Author Topic: Australia/USA Mustachian Philosophy Differences  (Read 53886 times)

Ozstache

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Australia/USA Mustachian Philosophy Differences
« on: February 20, 2015, 05:15:21 PM »
I have noted a considerable number of Australians now participating in these forums, and quite a few new ones recently at that. I therefore thought it may be worth putting up a post pointing out where Australian and USA mustachian philosophies tend to vary due to country differences that would be worthwhile for Australian forum participants to be aware of. This list is neither exhaustive nor absolute and I encourage others to query and add to what I have put up.

  • A 3.5%, not 4%, SWR is a more suitable mid-point target for the Australian investing environment. A 3.5% SWR in Australia with a 50/50 allocation over a 30 year period has historically provided the 95% success rate many aim for. References: http://wpfau.blogspot.com.au/search?q=australia+safe+withdrawal+rate and http://www.finsia.com/docs/default-source/Retirement-Risk-Zone/how-safe-are-safe-withdrawal-rates-in-retirement-an-australian-perspective.pdf?sfvrsn=2 page 21
  • Living off dividends. Entirely practical with Australian stocks as SWR-like dividend rates are easily achievable and franking credits commonly available provide a tax baseline of 30% company tax already paid which significantly reduces, and in some cases eliminates, your personal tax liability.
  • Owning rather than renting your home. Accommodation savings achieved by owning your own home, especially when owned outright, generally exceeds the opportunity cost of investing house capital elsewhere. Also own-home capital gains are tax free and have historically tracked at inflation or better (in many cases much better). Eg. Where I live, $550K can either buy a house that would rent out for $550 per week or be invested to yield $370 a week before tax @ 3.5% SWR. Even after $5K pa overheads (rates, maintenance, insurance) for owning the house, ie. ~ $100 per week, I am still better off by $80 per week by owning.
  • Paying off own-home mortgage. Provides an excellent tax-free ROI due to relatively higher mortgage and personal income tax rates in Australia AND progressively improves the own savings side of the own versus rent equation.
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.

FFA

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #1 on: February 20, 2015, 05:44:47 PM »
Excellent idea for a thread. Replying to subscribe. I think you covered most of the points already.

One further that immediately springs to mind is the whole area of Fixed Interest / Cash for saving and defensive investment allocation.

I would say, Australians typically hold less in bonds (?) since online saver accounts can be found with comparable interest rates, there are also competitive term deposits available (analogous to CD's elsewhere), and Australian investors might have more residential property in their portfolio which can also provide relatively fixed income and inflation hedge. So when you see typical portfolios described here eg 60/40 stocks/bonds, an Australian equivalent might also hold this "bonds" chunk in other cash/FI assets and the percentage may be a bit lower if offset by investment property holdings.

deborah

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #2 on: February 20, 2015, 06:28:53 PM »
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
I'm not sure of this one. As people only need to pay once they reach a certain income, and it disappears when you die, ER people may find that keeping student debt forever is a financially sound alternative. I do not think it is morally sound. However, this may change if/when the government alters HECS.

Australian health and unemployment are funded quite differently to that in the US as well.

kyith

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #3 on: February 20, 2015, 09:02:45 PM »
i believe the tax regime and the difference in how stocks structure their capital returns affects international folks how we choose our method. here in Singapore, there tends to be rather heavy on property rental as well, although in singapore the prices are rather crazy (yet people still buy them because property prices never goes down)

our tax regime is also favorable since capital gains and dividends are not taxed. but i digress

burrow

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #4 on: February 20, 2015, 09:18:38 PM »
  • Owning rather than renting your home. Accommodation savings achieved by owning your own home, especially when owned outright, generally exceeds the opportunity cost of investing house capital elsewhere. Also own-home capital gains are tax free and have historically tracked at inflation or better (in many cases much better). Eg. Where I live, $550K can either buy a house that would rent out for $550 per week or be invested to yield $370 a week before tax @ 3.5% SWR. Even after $5K pa overheads (rates, maintenance, insurance) for owning the house, ie. ~ $100 per week, I am still better off by $80 per week by owning.

