Compound Interest, 8th Wonder of The World

The 8th Wonder of The World

A Simple Idea.

Charlie Munger, the vice chairman of Berkshire Hathaway says, “Take a simple idea and take it seriously”. The simple idea that should be taken seriously by every investor is the ability to earn compound interest on your savings over the coming decades.

Compound Interest and College Fees

Let’s look at a simple example. We all want to give our kids, or even our grandkids, the best possible start in life and a good education is half the battle. However, education, particularly third level education does not come cheap. College fees may be free, but other costs certainly add up. Conservative estimates suggest annual costs vary, but begin from €10,000 to €12,000. Currently, the monthly child benefit amounts to almost €300 per month for two kids. Take the following scenario: 

  • Save €300 per month.
  • Investment strategy is market related.
  • Timeframe is for 10 years.
  • Assume annual interest rate, net of costs, is 5% per annum.
  • No indexation of contribution applies here.

Compound interest adds €11,544 to the value of your investment. We’ll leave you contemplate the difference between this and the current deposit based returns, which are small fractions of 1% per annum. Simple interest would have added €1,800 over the 10 years.

Snowball Effect

Think of compounding as like a snowball rolling down a steep hill. As it gathers more snow along the way, momentum increases and the ball becomes deeper and broader as it moves forward. Compound interest is amazing but just like most things in life, there’s no free lunch. The simple truth is that it takes a long time to work. To get the rewards you have to stick with it and stay the course during good times and bad. Problems arise with the snowball if you start making withdrawals, a 10 year horizon rather than a 10 month plan is required.

Investment Plans @ 5% p.a.

Focusing on trying to grow your wealth by compounding is a key element of any investment plan. The same applies with retirement plans. Just take a look at the graph below which JP Morgan Asset Management created to illustrate the power of compounding. One line shows the example of somebody starting to save at 25, let it be for retirement. This clever person that starts to save at 25 years old, accumulates circa €284,000 more in retirement funds than the person that starts at 35 years old. The 35 year old has still done well!

Investment Returns – What to Expect From Here.

Perhaps you are wondering about the 5% return piece of this jigsaw. Complex investment options can give the illusion of control. Our theory is that advice doesn’t have to be complicated to be good. Equities have delivered the best investment returns for investors over the long-term. Despite various recessions, business progress has been the order of the day in developed and democratic countries. Equities, which are essentially a collection of businesses, have reflected this.

The MSCI World Index has generated 10 year annualised returns of 7%, 6% and 12% for each of the last 3 decades, respectively (see table below). In our view the easiest way to ensure that a portion of your money will compound at a consistent rate over the coming decades is to invest in a strategy that gives you exposure to world equity markets.

We help you invest in portfolios that focus on large and medium sized companies that are globally diversified. Focusing on dividends plus dividend growth is, in our opinion, the most reliable way to invest in and make money from equities over the longer term. This applies particularly in today’s extraordinary bond market environment, where so many Euro government bonds have negative yields.

Meanwhile, European investment markets remain some 35% below its March 2000 highs, while Emerging Markets equities remain some 25% below their October 2007 highs. Japan is still 45% below its 1989 peak. The world is still concerned about global trade wars, rising Middle East tensions, Brexit, a slowing global economy, a possible recession next year, slowing industrial production, earnings estimates being revised down, possible impeachment of President Trump, etc. 

We do understand these fears, but perhaps investors are too negative in their views. In summary, while we are very aware of the global issues out there. Cautious optimism is a better market view than pessimism – Just look at the investment returns below for the disciplined investors availing of the eighth wonder of the world (Albert Einstein).

 

Pat Leahy, Certified Financial Planner.

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Investment Book Recommendation

The Little Book of Common Sense Investing
by John C. Bogle is probably the only investing book you’ll ever need to read. At the 2017 AGM of Warren Buffet’s company, Jack (John) Bogle was introduced as the “person who has done the most for the American investor.”

What is the Investment Outlook

What’s the Investment Outlook? Covid-19; What is the Investment Outlook? Covid-19 is first and foremost a human tragedy While markets were aware of COVID-19 in China, the catalyst for the market drop in late February was when the virus hit Europe. Then it became clear...

