In this edition we:

Click on the following link to have a look at the full newsletter - Financial Fortnight That Was - 10th February 2009.

The market update section is set out below:

ASX P/E Ratio and Dividend Yields

We have uploaded our latest Monday's Money Minute podcast on to the website.  This podcast looks at the dilemma facing investors who are fully or predominantly invested in cash now that the RBA has cut interest rates by a further 1% last week.

To listen to the podcast please click on the following link - Sitting Tight in Cash Dilemma.

The following is a transcript of the podcast along with some extra data for different marginal tax rates:

Last week's interest rate cute by the Reserve Bank of Australia has made investment choices that little bit more difficult for investors.  When the cash rate was sitting above 7%, investors holding cash were feeling pretty good about this especially considering the carnage on share markets around the world.

As these interest rates have been quickly driven downwards, the option to sit tight holding cash is not such an easy position to find yourself in.

One alternative might be to look more seriously at Australian shares.  As of Wednesday last week, the yield (dividend income) on the ASX200 was 6.8%.  If we assume that this yield is approximately 80% franked as per market averages, the effective income return for investors would be:

# - not including Medicare Levy

The big question is how much companies might cut their dividends as a response to falling earnings and or to shore up funding requirements by holding back more of their profits from shareholders.

The profit reporting season has started to provide some guidance on this matter.  A number of companies have reported significant cuts to future dividend payments while others have actually continued to increase dividends per share.

An average cut I have seen reported by analysts is around a 20% cut in dividends.  How does this change the comparison table?

 # - not including Medicare Levy

Still a significant premium!

In fact, it would take dividend cuts of 64% across the ASX200 to see effective dividend yields match cash returns.  This seems highly unlikely based on the current reporting by companies.  It also does not take into account that cash rates may fall further in future months.

Unfortunately the decision is still not cut and dried as there are clear risks involved with investing in shares going forward.  They have lost something like 40% in value since November 2007.  This is because they are a risky investment.  Before jumping in boots and all investors will need to weigh up how comfortable they are taking on extra risk in their portfolio.

One thing that investors can be certain of is that they would be buying shares 40% of their highs!

Regards,

Scott Keefer

In his latest article written for Alan Kohler's Eureka Report, Scott looks at an investor response to the latest interest rate cuts and the government's massive stimulus package.  He concludes by suggesting:

Beyond the 1% cut in interest we got this week from the Reserve Bank, the government's latest stimulus package represents the equivalent of $2000 for every man, woman and child in Australia. As and investors you must now:

For the entire article please click on the following link - Review your strategy ... and portfolio

Depending on how the negotiations go in the Senate regarding the latest stimulus package developed by the federal government, there is a chance that many will be receiving a $950 payment some time in April.  So what should you be doing with that money?

My response may not be what the government is hoping to hear but my first reaction is to say save the money.

With interest rates falling by the month the next logical question is where should you put the saved money? Here are some ideas the merits of which will depend on your personal situation:

• Put it towards that non tax deductible debt, the higher interest rate options first - Eg credit cards, personal loans etc
• Put it towards your mortgage - if you have an offset account even better, this will reduce interest payments but keep the cash accessible.  The interest cost reduction from putting it towards your loan will definitely out weigh any interest you would get from saving especially if you are stuck in a fixed interest loan.
• First Home Savers could put it towards a First Home Saver Account and by doing so get a 17% extra kickstart from the government - an extra $161.50.  The money goes into a 15% tax on income earnings within the account which could also be beneficial for some but one word of warning, the returns on the savings will not be flash going forward as most of the options offered are for the funds to sit in cash.
• Add the $950 to your investment portfolio - unless Australian share dividends are cut by 60% going forward the return you are likely to get from the dividend payments from shares should beat cash returns.
• If you won't need the money before retirement you could make a contribution into super.
• If you are likely to earn less than $30,352 during the current financial year then a personal contribution of $950 will entitle you to receive a government co-contribution of $1,425
• If you earn less than $60,352 then you could contribute some of it as a personal contribution and receive some government co-contribution and then use the rest to pay for your regular cost of living and then salary sacrifice extra into super.  An extra $950 in the hand would allow you to salary sacrifice $1,385 back into super and maintain the same amount of cash in hand to pay for your living costs.  By doing this you would save $230 of tax. (15% superannuation contributions tax compared to the 30% marginal tax rate plus 1.5% Medicare Levy for those earning more than $34,000)
• There are other superannuation contribution rules that may determine whether you are or are not able to make this extra contribution (for instance contribution limits) and these should be checked before jumping in.

There is actually one possible option to spend the money that is worth considering:

• If you are in small business, use the money towards purchasing $1,000 or more of business equipment which, if the stimulus package gets passed as it is, should entitle you to a 30% rebate from the government.  A saving of $285 on the $950.  But only if you NEED the equipment don't be sucked into the trap of purchasing unnecessary equipment!

It will be interesting to see what the end package looks like.  What ever happens I am sure there will be some great financial strategies that can be employed to make the most of what is on offer.