A debate that seems to polarise! We own our own home but all the research I have read tends to suggest that residential property is not a good investment long-term, compared to alternatives. I don't count our home as an asset, but then I don't count implied rent as an expense either.

Conversely, security of tenure, the psychological benefits of ownership, family stability, enforced savings (for less well disciplined money managers) and creative license are very good reasons to own.

  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.


A good reason to keep a significant portion of investments outside the super environment, especially when planning to retire well before 60....65?....70? Our investments are 50/50.

pancakes

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #5 on: February 20, 2015, 09:25:22 PM »
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
I'm not sure of this one. As people only need to pay once they reach a certain income, and it disappears when you die, ER people may find that keeping student debt forever is a financially sound alternative. I do not think it is morally sound. However, this may change if/when the government alters HECS.
There is a risk that the terms of HECS loans can be changed on current loan holders though? Please correct me if I am wrong but I believe that the government of the day could make legislative changes to make an outstanding balance at death payable from the deceased estate? 

If proposed deregulation of fees happens this does seem like a likely next step. At the moment I believe the figure is about 20% of university debt is never paid off. With deregulation that value will only increase. I'm not sure that as a country we can afford to have huge debts written off at death.

Given the amount of university debt that the government is already writing off, I'm surprised that they don't bring back more attractive bonuses for voluntary repayments.

I would repay my debt tomorrow if the 25% discount was brought back. At the moment I'm not making more than the compulsory payments (at the lowest bracket), will most likely stop working in a few years to care for children and then go back to earning a low income before retiring and carrying the balance to my grave.
« Last Edit: February 20, 2015, 09:28:30 PM by pancakes »

deborah

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #6 on: February 20, 2015, 09:39:43 PM »
Thanks Ozstashe for starting this thread!
  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.
I tend to agree that the current tax shelter is not going to exist for much longer, but my conclusion is a bit different. If I was in my early career now and earning a reasonable amount, I would put 50/50 inside/outside super as per Burrow - or more probably 30/70 - depending on how soon I was retiring. This would enable me to have it in the current tax haven for longer, and could mean that proportion of my super would remain in a better environment (if changes to super grandfather what is already there). When the new scheme came in, I would revise this. It would mean that if I had a windfall, and retired even sooner, or started to have more expenses (eg. kids), I could reduce (or 0) the amount I was putting into super and it would just get bigger.

skyrefuge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #7 on: February 20, 2015, 10:17:15 PM »

That FINSIA report is generally pretty awesome, but I really wish they would have shown the full analysis for the US too. That's because SWR results vary based on the dataset and particular methodology used. As far as I know, no one has used that particular dataset+methodology on the US, so it's entirely possible that it would show a much lower difference (or even a negative difference) between US and Australian SWRs than the 0.5% you suggest here.

For example, if I use the 50/50, 30-year, 95%-success setup that gave 3.54% for Australia, cFIREsim (again, using different dataset+methodology) gives only 3.66% for the US. If I change it to 75/25, then we have 4.01% for Australia vs. 3.88% for the US.

Also note that these numbers assume you're using entirely domestic stocks/bonds, which is unlikely to be the case for either Australian or US retirees.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #8 on: February 21, 2015, 12:16:56 AM »
Excellent idea for a thread. Replying to subscribe. I think you covered most of the points already.

One further that immediately springs to mind is the whole area of Fixed Interest / Cash for saving and defensive investment allocation.

I would say, Australians typically hold less in bonds (?) since online saver accounts can be found with comparable interest rates, there are also competitive term deposits available (analogous to CD's elsewhere), and Australian investors might have more residential property in their portfolio which can also provide relatively fixed income and inflation hedge. So when you see typical portfolios described here eg 60/40 stocks/bonds, an Australian equivalent might also hold this "bonds" chunk in other cash/FI assets and the percentage may be a bit lower if offset by investment property holdings.