How to Pick Winning Investments

How to Pick Winning Investments

There’s no greater feeling than being on the right side of a winning stock. The joy of being ‘right’ and making money in the process is insatiable. Jason Zweig, in his excellent book, “Your Money and Your Brain” describes how the brain activity of a person that’s making money on their investments is similar to a person who is high on cocaine. It’s that powerful!

Picking Winners

The problem with picking stocks is that it tells us nothing about the future. Companies and industries change on a continual basis, as technology and human creativity move forward.

Similarly, the stock market, which is essentially a collection of businesses, is always changing. An investor in 1910 would have been excited about the choice of car companies they could invest in. By the 1990s, investors’ attention switched to the new economy as characterised by technology companies such as Cisco, Microsoft, and Netscape.

Even over the last decade, the list of the world’s biggest companies has evolved significantly as the fortunes of different industries ebb and flow. Picking tomorrow’s winners is not simply a case of looking at the companies that have been successful in the past.

What are the chances?

So, what are your chances of successfully picking winning companies? Not all companies are created equal and a large amount of companies provide mediocre returns at best. In his recent study[1], Hendrik Bessembinder, a finance professor at Arizona State University, found a minority of companies provide the majority of the returns in the stock market. Mr. Bessembinder estimates that $32 trillion of wealth (returns in excess of Treasury Bills) was created between 1926 and 2015 via approximately 26,000 stocks that have traded on the New York stock exchange, American stock exchange, and the Nasdaq (All US exchanges).

Of these 26,000 stocks, only 86 of the top-performing stocks (less than 0.33%), were collectively responsible for over half of the wealth creation. The most astonishing fact is that just over 4 per cent of the companies account for all the wealth created. The other 96% only matched the return of the one-month Treasury Bill – with many of them producing less. This is extraordinary. It demonstrates that if you try to pick stocks, you’re very likely to miss the relatively small number of companies that turn out to be winners.

[1] Bessembinder, Hendrik (Hank), Do Stocks Outperform Treasury Bills? (May 28, 2018). Journal of Financial Economics (JFE)

What simple solution should investors implement?

Investors do better when they apply simple solutions to the complex world of investing.  Occam’s Razor is the problem-solving principle which states that simpler solutions are better than solutions that are more complex. If we apply these thoughts to investing, the message is clear; simplicity always beats complexity.

So, what simple solution can an investor implement? Investing in a ‘simple’ globally-diversified equity portfolio will increase the likelihood of having a better investment outcome as you have exposure to all the winners. For example, from 1994-2017, the annual return from an all-World equity index was 8% (see graph below)[1]. If you excluded the top 10% of best-performing stocks, your return dropped to 3.6% per annum. If you excluded the top 25% of the best-performing stocks, your return would have been -4.4% per annum. Stock returns are not uniformly distributed- some stocks do well, some not so well, but by remaining diversified you maximise the chance of capturing the returns available from investing in the stock market.

[1] The ‘all stocks’ world index consists of all eligible stocks in the developed and emerging markets. Returns in USD. Diversification does not eliminate the risk of market loss. Past performance is no guarantee of future results. Index data from DFA.

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How Goalkeepers and Investors are very similar?

How Goalkeepers and Investors are very similar?

Russia 2018 was hailed as a huge success. Moody’s, the ratings agency, said the World Cup’s boost to the country’s gross domestic product (GDP) would be between $26 billion and $30.8 billion over the 10 years from 2013 through to 2023.

One of the more notable statistics from Russia 2018 was the fact that there were 22 penalties scored, considerably more than in any previous World Cup. As I watched some of the action, I was reminded that investors are also prone to making short-term decisions. So, is there a link between how investors and goalkeepers behave when making decisions under pressure?

Many goalkeepers, not unlike investors, have an ‘action bias’. The urge to catch the latest investment trend, such as bitcoin or blockchain, runs deep. According to a 2007 study of 286 penalty kicks, almost 29pc are shot down the middle – a similar number to the amount placed to the left or right. The study found that the goalkeeper has a 33pc chance of saving the penalty if choosing to remain in the centre. However, 96pc of goalkeepers chose to dive to the left or right, eschewing the option to stay in the middle.

