30 July 2024
The cost of superannuation fund financial advice.
A $6 million mum-and-dad SMSF has little more advisory complexity than a modest 2 person fund with $800,000 of assets. There may be a few extra investments, but often it will be a case of mainly holding similar investments in larger quantities. In recent years SMSF software has been much improved, streamlining administration and providing fund advisers with instant access to the information needed from which to formulate advice.
For many SMSFs it is timely to request of your adviser that they justify and reduce their fees. Most will not admit it but will be prepared, if pressed, to make sometimes substantial fee adjustments to keep their clients. By all means seek alternative quotes but don’t make them available to your current advisor. A good negotiator will keep that information to themselves.
Does the adviser’s service justify the fees charged?
Good advisers will have regular client contact commenting on each fund individually. They will demonstrate that their advice is relevant to the fund and its members, including demonstrating deep knowledge of their client’s wider circumstances such as the direction and projection of their business/practice income, tax planning, their business and home related debts and family expenses including education costs of children or assisted grand-children. They will be alert to company announcements by widely held stocks and use it as the subject of a quick email note to clients rather than have them reliant on the finance pages of the daily press. Advisers who simply pass on an occasional economic/budget report distributed to them by a professional association of accountants or financial planners are extracting high fees for little work. They may be simply patting their clients on the head and recommending occasional relatively minor investment changes.
Wealth versus risk; demystifying investment approach.
Often commentators speak of the desirability of investment strategies becoming more conservative as we grow older. That approach is appropriate for those of modest means but is ignored, for good reason, by the wealthy because long-term market returns are significantly greater than fixed interest returns. The wealthy can afford the inevitable fluctuations in investment values whereas those of limited means cannot. To use extreme examples, 90 plus year-olds Warren Buffet and Rupert Murdoch would be unlikely to convert their share ownerships of News Corps or Berkshire Hathaway into cash because of their age. They have grown extremely wealthy because over many years their major asset has increased in value far in excess of the interest return on very safe government bonds.
Naturally Widow Jones with $400,000 of assets apart from her home relies on being able to draw a modest amount per year to augment her government pension amount and will prefer a conservative investment strategy.
For those with many years until anticipated retirement, or for those with large superannuation funds and other assets being heavily biased toward the Australian share market, a heavily weighted cost effective (low management expense ratio) exchange traded funds such as the S&P 500 ETF is logical. Many of those 500 companies are global in nature and overcome the pretense of some investment advisers that they are making a fund more diversified by including a range of geographic ETFs rather than the one ETF which covers the globe. Another US share markets fund coded VTS, is a near clone of IVV. Provided that selection of Australian stocks concentrates on companies with a reliable history of paying dividends, such a strategy will fluctuate in value but over the long- term produce returns substantially above interest-bearing securities.
The cost of free power.
Political posturing about free wind and free solar ignore the associated capital costs. Based on AEMO figures back in 2012, mainly coal-generated electricity cost averaged around $30 per MWh. In the June quarter the average cost across the market was$133 per MWh. The huge capital costs of wind and solar collection and the networks of additional transmission lines requires a huge amount of capital which comes at vast cost. This is why electricity costs are so high.
Wind and solar will make an expensive contribution but we are going to need gas generated firming power well into the future until significant nuclear generators can be built. 32 nations have nuclear power. Lots more nuclear power generators are being built.
Significantly COP 28, the high church of green enthusiasts, endorsed nuclear power.
Last week Energy Minister Bowen told the National Press Club that the green hydrogen transition was progressing “at pace”. Less than three hours later Andrew Forrest’s Fortescue Metals told investors that it was kicking its target down the road from 2030 to a destination approaching Never-Never land.
An early election?
There is a possibility that the federal Government may choose to go to an early election in December if it fears that the economy is going to deteriorate further or that the Reserve Bank is likely to raise interest rates again.
With inflation remaining above the Reserve Bank’s target range and showing little signs of easing there is a reduced chance of an interest cut this year but a possibility of an increase.
Government spending driving up debt.
The Commonwealth government’s spending, including its ‘off budget’ spending, plus state government deficits fuels inflation despite claims to the contrary. Off budget expenditure includes capital items but some of these have little chance of ever being worth the capital invested in them. Examples are Snowy Two and the NBN both financed off budget along with many environmental project hand-outs. Budget surpluses are as much a product of creative accounting as they are accurate records of government expenditure.