Good point FFA. I personally don't hold any bonds and use fixed interest as a proxy. Also, while my own house is the only property I currently hold, I am likely to get another one (using some of that fixed interest money) to use for family, investment and as a potential downsizer when I get really old, in that order. As much as I think property is a rip off in Australia, there is something to be said for the security of bricks and mortar should this facade of modern economics unravel in future.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #9 on: February 21, 2015, 12:30:54 AM »
  • Owning rather than renting your home. Accommodation savings achieved by owning your own home, especially when owned outright, generally exceeds the opportunity cost of investing house capital elsewhere. Also own-home capital gains are tax free and have historically tracked at inflation or better (in many cases much better). Eg. Where I live, $550K can either buy a house that would rent out for $550 per week or be invested to yield $370 a week before tax @ 3.5% SWR. Even after $5K pa overheads (rates, maintenance, insurance) for owning the house, ie. ~ $100 per week, I am still better off by $80 per week by owning.

A debate that seems to polarise! We own our own home but all the research I have read tends to suggest that residential property is not a good investment long-term, compared to alternatives. I don't count our home as an asset, but then I don't count implied rent as an expense either.

Conversely, security of tenure, the psychological benefits of ownership, family stability, enforced savings (for less well disciplined money managers) and creative license are very good reasons to own.


I have found USA own versus rent comparisons tend to favour renting due to their high property taxes and HOA fees. Our overheads, for houses at least, in Australia are much lower. Units are usually less favourable due to body corporate fees.

If you don't mind me asking, how does your current home stack up in a buy versus rent comparison? ie. What is the estimated value of your place now, what do you pay in overheads and how much do you think it would rent out for? Would a 3.5% SWR on the same investment amount as your house value be able to pay that rent after you've paid tax on it and the overheads are deducted?

Sunnymo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #10 on: February 21, 2015, 12:34:09 AM »

  • Paying off own-home mortgage. Provides an excellent tax-free ROI due to relatively higher mortgage and personal income tax rates in Australia AND progressively improves the own savings side of the own versus rent equation.


From the time that I have spent of the MMM forum it seems that our US friends fall broadly in to 2 schools of thought on the pay off your house question:
1. A home loan is debt, debt is bad therefore pay down that beast as quickly as possibly.
or
2. A home loan is tax deductible for the interest component (up to 2 properties) so having a home loan is not necessarily a bad thing and can be advantageous to your income tax position so hang on to that baby (while you pay down other debt).

However we Aussies get no tax advantage from the owner occupied home loan and hence are more inclined as a group to try and kill the home loan. We also have little/no access to fixed rates beyond five years or terms that are not 25/30 years so these factor in to our approach to home loans.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #11 on: February 21, 2015, 12:35:29 AM »
Thanks Ozstashe for starting this thread!
  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.
I tend to agree that the current tax shelter is not going to exist for much longer, but my conclusion is a bit different. If I was in my early career now and earning a reasonable amount, I would put 50/50 inside/outside super as per Burrow - or more probably 30/70 - depending on how soon I was retiring. This would enable me to have it in the current tax haven for longer, and could mean that proportion of my super would remain in a better environment (if changes to super grandfather what is already there). When the new scheme came in, I would revise this. It would mean that if I had a windfall, and retired even sooner, or started to have more expenses (eg. kids), I could reduce (or 0) the amount I was putting into super and it would just get bigger.

I'm probably a bit of a pessimist, but here is the list of changes to super I think our government could be capable of initiating in future:
  • Contribution tax increased
  • Withdrawal tax introduced
  • Preservation age extended
  • Lump sum withdrawals restricted or even removed
  • Annuities becoming compulsory
  • Residual balances being retained by government rather than your estate upon your death

Sunnymo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #12 on: February 21, 2015, 12:50:24 AM »
Housing in general (outside major centres) is cheaper and building up a cashflow positive portfolio of 5/10/15/20 etc properties is a doable strategy for a middle class two income family. It is a FIRE strategy that a number of people on these boards are working on.