Investors, just like goalkeepers, see action as a positive thing. In today’s world of 24-hour information and soundbites, it seems that being ‘active’ is part of who we are.

In the investment world, Ned Davis, a US-based investment research company, has shown that investors are now holding equities for much shorter periods of time. Over the last 90 years, the average holding period of individual equities has declined from eight years to approximately eight months as of the end of 2016. The need for action also extends to investment fund managers.

A recent study* by the University of Ontario, suggests that past fund performance is negatively impacted by the number of times a fund manager changes the investments within his portfolio. The study suggests that the frequent churning of a portfolio is value destroying for investors and results in poorer performance than those fund managers who stick with their investments.

The global stock market (MSCI World) has increased by 1,860% since 1970. If you tried to identify the market troughs during this period, and as a result missed the top 10 performing months due to poor ‘market timing’, your investment return would have reduced by 66%.

Sometimes it pays to be inactive, and to “stay the course” with your investments. The key is to be invested.

*Portfolio Turnover Activity and Mutual Fund Performance

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Financial Decisions: How to make the Best Choices in 2018

Financial Decisions: How to make the Best Choices in 2018

Financial Decisions

The financial decisions we make earlier in life can have a significant impact on our lifestyle in later years. With life expectancy increasing all the time, It also increases our responsibility to be organised financially to fund ourselves for 20 plus years into retirement.

Six Financial Decisions you May Regret Later in Life

  1. Your Starting Salary:

Employees who negotiate their starting salaries averaged a €5,000 increase compared to those who didn’t negotiate. Career guidance advice to increase your chances of salary increases recommends you, volunteer enthusiastically, highlight your team player skills and provide solutions to work related problems.

  1. The Company You Work For:

A 30 year old should carefully research the pension and sick pay benefits offered by their employer. Many employers simply provide the facility to make pension contributions without any encouragement or incentive from the employer. A 30 year old with no pension contributions will fall far behind another 30 year old who chooses to make personal pension contributions.

  1. Your Choice of Partner:

Who you marry, if you marry, is one of the most important financial decision you can make. If you and your partner are compatible money-wise and commit to setting up a financial plan to save, invest and build your future, you can enjoy life and create financial security at the same time.

  1. Having Children:

In the last few decades, the average age of first time parents has  increased. When will your children be past the very expensive college years? The lifestyle you desire in your 50’s will be more achievable the earlier you start planning financially for planned future expenses.

  1. How you Save and Invest:

We suggest a contingency fund of circa 4 months income on deposit. This is so you don’t need to sell your long term education or retirement funds at an inopportune time. Those people who’ve consulted a Financial Broker have significantly more in savings and investments with an average of €71,800 compared with €25,770.

  1. Whether you rent or buy a house:

There are instances when it is better to rent than to buy a house. If you need mobility, don’t plan on staying in your area for long, you may be then renting might be the smarter option. However, as a homeowner, the mortgage will eventually be paid off and your housing budget will only have to cover taxes and repairs, so there may be more money to enjoy during your retirement.

Financial advice can benefit your Financial Decisions

Getting financial advice means success, as people balance the day-to-day priorities with their long- term goals. Working with a Financial Broker ensures a personalised and holistic approach to a client’s finances. The past we can’t change, but we can plan for the future. If you are getting advice from us, your are receiving direction from impartial and Certified Financial Planners.

To discuss how best to plan for your future.

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Our top tips on how to insure you and your family in 2018

Our top tips on how to insure you and your family in 2018

Do you have Adequate cover?

More and more couples in Ireland are choosing to cohabit and have children now, rather than marry. If you are one of these couples, have you spoken about ‘life of another’ family protection or personal protection?

When it comes to protecting your family its important that you have the correct cover. Do cohabiting couples have adequate and appropriate protection in the event of death?

