9 August 2021

Investments in Shares Are Far More Beneficial than Fixed Interest/ Bonds Over the Long Term, but Can Be Far More Volatile

The work of Elroy Dimson, Paul Marsh and Miles Staunton published in Credit Suisse Global Investment yearbooks shows that diversified portfolios of corporate equities have dramatically outperformed government bonds.

A pound invested and reinvested in the UK share market in 1900 would have become 572 pounds by 2020. The same pound invested in UK government bonds would have only become 10.40 pounds.

A dollar invested in the US market would have become $2291 USD compared with $12 USD.

Volatility = Risk

The above returns are staggering over time but require the patience to sit through sometimes lengthy periods when stock market returns are negative. These market fluctuations, called volatility, are defined as “risk” in financial market formulae. This requires a long-term investment approach—the longer the better. Over many years periodic market wide slumps are interspersed with periods of high growth. This requires patience. A foremost example of this has been the Warren Buffett guided Berkshire Hathaway.  

Who Can Take Risk To Get Better Long-Term Returns?

Some investors are better able to accept risk in order to make long term gains. This ability to absorb risk in order to make gains is related to the magnitude of investments and the reliability of income of the investor. Essentially the wealthier people are, the more likely they are to have been long term investors who are able to remain invested through market fluctuations and to have enjoyed higher investment returns. 

Differing Circumstances

Example One 

Benny, a well performed dentist, bought his own practice at age 31 with about 8 years clinical experience and is married to Brenda, an Oral Therapist. They set up their own superannuation fund (SMSF) and transfer in existing super. They figure on owning the practice for about 30 years and enjoying retirement for another 20 to 30 years. Their investment time horizon is over 50 years so they invest in a share portfolio including the two major US plus global exchange traded funds (ETFs), I Shares S& P 500 index fund (code IVV) and the Vanguard US total markets fund (code VTS), plus about 20 to 22 carefully chosen Australian stocks. Both of the ETFs have very low management expense ratios and own a cross section of huge companies with global reach. They contribute their concessional superannuation limits of $27,500 each per year, and as dental income permits top this up with additional non concessional contributions which attract no contribution tax but are not tax deductible. They use contributions and fund earning to regularly add to investment in shares and top up the ETFs. They periodically sell any outright losers and keeping the well-performed stocks, using investment of contributions and dividends to rebalance their fund. Benny and Brenda periodically experience a period when the market turns negative due to some financial or other crisis but keep to their simple plan and invariably the market recovers and powers on. They pass their respective pension account limits ($1,700,000 each) long before retirement but continue to make their permitted concessional contributions of $27,500 each. At retirement they may roll a significant amount into their fund using the government’s small business capital gains tax concessions. Their assets at retirement mean that they can afford to continue the same investment strategy in retirement because the risk of periodic market adjustments won’t jeopardise their retirement income needs.

Example Two 

Cynthia and Cyril have modest income and struggled to pay off their mortgage and educate three children. Cynthia works part time as a dentist needs to look after children, one of whom has an adverse health condition which precludes full time practice for many years. For her practice ownership would present too many difficulties. Cyril, a town planner earns an average wage. Each sacrifice a modest extra amount into superannuation and at about age 40 they transfer their respective super of about $425,000 total into an SMSF. They are mindful of health risks and of possible threats to Cyril’s employment. They are unwilling to take significant risk and maintain a substantial allocation of their fund in cash and bank hybrid securities with no more than 40 percent weighting in shares. It takes many years to pay off their home and one of their children requires ongoing support. Their fund growth is slower but it is important to them to be able to count on drawing regular pensions from it in eventual retirement. Their fund is insufficient for them to take the risk of being near fully invested in equities.

The Mega Wealthy

 For those with massive wealth having large amounts in cash is rarely seen as other than a temporary option. The very wealthy have most of their wealth invested in businesses and routinely they and or the businesses in which they are invested carry a judicious amount of debt because in most years their return on business investment is much greater than the net after tax cost of debt. These investors accept greater risk for much higher long-term return.

Those with strong and reliable income flow are likely to invest in Australian and international shares. Those with modest and less reliable income flow will invest a substantial proportion in low volatility interest bearing securities, bank hybrid securities and real estate investment trusts.

For those with good income potential, which include owners of successful dental and veterinary practices, dental and veterinary specialists, as well as medical surgeons, the opportunity for most includes the gradual building of significant wealth via their practices and over time accelerating capital formation via their investments, preferably within their SMSFs. Successful dental and veterinary practice owners benefit from maintaining practice-related debt, paying off their long-term home in quick order, while building their super funds and in some cases investing personally in the share market when faced with limits on superannuation funding. A successful strategy is to hold onto their most successful investments long term, periodically culling out their losers and limiting sales of the in between stocks to amounts necessary to balance out capital losses. The more successful they are the greater is their ability to carry successful investments in which they are heavily weighted. The richest Australians invariably have much of their wealth concentrated in a major enterprise. Nobody suggests that Solomon Lew should sell down his controlling interest in Premier Investments, that Gina Reinhardt should sell most of her iron ore mine nor that the Pratt family should divest itself of much of Visy Industries. The strictures about overweight investments apply to those who like Cynthia and Cyril above cannot afford to risk a major reduction in their wealth and who therefore adopt a conservative investment approach.

The Book Is The Best Investment Many Dentists Will Ever Make And Which They Cannot Afford To Be Without

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.

—Merv Saultry, Founder Dental Innovations Network 

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owing their own practices and for those aspiring to own practices. Among the topics included:

Understand key practice valuation criteria.

Learn how some dentists inadvertently reduce the value of their practice by $500,000

Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value. 

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.  