Given the high cost of property across the board (not crazy cheap in regional areas) there are fewer people pursuing this strategy in Aus. Most property investors in Aus have 1/2/3 properties and they are generally cashflow negative and hence tax deductible.

Stepping away from property it seems the preferred non tax advantaged/retirement savings vehicle is managed/mutual funds (hello, Vanguard). I see disproportionally little commentary about direct shares. Many Aussies have some direct share investment through major IPOs/demutualisations (Telstra, Medibank, AMP, NRMA etc). Again the differing tax treatment through franking credits and higher average yields (made even better by franking credits) feeds in to this.

Also given that Super has been compulsory for over 20 years rather than US 401k participation which is optional means that we may be more aware the effects of stock market performance on our retirement fortunes.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #13 on: February 21, 2015, 01:09:56 AM »
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
I'm not sure of this one. As people only need to pay once they reach a certain income, and it disappears when you die, ER people may find that keeping student debt forever is a financially sound alternative. I do not think it is morally sound. However, this may change if/when the government alters HECS.
There is a risk that the terms of HECS loans can be changed on current loan holders though? Please correct me if I am wrong but I believe that the government of the day could make legislative changes to make an outstanding balance at death payable from the deceased estate? 

If proposed deregulation of fees happens this does seem like a likely next step. At the moment I believe the figure is about 20% of university debt is never paid off. With deregulation that value will only increase. I'm not sure that as a country we can afford to have huge debts written off at death.

Given the amount of university debt that the government is already writing off, I'm surprised that they don't bring back more attractive bonuses for voluntary repayments.

I would repay my debt tomorrow if the 25% discount was brought back. At the moment I'm not making more than the compulsory payments (at the lowest bracket), will most likely stop working in a few years to care for children and then go back to earning a low income before retiring and carrying the balance to my grave.

A timely news story on a recent study on the low repayment rate of student loans here in Australia, supporting your claim of 20% of university loans never being repaid and an even higher 40% non-repayment rate for diploma level courses. The primary recommendation of the study is to reduce the income threshold at which you are required to start repaying the loan below the current $53,000 threshold. See: https://au.finance.yahoo.com/news/forty-per-cent-government-money-050524262.html

burrow

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #14 on: February 21, 2015, 01:25:42 AM »
"If you don't mind me asking, how does your current home stack up in a buy versus rent comparison? ie. What is the estimated value of your place now, what do you pay in overheads and how much do you think it would rent out for? Would a 3.5% SWR on the same investment amount as your house value be able to pay that rent after you've paid tax on it and the overheads are deducted?"

Oz, our house would sell at market today for about 700K but rental yield is only about 3.7% ($26K pa). Overheads (rates/insurance/maintenance etc) total about $5K pa, providing a net yield of about 3.0%. If this 700K was invested in franked Australian shares, it would generate tax-free income of about $38.5K (5.5%) based on current holdings.
« Last Edit: February 21, 2015, 01:28:30 AM by burrow »

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #15 on: February 21, 2015, 01:48:10 AM »
"If you don't mind me asking, how does your current home stack up in a buy versus rent comparison? ie. What is the estimated value of your place now, what do you pay in overheads and how much do you think it would rent out for? Would a 3.5% SWR on the same investment amount as your house value be able to pay that rent after you've paid tax on it and the overheads are deducted?"

Oz, our house would sell at market today for about 700K but rental yield is only about 3.7% ($26K pa). Overheads (rates/insurance/maintenance etc) total about $5K pa, providing a net yield of about 3.0%. If this 700K was invested in franked Australian shares, it would generate tax-free income of about $38.5K (5.5%) based on current holdings.