Why do you need ‘life of another’

Cohabiting couples are treated as strangers, from an inheritance tax perspective, in the event of death. This may result in a significant percentage of a jointly owned property inherited being passed to Revenue in tax.

‘Life of Another’ Cover explained

So let’s paint the picture. Ann and Barry are unmarried and jointly own a house together, valued at €300,000. They have 2 lovely children named Jack and Jill. They have the following protection in place:

  1. Joint mortgage protection policy that clears the mortgage in the event of either of their deaths
  2. Ann also has a term life cover policy for €200,000 to provide for the children in the event of her death, which is also paid for from the joint account.

5 years later Ann dies in a tragic accident. Barry already owns 50% of the house and inherits the other 50% from Ann, valued at €150,000. What happens from a tax perspective?

  1. As Ann and Barry were not married, the threshold for property passing between them in the event of death is €15,075.
  2. The balance of €134,925 is taxable at 33%, which results in a tax bill of €44,525 for Barry.

The good news is while the Dwelling House Exemption Relief still exists this tax bill of €44,525 may be avoided. If a house which has been someone’s main residence, they may be exempt from inheritance tax subject to certain conditions (that’s a story for another day).

Tax Implications

What are the tax implications for the €200,000 term life cover policy for the purpose of replacing Ann’s income though? This is liable for tax at 33% which amounts to a massive €61,038.

What’s the solution?

If the protection policy, number 2 above, was structured on a ‘life of another’ basis Barry, Jack and Jill would have an extra €61,038 to help deal with their financial difficulties.

This structure means Barry owns the policy, makes the claim in the event of death, and since he has paid the premiums the proceeds go to him tax free.

The proceeds are paid directly to Barry, and not to Ann’s estate, and there will be no probate delay. Another important point is that there can be no claim on the policy proceeds from any relatives of the deceased.

Hopefully, Jack and Jill will see their parents grow old together, but statistics from the CSO show that at least 1 kid in a junior infant’s class of 20 kids will have to deal with the death of a parent in the next 10 years.

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Want to learn how to reduce your 2018 Income Tax Bill?

Want to learn how to reduce your 2018 Income Tax Bill?

The methods of legitimately reducing your income tax bill have diminished greatly over recent years. This applies to self-employed individuals, PAYE employees and Directors of companies alike. A simple example of this, is tax relief on medical expenses has halved to 20%, and such modest relief is even subject to conditions.

Some financial stability has been restored in Ireland. The economy and incomes, and hopefully your disposable income, is improving. As a result personal debt levels are reducing, gradually. Deposit rates are at all-time lows. Taxation of such deposits is a penal 40% on interest.

Income Tax Relief

Income tax relief is still available on pension contributions. Your retirement may seem like a long way off. Ultimately the choice of retiring or not is down to each individual. Technically, to benefit from a retirement fund you do not need to actually retire, just reach a certain age i.e 60 or 65.

Personal pension plans are designed to give yourself the option in the future of being able to afford to retire. Alternatively, if you choose not to make provision for retirement will you be forced to continue working, for financial reasons? Personal pensions are for people who don’t have a pension scheme through work, and who want to set aside provision for their future themselves.

The good news is the income tax benefits of pension funding are still unrivalled. The caustic pension levy on personal pensions is gone. Tax-free investment growth on pension funds continues. Therefore you can still turn €6,000 into €10,000 if you are paying the marginal rate of income tax.

Income Tax Deadline’s

The amount an individual can contribute for tax relief purposes is subject to your age, an earnings cap and your 2016 earnings. Revenue does reserve the right to request tax certificates for personal pension contributions. Therefore this document should be kept in case they are requested at a later stage. You must elect to backdate pension contributions by 31st October 2017 for 2016 tax year.

Pension planning remains the best tool for extracting wealth from your business. Have you considered a pension audit (contact us link)? You will need a financial broker to identify your net relevant earnings for tax relief purposes.

Your opportunity to reduce your 2016 income tax liability ends on 31st October 2017, or 10th November 2017 if you pay and file through Revenue On-Line Service (ROS).

Smart tax and financial planning now can help you give yourself the option of winding down to enjoy the lifestyle you wish for in later life.

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