Regards,
Scott Keefer

In my morning reading time today I came across an item written by William McNabb, the Vanguard Group's CEO.  The explanations are from a US perspective but are definitely transferable into the Australian context.  The following is taken directly from his article:

• Respect risk. Investments with the potential for great returns also carry great risks. It's tempting to only look at one side of the equation. This was perhaps the most obvious lesson learned during 2008, when risky and complex investment strategies failed en masse. Unfortunately, this lesson gets forgotten in every investment boom and relearned in each ensuing bust. That makes this advice seem too late-but, in reality, it can help us respond to the recent setback and keep us alert when investors once again fail to appreciate the market's true risks. If you've suffered a significant decline in your investment portfolios, you may be tempted to look for ways to play "catch up." Don't. Simply put, you can't invest your way out of a low account balance. And it's dangerous to try.

• Save aggressively. For 2009, I'm more convinced than ever that investors of all types need to save aggressively, or even "oversave." The sad truth is that Americans have been relatively poor savers in recent years. It can be hard-and discouraging-to save and invest money during a market downturn. The thinking often goes, "Why put money in the stock market when it's been posting poor results?" But it may be wiser to ask, "Are you better off making contributions to your retirement account when the Dow Jones Industrial Average is near 8,000 points (where it's been recently) or near 14,000 (where it peaked in October 2007)?"

• Be balanced and diversified. Creating a portfolio with a mix of different asset classes (stock, bond, and money market funds) is critical to limiting volatility. Maintaining the appropriate mix (based on your risk tolerance and time horizon) is critical to ensuring that your portfolio continues to reflect your risk and return parameters through good markets and bad. But this discipline can be uncomfortable. Many of Vanguard's own balanced funds, for example, are required to maintain a certain ratio between their stock and bond holdings. That often means that when their stock portfolios perform well, the fund managers must buy bonds; when stocks do poorly, they must buy more stocks. It feels counterintuitive, and from an emotional standpoint, it can be a challenge for many investors. But it's a sensible approach that, over time, has produced solid results. I noted above that stocks have averaged an annual return of 9.6% over the past 82 years. A hypothetical portfolio consisting of half stocks and half corporate bonds would have averaged an annual 8.2% over that same span.

I think the comments are very pertinent and well worth sharing.  The full text of the article can be found at - Thee Investment Maxims from vanguard's CEO.

A recent enquiry was received by me asking the following:

I am soon to reach Age Pension age.  I intend to keep working for a few more years.

Should I apply for the Pension Bonus Scheme?

The Pension Bonus Scheme was introduced 1^st July 1998.  It was introduced as an encouragement for those of age pension age to continue working and put off claiming the age pension for a period of at least 1 year.  If you do so and you are eligible to claim the age pension at a later date, you will receive a lump sum benefit for not claiming the pension.

How much is this lump sum benefit?

The amount of bonus you get depends on:

·  the amount of basic Age Pension you are entitled to when you eventually claim

·  the length of time you have been an accruing member of the Pension Bonus Scheme, and

·  whether you were single or partnered during the time you deferred your Age Pension.

You must be an accruing member for at least one year to be paid a bonus. A maximum of five years accruing membership can be taken into account when working out your bonus. Work after 75 years of age cannot be included.

If you are entitled to a part-rate Age Pension, you may be entitled to a part-rate bonus. For example, if you receive 75 per cent of the basic rate of Age Pension when you retire, your bonus will be 75 per cent of the amounts in the following table.

Maximum amounts of bonus payable (accurate as at April 2008) where the maximum rate of Age Pension is granted

The relationship between the initial pension rate and the amount of bonus means; members will generally benefit by claiming their pension and bonus after employment income ceases.

The bonus you get is a multiple of 9.4 per cent of your basic Age Pension rate for each accruing bonus period.

Example of how the Pension Bonus is calculated

Glen registered for the Pension Bonus Scheme on 3 March 2003 at 65 years of age. He was self-employed and worked an average of 35 hours a week until he retired on 2 March 2008, accruing five full bonus years.

Glen is single and has never given away any income or assets. He claimed Age Pension and the Pension Bonus on 1 April 2008 within 13 weeks of his retirement.

Glen has other income and assets. After the income and assets tests are applied, he receives 56 per cent of the maximum rate of basic Age Pension or $7,961.40 (after rounding). His bonus is calculated as follows - 56% of the full 5 year bonus lump sum for a single person of $33,409.50.

This gives Glen a total bonus of $18 709.30 (after rounding).

For some, you may be better off claiming the Age pension immediately rather than deferring in order t receive the pension bonus at a later date.  Particularly, if the pension payments you would receive if you claimed the pension immediately are greater than the pension bonus you would receive at the time you intend to claim it then you may well be better off claiming the pension immediately.

This decision would depend on a range of issues including your current level of income and assets, the amount of income you need in retirement, taxation, superannuation and health and lifestyle issues.

The latest edition of our fortnightly email newsletter for 2009 has been sent to subscribers. 

In this edition we:

consider the use of fixed interest investments in a portfolio,
take a look at 2009 School Costs as a guide to planning for future education costs for your children,
provide a summary of the movements in markets over the past fortnight including 3, 5 and 10 year return history,
look at 10 tips on avoiding investment fraud,
provide a link to some useful videos on You Tube,
provide a link to Scott's latest Eureka Report article,
welcome back the Monday's Money Minute Podcasts, and
look at a case study involving the Pension Bonus Scheme.

If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.

The following is the market news section for the latest newsletter:

ASX P/E Ratio and Dividend Yields