Most state governments, particularly in Victoria, are running up huge debts with projects over time and over budget. The Victorian Government has demanded its departments make major spending cuts including in hospitals and the law courts while simultaneously looking for more ways to extract money from heavily taxed Victorians. Recently it proposed huge increases to process probate applications to make up for its intended cuts to the budgets of the court system. It will be more expensive to die in Victoria. Victorian major projects are running vastly over budget and time. This was the situation before the extensive allegations against the CFMEU’s corruption exploded across the media embroiling the Jacinta Allan Victorian and Albanese Commonwealth governments in damage control.
Business failures.
Many thousands of Victorian businesses have gone bust recently. Behind this are human tragedies involving families who lost their homes which they had used as security to finance their businesses. Those fortunate to be able to afford to dine in restaurants cannot avoid noticing that some, where it was impossible to get a table without booking well in advance, now have lots of vacant seating.
Recently it was reported that Victoria’s huge suburban loop rail project (SRL) is likely to carry far less passengers than publicly stated. Reportedly then deputy premier, Jacinta Allan was warned four years ago that few people would use the SRL compared to the growth corridors in the North and West of Melbourne. Infrastructure Australia has steadfastly avoided endorsing the project but the Victorian Government has pushed on despite its mountainous and increasing state debt. Clearly Victoria cannot afford it.
The Melbourne Outer Circle Railway was completed in 1891 and closed because of lack of use in 1897. History threatens to repeat.
The cost of the CFMEU.
The behavior of the major construction industry union, the CFMEU, has massively inflated the cost of Victoria’s ‘Big Build’ of public infrastructure adding $Billions to the state debt. By soaking up tradespeople it has added to delays and costs of home building, raised the costs of houses and creating rental shortages. The actions of the CFMEU have added huge costs to the budgets of governments, particularly the Victorian Government with flow on impact throughout the economy.
Australia’s twin economic problems.
The economy is facing the twin problems of rising cost of living and falling productivity per worker. Australia is having a per capita recession. National productivity is propped up by huge numbers of immigrants increasing pressure on services, but cannot mask the fact that the average family is worse off.
Private equity and family offices. High return = risk. The hidden underbelly of failed businesses and failed property developers.
The name given to the investment entities of the mega wealthy are “family offices”, some with a full-time manager of their wealth. They look for investments which hold out the prospect of higher returns than are available conventionally. They seek to provide loans to entrepreneurs at interest rates far above what banks charge to prudent borrowers. They are a key source of financing for Private Equity investment companies. Their non-bank lending comes with much higher risk particularly at times of significant failure among property developers or entrepreneurs with high-risk business strategies. The troubles of prominent Sydney Hotels investor Jon Adgemis come to mind with his portfolio of heavily geared hotels. He borrowed off private investors at extremely high interest rates on secondary mortgages and quickly bought about 20 hotels expecting that he could renovate them quickly, promote their offerings, revalue and replace expensive private borrowings with cheaper bank finance. His plan was difficult to execute and has resulted in a number ofclosures and forced sales. It threatens to become a feast for liquidators and may result in substantial losses for private lenders who took a big risk seeking high returns. The situation may be more dire than reported in the financial press. Recently Jon Adgemis has had to cede control to Public Hospitality Group as a condition of refinancing after messy trading of positions among various lenders.
The extent of private lending at rates greater than double bank business lending rates is unknown but is substantial. At a time of a surge in business failures forced borrowing of last resort at usurious interest rates will have become widespread, particularly with respect to property developers, who have spent more than bank finance limits and rely on ‘Mezzanine’ finance to complete projects. Failures of building companies have surged.
Structuring dental practice ownership and operation.
No two dental practices are exactly alike and no two dentists have identical skill sets but there are broad similarities.
Dentists buying practices, post capital gains tax introduction and expanded superannuation contributions in the 1980s avoided buying inside companies and should buy them in their personal names or in the joint names of dentist and spouse. Having bought in personal names they can, in due course, license their practice to be operated (but not owned) by a company. This involves payment of an annual license fee by the company, typically, of 2 percent of dental fees. This avoids the future capital gains tax issues of having a practice sold by a company which creates additional capital gains tax and surrenders the halving benefit on sale of long held assets.
There is a timing issue in introducing a company licensing agreement as the new practice owner wants to receive the lower taxed portion of their first-year income personally before starting the company operation and deferring part of practice income to be recognized in the company after 30 June. From that point the company will pay its shareholders franked dividends as income and company tax payments permit. Getting the timing right when making the initial switch from personal ownership/operation to company operation must be calculated carefully and varies with income size of the practice.