Your unusually low rental yield and currently high dividend return is what pushes renting way out in front of owning. At the more commonly occurring 5% or better gross rental yield for houses and the NATO standard 3.5% SWR, the odds would dip in owning's favour. I'm interested if anyone else calculates that owning beats renting in their circumstance. If not, scratch that one off my initial list!

burrow

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #16 on: February 21, 2015, 02:51:59 AM »
Oz,

Just wondering why you are comparing rental yield with SWR? I would have thought it should be compared with investment alternatives ie the 'opportunity cost' of renting and investing the difference.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #17 on: February 21, 2015, 03:16:13 AM »
Because if rent is now a living expense, like other living expenses it has to be funded by your stash for which an SWR traditionally applies.

Also, according to this website at least http://dividends.com.au/compound-returns-with-dividend-reinvestment/ , the long term average dividend yield of the Australian share market is 4%, which indicates the 5.5% dividend you are currently enjoying is above average and hence not to be relied upon as a basis for future returns.

« Last Edit: February 21, 2015, 03:51:17 AM by Ozstache »

bigchrisb

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #18 on: February 21, 2015, 04:17:41 AM »
Owning outright beats renting for me. This is because my rent would be paid out of post tax money, while my imputed rent isn't taxed. I'm on the top marginal tax rate. If I were on the bottom tax rate, renting and investing would come out on top

deborah

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #19 on: February 21, 2015, 04:20:52 AM »
Thanks Ozstashe for starting this thread!
  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.
I tend to agree that the current tax shelter is not going to exist for much longer, but my conclusion is a bit different. If I was in my early career now and earning a reasonable amount, I would put 50/50 inside/outside super as per Burrow - or more probably 30/70 - depending on how soon I was retiring. This would enable me to have it in the current tax haven for longer, and could mean that proportion of my super would remain in a better environment (if changes to super grandfather what is already there). When the new scheme came in, I would revise this. It would mean that if I had a windfall, and retired even sooner, or started to have more expenses (eg. kids), I could reduce (or 0) the amount I was putting into super and it would just get bigger.

I'm probably a bit of a pessimist, but here is the list of changes to super I think our government could be capable of initiating in future:
  • Contribution tax increased Agree
  • Withdrawal tax introduced Agree - 0% withdrawal after 60 is money for jam
  • Preservation age extended Not sure - see below
  • Lump sum withdrawals restricted or even removed Not sure - see below
  • Annuities becoming compulsory Not sure - see below
  • Residual balances being retained by government rather than your estate upon your death Already happening to a certain extent
Preservation age extended - one problem is the high number of tradies and blue collar workers who just wear out. They need the preservation age to be lower, and the tradies for one tend to be the swinging voters that each political party needs to pander. A year ago, I would have said yes, but I have changed my mind - I definitely cannot see it extended above 65.

Lump Sum withdrawals - necessary for moving to a higher level of aged care - particularly with the enormous increase that the last government placed upon people with care packages. When you do the figures, lump sum withdrawal from super is mandatory. Maybe an age limit for lump sum withdrawals - minimum age 70?

Compulsory Annuities - sitting on the fence about this - annuities are such a very poor investment at the moment. But everyone says the missing brick is how the money in your super lasts for your retirement - and annuities should be the missing brick but they need to be worthwhile.

The way superannuation is currently structured it all gradually comes out because you cannot add any after 65 or 75, and the withdrawal rates increase each year. If they stopped you from having part in pension phase and part in accumulation phase, they wouldn't need to put on a withdrawal tax because after a number of years is would all be out from under the super umbrella anyway.

One difference I have recently discovered between the US and ourselves is that we are mostly DC (I think the figure was 17% DB), whereas the US is still mostly DB (I think it is something like 60%). This makes for quite different dialogues about pensions. I don't think anywhere near as many people ever had a DB in Australia - it may possibly partly be because of our aged pension.

happy

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #20 on: February 21, 2015, 05:06:49 AM »
@Deborah: What does DB and DC stand for?
@ Ozstache - great thread.