This publication is now available to dentists and dental specialists. book will be mailed to those who make a tax-deductible donation of at least $60 to the Delany Foundation a charity I support which contributes to schools in Ghana, Kenya and Papua New Guinea.  All such donations will benefit the charity’s work. The printing and distribution costs will be met by me personally.

To obtain a copy: 

1.     Go to the Delany Foundation website at http://www.delanyfoundation.org.au

2.     Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

3.     Email financialsuccessfordentists@gmail.com confirming that your donation has been made, as well as your name and mail address

4.     A copy of the book will be mailed directly to you

Investment Outlook 

As a general rule, houses and shares increase in value when interest rates fall and stagnate or fall in value when interest rates rise. There are of course reasons why specific stocks go against trends. It is prudent to note that we currently experience interest rates at the lowest point in memory and therefore ask whether the gains experienced last financial year in the share market can continue? Since interest rates cannot fall further and some fixed rates over three years or more have increased slightly it is likely that an overall return of 6 or 7 percent in the current financial year will turn out to be regarded as satisfactory or better.

My Favorite Stocks 

ARB Corporation 

ARB Corporation is a success story over many years. Recently it has been in record territory on the back of strong sales. With international air travel likely to remain seriously restricted for several years, many people are contemplating outback road tripping in Australia as soon as Covid border restrictions ease. Outback trippers drive off road vehicles fitted out with specialist accessories of which ARB’s brand is strongly preferred. ARB also has a growing international distribution network. It has been a core asset of our family superannuation fund for about 25 years. 

CSL 

CSL hit an all time high of $318.58 on 24 November 2020. 9 years earlier, on 29 August 2011, it was $28.12. Covid interfered with its blood plasma collection, forcing a reduction in share price and it has recently traded at $294.35 representing 26.4 percent compound annual growth over 10 years. CSL’s range of products in production or in development are such that its future looks robust. Its growth areas are in plasma, recombinants, cell and gene therapy and influenza vaccines. It has expanded the number of its blood plasma collection centers. Regardless of Covid, people will continue to suffer from a variety of medical conditions whose treatment draws on CSL’s pharmaceutical products. With aging populations increasing health related spending at a much greater rate than inflation, CSL is internationally placed to resume long term growth. Those interested should access CSL via the ASX 200 site and see its presentation to the Macquarie conference of 5 May 2021. We intend keeping CSL in our family superannuation fund. 

Wesfarmers

Wesfarmers has a history of excellent management since its foundation as a small West Australian farmers’ cooperative a century ago. Today it is a giant business owning Bunnings, Officeworks, K Mart, Target, the Mt Holland Lithium Project, a chemical business and an industrial safety business. Recent purchases into Bunnings include Adelaide Tools and Beaumont Tiles. Wesfarmers compound annual growth rate over 10 years has been 14.4 percent per annum. Its history of reliable growth over many years makes it a stock to hold onto. With so many successes, we can forgive its failed UK hardware venture—its only significant failure. Wesfarmers’ businesses generate reliable cash flow and it has a history of paying regular franked dividends. Target has been a poor performer but a combination of closure of some stores, conversion of some to K Mart stores, and product changes has seen improvement. The quality of Wesfarmers management means we want to keep it in our family superannuation fund as a long-term investment.

Xero

As a New Zealand company, Xero’s financial year ends on 31 March.  It is a growth business reinvesting its net cash flow into growth strategies including bolt on services, which include invoice lending facilitation platform, Waddle, workforce management platform Planday and E-invoicing technology business Tickstar. 

During its financial year ended 31 March 2021, a period when businesses were most impacted by Covid, it grew its customer base by 456,000 and operating revenue by 18 percent. Xero is trading on an astronomical PE, reflecting the reinvestment of nearly all free cash flow in customer growth. 

Over 30 years ago Solution 6 provided accounting software suitable for the emerging IT accounting use by business. Solution 6 later became poorly managed under Chris Tyler and was supplanted by Craig Winkler’s MYOB which was spectacularly successful and eventually swallowed up Solution 6. In due course MYOB was bought out by a private equity buyer just as Xero was emerging as the new and technically more complete solution to accounting and a range of business needs. Xero has now bitten deeply into MYOB’s market and is rapidly expanding internationally. We view it as a growth element of our superannuation fund and expect it to continue to invest its free cash flow in growing the business for several more years.

BHP or Rio Tinto? 

Given the size of the Australian share market and the size of these global giant resource companies, many investors have one or both in their SMSFs or investment portfolios. Both have been hugely profitable recently—but going back some years, both destroyed huge amounts of shareholder’s wealth. In BHP’s case this included the Billiton merger much of which has since been cast off with South 32, OK Tedi and its US shale oil misadventure since sold at substantial loss. Rio’s badly timed and hugely overpriced Alcan purchase just before the Global Financial Crisis forced it to raise a huge amount of capital and elements of Alcan have since been sold off.

The iron ore boom has been hugely profitable for both companies, and both are heavily involved in copper production with likely massive changeover to electric vehicles leading to a huge increase in demand for copper. BHP is yet to make a final decision on the development of its Canadian potash fields. It maintains massive oil and gas interests. Rio has neither Potash nor Oil and Gas. Rio’s project in Mongolia appears to have major cost overruns.

Both companies are dual listed in London and Australia and hence much bigger than the capitalization attributed to their Australian listing.

We hold a greater quantity of BHP than of Rio. Both are at risk of a significant fall in earnings if there is a significant drop in the iron ore price, but at the moment are hugely profitable. Investors need to do careful research.

General Advice 

Advice on investments is general advice and readers must do additional research of their own accessing broker reports and taking professional advice as necessary. All investors must have a deep knowledge of individual company financial performance, business strategy and economic risk. Investment decisions must also relate to individual circumstances including net assets, annual income and years to retirement.

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all 

Graham Middleton