A company conducting a practice with additional clinical staff can choose to retain part of its income whereas trusts must distribute all of their income in the year in which it is earned.
Depending on personal circumstances there is, often, significant advantage in having a non-dentist spouse as co-owner of the practice provided that the dental practitioner receives sufficient income to satisfy an ATO test. Where there are multiple clinical staff having a co -owner spouse receiving a significant income from their investment is advantageous provided that the dentist co-owner receives practice related income judged to be commensurate with that of employed dentists across the profession. For many this would be below $250,000 of combined salary and superannuation or $250,000 of net income after claiming up to $30,000 of superannuation deduction. There is a wide disparity between dentists. No two dentists are exactly alike in the treatment mix that they provide, their proportion of preferred provider patients, the skill in their hands or the number of clinical hours per week that they work.
Accountants differ widely.
Having valued hundreds of dental and veterinary practices spread throughout Australia over about 30 years I had the opportunity of observing in their financials what hundreds of accountants had advised with respect to spouse salaries, dividends or trust distributions. There has been such a wide disparity as to regard most of their advice as having been plucked out of thin air.
Buying premises inside super funds. Be careful concerning accounting advice.
Accountants often advise this approach because it suits their self- interested of creating an additional recurring stream of accounting fees. Mostly it is not in the long-term interest of their clients. Often business/practice owners have far too little superannuation to justify setting up an SMSF and can source finance more cheaply if done directly rather than via a more expensive non-recourse borrowing loan via their super fund. There are particular limited circumstances where it is advisable. An example might be where a dentist owning premises directly needs to extract capital in order to move to a significantly more expensive home and has significant assets inside their SMSF. These circumstances are rare. Most are best off buying directly or perhaps in a family trust. Many will be advantaged by not having them in their super fund but being able to claim the small business active asset concessions at sale at retirement.
New superannuation limits.
The governments stated intention, subject to its legislation passing the Senate, is that from 1 July 2025 individuals with superannuation assets above $3 million will be charged 30 percent tax on the earnings of the excess amount including tax on unrealized capital gains. This has placed individuals with substantial properties inside superannuation funds with member balances above $3 million in an awkward situation. For example, a farming couple with say, $5 million of superannuation each who have built up their superannuation over 40 years and who expanded their land by buying the adjoining property inside their SMSF based on an accountant’s advice. Land prices may have fluctuated substantially based on seasonal changes and they can be faced with a huge change in value without their fund having the cash to pay the tax on the unrealized gain. It is a diabolical tax suggested to the government by industry superannuation funds jealous of SMSFs. At time of writing, it was still being haggled over in the Senate.
The move to tax balances above $3 million more heavily makes it more important to contribute to spouse superannuation accounts with the objective of achieving equal balances at retirement. A joint two-person combined limit of $6 million remains a substantial goal for most.
Reasons not to start a self-managed super fund.
The first reason is insufficient superannuation assets to make it worthwhile.
A second reason is a lack of interest in financial matters.
There are several pre-conditions to the decision to start an SMSF.
1. Generally, they should not be started unless a single individual or two persons in a permanent relationship have combined superannuation assets including current financial year contributions of minimum $400,000. Below that point it is unlikely to be cost effective.
2. The individuals concerned need sufficient income to enable them to make regular substantial contributions.
3. They should have many years to their likely retirement dates enabling them to build up substantial pension accounts in their fund enabling it to pay them regular superannuation pensions during an expected lengthy retirement.
Reasons to start a self-managed super fund.
Having met the above preconditions, the decision to start an SMSF may be based on a strong interest in investment markets possibly allied with a distrust of the management of public offer and industry superannuation funds. It is desirable that SMSF members have a good awareness of financial markets including share markets, exchange traded funds, and interest-bearing securities including bank hybrid securities and the discipline to remain informed and follow a long-term strategy.
Do Not.
Those who start SMSFs expecting to regularly trade in and out of stocks face many pitfalls. Those who I observed insisting on doing this rather than following a steadier more cautious approach had disastrous results. They become seduced by the excitement of making lots of trades and when the market turned down chased their losses. They also created an administrative/accounting tangle to the point that SMSF administrators did not want to administer their funds.
Why shares are a more cost-effective investment than residential rental property.