Just over 2 years ago I worked out rent vs stay in my house in great detail and it came out in favour of staying here, even if I rented a lower standard of housing. I was a bit disappointed because I'd gotten mustache fever and with the improved cash flow by selling up and renting, I theoretically could have retired. The subsequent 2 years have seen capital gains in housing of 15 and 12%,  tax -free - woohoo! So glad I stayed put.

FFA

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #21 on: February 21, 2015, 08:37:34 AM »
Defined benefit (company takes the investment risk and pays you a fixed formula return)
Defined contribution (you take the investment risk)

deborah

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #22 on: February 21, 2015, 02:54:39 PM »
As FFA says:

Defined benefit (company takes the investment risk and pays you a fixed formula return) = pension - often relates more to the age you retire than the contributions you put in. It you leave the company before retirement you often only get what you have put in.
Defined contribution (you take the investment risk) - You invest so you get the returns on investment whenever it comes out.

happy

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #23 on: February 21, 2015, 03:02:29 PM »
Thanks, I'm familiar with both since I have super in both types. I just couldn't figure out what the abbreviations were in your sentence.

marty998

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #24 on: February 21, 2015, 04:26:28 PM »
Appears I missed the fun here yesterday!

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #25 on: February 21, 2015, 10:59:58 PM »
Great thread. I've come to the same basic conclusions and I am following a similar path and its good to get some positive reinforcement however I'm not convinced on the 3.5% SWR versus 4% SWR. With the higher dividend payout I think we could for instance get to say a 625k asset base and invest it entirely in the market and kick back living on dividends.

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #26 on: February 21, 2015, 11:42:54 PM »
Great thread. I've come to the same basic conclusions and I am following a similar path and its good to get some positive reinforcement however I'm not convinced on the 3.5% SWR versus 4% SWR. With the higher dividend payout I think we could for instance get to say a 625k asset base and invest it entirely in the market and kick back living on dividends.

You raise an interesting conflict between the results on page 21 of the Finsia report, which shows that a 2.74% SWR is the SAFEMAX100 (ie. no failures) with 100% stocks over 30 years, yet other references I have found (such as http://www.macrobusiness.com.au/2011/06/relying-on-stock-market-averages/ and http://www.finsia.com/docs/default-source/jassa-new/jassa-2006/3_2006_equity_returns.pdf?sfvrsn=6 page 20) show the long-term weighted dividend return average to be over 4%. If someone is only living off these dividends, achieving an effective 4%+ average SWR, and never selling their shares, how can their portfolio fail 6% of the time (Finsia table 5 on page 20) with 100% stocks over 40 years at exactly 4% SWR?

One possibility is that if you retired just when the short-term dividend yield dropped below 4%, you would have to draw down on your capital to maintain the 4% SWR. Perhaps that draw down permanently injures your capital base such that a continued 4% SWR draws it down to nothing, even after dividend yields climb over 4% again. ie the sequence of return monster gets you.

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #27 on: February 22, 2015, 12:41:23 AM »
Nice thread. I appreciate the enthusiastic debate.

Regarding HECS, no matter which way I run the numbers, at present I can't justify making voluntary repayments. A 5% bonus is just not sufficient motivation. I think if I applied for a mortgage my (large-ish) HECS debt would be taken into consideration as it affects my take-home pay (presently, it's taken out at about 7% of my income, I think) which may be a motivator for some. In terms of the potential to change the repayment 'rules', I agree that there's some risk. My solution is to have the funds sitting elsewhere, making more in interest/dividends than the indexing that HECS-HELP debts are subjected to... and if for some reason due to government legislation it becomes advantageous to pay it all off, I can do it quickly. Probably with a rewards credit card, as the ATO accepts credit card payments.

Super? I'm 30, so I'm counting on the situation being different by the time I can access it, which is more than 20 terms away...

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #28 on: February 22, 2015, 12:55:06 AM »
Great thread. I've come to the same basic conclusions and I am following a similar path and its good to get some positive reinforcement however I'm not convinced on the 3.5% SWR versus 4% SWR. With the higher dividend payout I think we could for instance get to say a 625k asset base and invest it entirely in the market and kick back living on dividends.

