resist panic.

The reversion to mean principle relies on diversification to work well. A diversified portfolio will broadly track the movement of the market as a whole. Investment risk will then change from a risk of loss to a time risk, providing funds remain invested. A diversified portfolio will always regain any value lost; the only uncertainty is how long it will take to do so. This is why the time frame for investment is such an important part of investment strategy. If funds are needed in the short term for another purpose, there is a risk that investments will need to be sold at a loss, before they have had time to recover their value. A well-considered strategy takes investment time frames into account. Short term volatility shouldn’t alter the strategy for achieving a long term goal.

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Fixed Interest Ladders for Peace of Mind

LadderFixed Interest Ladders for Peace of Mind

Managing money to cover short term needs can be challenging. Money needs to be available at the right time while still earning a reasonable rate of interest and without taking too much risk. Added to these issues is the uncertainty of which way interest rates will go in future. A strategy called ‘laddering’ can be used to minimise the effect of interest rate uncertainty and enable an investor to take advantage of opportunities when interest rates go up while also reducing the impact of falling interest rates.

Many investors make the mistake of investing most of their short term funds in one or two large amounts, with the income from the investments providing a top-up for income from other sources. This can present problems. Firstly, the income from the investments may not be enough to top-up other income, especially when interest rates are low. Tapping into the capital may involve costs, loss of capital or loss or income. Once the investment matures, it will need to be reinvested at whatever the going market rate is, which may be unfavourable at that time.

A fixed interest ladder is a portfolio of fixed income investments (term deposits or bonds) which have staggered maturities. The total amount to be invested is divided into smaller amounts with each amount initially invested for maturities six to twelve months apart. As each amount matures, it can be reinvested for a period six to twelve months after the longest maturity. Once set up, this means that funds maturing can be invested for the medium term in the knowledge that the next maturing amount will be available in the short term if required. Reinvesting in smaller amounts reduces the uncertainty of reinvestment interest rates. Overall, the regular maturities and interest rate payments provide more certainty of cash flow.

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Eggs in Baskets

Egg BasketEggs in Baskets

Time and again, despite knowing that putting all your eggs in one basket is a bad idea, investors lose money by chasing high returns or taking a gamble on a supposed ‘sure bet’. In the current environment of low returns, it is very tempting to look for opportunities to increase returns. This particularly applies to retirees who are struggling to make ends meet having seen their interest income fall to about one third of what it was prior to the Global Financial Crisis.

Investment ‘baskets’ operate at two levels. At the highest level is the split between different investment types (asset classes), such as cash, fixed interest investments, property and shares. At the next level, there are specific investments, such as individual bonds, properties or shares which fill each of the baskets. Investors who select a number of specific investments in just one asset class, such as fixed interest, are in effect putting all their eggs in one basket. The classic example of this is investors who spread their money across several finance companies in the belief that this would reduce their investment risk.

There is a key difference between investment and speculation. A speculator is prepared to take high risks for the possibility of extraordinary returns while an investor seeks a balance between risk and return and preservation or growth of capital in the long term. These are exactly what diversification provides.

It is difficult to predict which asset classes will provide the best returns in the short term. Chasing short term returns by trying to pick winners almost invariably leads to a poor outcome. A safer approach is to spread funds into different baskets knowing that some will perform better than others in the short term but there will be balance between risk and return in the long term.

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Why Investors Shouldn’t Read Headlines

newspaper headlineWhy Investors Shouldn’t Read Headlines

There is nothing like a sudden drop in the share market to send investors into a panic. It is easy at the time of investing to be full of confidence and classify yourself as someone willing to take risk in exchange for the potential of a higher return. However, when volatility strikes, confidence can quickly be eroded. Volatility quickly sorts out those investors who truly understand their tolerance and capacity for risk and those who don’t.

The principal risk management tool for share market investors is diversification. For small investment amounts, diversification can be achieved through investing in a fund. Investors who choose to ignore the principle of diversification are in effect speculators rather than investors, believing they can pick winners and taking on higher risk for the chance of higher returns. A diversified portfolio of shares will mimic the behaviour of the market as a whole, reaching neither infinity nor zero in value, but moving above and below a market trend line. The key risk for diversified investors becomes one of how long funds need to remain invested in order for the market to return to trend. A loss will only be crystallised if investments are sold before this happens. This is where the concept of risk capacity becomes important; that is, the ability to absorb loss without significant impact on your overall financial situation. Investors with a short investment time frame or a low level of wealth or income are more likely to have a low capacity for risk.

The key to being a successful investor is to learn to overcome the emotions of fear and greed and make sound investment decisions based on objective analysis and a long term strategy. Investors should pay little heed to news headlines, which are designed to sell newspapers, not provide investment advice.

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