· The acquisition cost of property in the form of stamp duty and conveyancing is far greater than the acquisition cost of shares in these days of cheap brokerage.
· The selling cost of property in the form of agent’s commission and advertising plus legal assistance is much greater than the cost of selling shares.
· Rental housing is subject to land tax which varies between states whereas there is no equivalent tax on shares.
· Rental property can be difficult to sell. There is a virtually continuous market in shares of significant companies.
· It is easy to split a parcel of shares selling some to meet a need but retaining the remainder. It is impractical to sell bits of a rental property.
· Purchasers of rental properties often underestimate the landlord’s costs in the form of municipal and water authority rates, Land tax, insurance, property maintenance cost, agents letting fees and property management fees. These costs do not apply to share ownership.
· Share owners don’t risk the costs of bad tenants.
Bank hybrids in super funds but not in separate portfolios
For those with an SMSF as well as a separate investment portfolio bank hybrids which currently have grossed up returns above 7 percent per annum are a suitable component of an SMSF’s investments, particularly where members are in or approaching retirement. For wealthier persons, with substantial taxable income, they are best kept out of separate investment portfolios which concentrate on long term growth stocks with relatively small dividends but long-term substantial capital gains. Since the taxation of capital gains is deferred until the assets are sold and the 50 percent halving rule applies this is a better strategy. SMSFs with significantly lower tax rates, particularly when paying pensions, are more suitable ownership vehicles for bank hybrid securities.
Keeping SMSF investments simple.
For those who want to have their own SMSF but not spend huge amounts of time studying company financials having a large segment of their fund invested in the long-established Argo or AFIC Australian share funds may be expected to generate market returns over the long term. If required to make a choice I would select Argo because of the large number of stocks within a large weighting is appropriate. Both have very low internal management expense ratios unlike more recent listed investment companies which are loaded with charges.
To add international exposure a popular choice is the I Shares S&P 500 exchange traded fund. With the top 500 shares listed on the New York Stock Exchange and NASDAQ, many of them global businesses it offers huge internal diversification and is suitable for a large weighting. Many investment advisers will offer a range of ETFs covering different areas to give an impression of providing wide ranging advice when they can cover these multiple bases by offering the one wide ranging international fund.
Some advisers will argue for wide diversification among individual stocks ignoring the huge internal diversification in Argo, AFIC and I Shares S&P 500 ETF.
Younger holders of SMSFs will be mainly invested in the above with little cash or fixed interest. Approaching retirement, they will increase their holdings of interest paying securities, but the wealthier they are the less important and the lower the proportion of interest-bearing securities is necessary.
When choosing the amount of diversification take into account other assets such as equity in a business or practice or business premises.
False comparisons.
Recently I saw a table of returns of different forms of investments circulated by investment advisers which on perusal gave false comparisons of investments that might be considered for SMSFs. The table ignored franking of bank hybrids by comparing their return without franking with the unfranked Treasury notes (government bonds). It also ignored different outcomes between franked, partially franked and unfranked shares. Are your advisers actually advising you? Or, are they simply passing on tables prepared by someone else?
Graham Middleton 0448 784 594
For archive of articles including ones by Graham Middleton go to website at grahammiddleton.com. Watch for detailed article on Dental Practice valuation in two parts appearing shortly.
General advice and need to confirm.
As I sold out of an accounting and financial services group, of which I had been a founding partner, on 30 June 2020 I am no longer licensed. The above is general advice and should be confirmed with a currently licensed investment adviser. One I would recommend to you is Campbell Thompson at Ord Minette who is both courteous and experienced. His number is 0407 839 229. His assistant Simone Shelton 0402 085 892 is a helpful person also. If you are after simple transaction advice, they are ideal. I use them but have absolutely no financial interest in any services that they provide to others.
My Financial interest.
I have no financial interest in the advice I provided and seek no fee. I am secure financially and I seek no personal remuneration. If you find it worthwhile you are able to acknowledge it by making a tax-deductible donation to the registered charity which I support, the Delany Foundation who, I am confident, will apply it to worthy use.
Financial Success for Dentists
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 owning 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.
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
To Obtain a Copy:
· Go to the Delany Foundation website at http://www.delanyfoundation.org.au
· Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
· Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
· A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly by email at graham.george.middleton@gmail.com and by mail at Graham Midldeton, 37 Charteris Drive, Ivanhoe East, VIC 3079.