You raise an interesting conflict between the results on page 21 of the Finsia report, which shows that a 2.74% SWR is the SAFEMAX100 (ie. no failures) with 100% stocks over 30 years, yet other references I have found (such as http://www.macrobusiness.com.au/2011/06/relying-on-stock-market-averages/ and http://www.finsia.com/docs/default-source/jassa-new/jassa-2006/3_2006_equity_returns.pdf?sfvrsn=6 page 20) show the long-term weighted dividend return average to be over 4%. If someone is only living off these dividends, achieving an effective 4%+ average SWR, and never selling their shares, how can their portfolio fail 6% of the time (Finsia table 5 on page 20) with 100% stocks over 40 years at exactly 4% SWR?

One possibility is that if you retired just when the short-term dividend yield dropped below 4%, you would have to draw down on your capital to maintain the 4% SWR. Perhaps that draw down permanently injures your capital base such that a continued 4% SWR draws it down to nothing, even after dividend yields climb over 4% again. ie the sequence of return monster gets you.

The only area to fail would be if dividends were cut which could mean going to nothing. I'm still paying off my house but I have money in super. I think when we start investing outside of super we will basically invest 100% in the stock market via a low cost etf. Once we reach the base level amount where dividends support a massive part of our living expenses (we might make it 100%) we will then save something on the side in cash/fixed interest/bonds as a buffer.

The only issue I have with what I just posted is that I do like the idea of holding some commodities and re-balancing every so often. I figure that this is a safe way to ensure you buy low and sell high.

johnnydoe

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #29 on: February 22, 2015, 02:24:40 AM »
Car expenses. On the living expenses side of early retirement, for those that need a car, the RACQ releases a yearly guide on what cars have been the cheapest to operate and maintain. I used it to figure out which car would suit my needs, then bought it second hand.

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #30 on: February 22, 2015, 02:36:44 AM »
Excellent idea for a thread. Replying to subscribe. I think you covered most of the points already.

One further that immediately springs to mind is the whole area of Fixed Interest / Cash for saving and defensive investment allocation.

I would say, Australians typically hold less in bonds (?) since online saver accounts can be found with comparable interest rates, there are also competitive term deposits available (analogous to CD's elsewhere), and Australian investors might have more residential property in their portfolio which can also provide relatively fixed income and inflation hedge. So when you see typical portfolios described here eg 60/40 stocks/bonds, an Australian equivalent might also hold this "bonds" chunk in other cash/FI assets and the percentage may be a bit lower if offset by investment property holdings.

That's interesting, because it means that a significant proportion of any Australian asset allocation is pretty much always going to be liquid. With the high interest savings accounts.

Also, when it comes to residential property, are you talking REITs or being landlords?

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #31 on: February 22, 2015, 03:42:29 AM »
Also, when it comes to residential property, are you talking REITs or being landlords?
I had landlords in mind, but even if you throw in reits and I believe the asx itself has a higher exposure to property (Westfield holdings et al) than most other indices.

dungoofed

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #32 on: February 22, 2015, 04:53:59 AM »
Put "Australia" in the title and watch all the Aussies jump in lol. But I guess it proves that there is a massive shortage of good information out there, and it makes me wonder how bad it must be for other countries where there is even less information/transparency/etc. 

skyrefuge - thanks for bringing some diversity :-P

  • A 3.5%, not 4%, SWR is a more suitable mid-point target for the Australian investing environment. A 3.5% SWR in Australia with a 50/50 allocation over a 30 year period has historically provided the 95% success rate many aim for. References: http://wpfau.blogspot.com.au/search?q=australia+safe+withdrawal+rate and http://www.finsia.com/docs/default-source/Retirement-Risk-Zone/how-safe-are-safe-withdrawal-rates-in-retirement-an-australian-perspective.pdf?sfvrsn=2 page 21
  • Living off dividends. Entirely practical with Australian stocks as SWR-like dividend rates are easily achievable and franking credits commonly available provide a tax baseline of 30% company tax already paid which significantly reduces, and in some cases eliminates, your personal tax liability.
  • Owning rather than renting your home. Accommodation savings achieved by owning your own home, especially when owned outright, generally exceeds the opportunity cost of investing house capital elsewhere. Also own-home capital gains are tax free and have historically tracked at inflation or better (in many cases much better). Eg. Where I live, $550K can either buy a house that would rent out for $550 per week or be invested to yield $370 a week before tax @ 3.5% SWR. Even after $5K pa overheads (rates, maintenance, insurance) for owning the house, ie. ~ $100 per week, I am still better off by $80 per week by owning.
  • Paying off own-home mortgage. Provides an excellent tax-free ROI due to relatively higher mortgage and personal income tax rates in Australia AND progressively improves the own savings side of the own versus rent equation.
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
  • Investing in super (retirement) funds. While super is tax effective for now, it isnít accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.

You've definitely hit some of the big ones. Apart from the other suggestions so far I would consider adding:

1) high transaction costs for investing. Average $15 trades, with spreads and MERs that make me want to cry. These have come down a lot but they still have a way to go.

2) pitiful bond market.

3) A decent interest rate on savings (but as we are seeing in recent years this is being eroded at the whim of the government. Also I just saw FFA mentioned this, but I don't want to re-number my bullets).

4) lack of tax-free Municipal Bonds ("munis").

5) lowest tax bracket starts at $18,000. That's $36,000 tax free income for a couple.

6) However there are less (different?) loopholes for reducing tax.

7) Less world-class, market-leading companies on the ASX. Also slightly different fundamentals, which makes analysing companies more challenging as a lot of the writing out there is specifically for the US market.

8) Treatment of bequeathed assets (still investigating this).

Regarding renting vs owning, I'm still in Japan at the moment but when I go back as much as I'd like to have my own house I think I'll probably rent as I already have a lot of exposure to the property market by proxy through my parents.


Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #33 on: February 22, 2015, 11:49:38 AM »
I have noted a considerable number of Australians now participating in these forums, and quite a few new ones recently at that. I therefore thought it may be worth putting up a post pointing out where Australian and USA mustachian philosophies tend to vary due to country differences that would be worthwhile for Australian forum participants to be aware of. This list is neither exhaustive nor absolute and I encourage others to query and add to what I have put up.

  • A 3.5%, not 4%, SWR is a more suitable mid-point target for the Australian investing environment. A 3.5% SWR in Australia with a 50/50 allocation over a 30 year period has historically provided the 95% success rate many aim for. References: http://wpfau.blogspot.com.au/search?q=australia+safe+withdrawal+rate and http://www.finsia.com/docs/default-source/Retirement-Risk-Zone/how-safe-are-safe-withdrawal-rates-in-retirement-an-australian-perspective.pdf?sfvrsn=2 page 21
  • Living off dividends. Entirely practical with Australian stocks as SWR-like dividend rates are easily achievable and franking credits commonly available provide a tax baseline of 30% company tax already paid which significantly reduces, and in some cases eliminates, your personal tax liability.
  • Owning rather than renting your home. Accommodation savings achieved by owning your own home, especially when owned outright, generally exceeds the opportunity cost of investing house capital elsewhere. Also own-home capital gains are tax free and have historically tracked at inflation or better (in many cases much better). Eg. Where I live, $550K can either buy a house that would rent out for $550 per week or be invested to yield $370 a week before tax @ 3.5% SWR. Even after $5K pa overheads (rates, maintenance, insurance) for owning the house, ie. ~ $100 per week, I am still better off by $80 per week by owning.
  • Paying off own-home mortgage. Provides an excellent tax-free ROI due to relatively higher mortgage and personal income tax rates in Australia AND progressively improves the own savings side of the own versus rent equation.
  • Paying off student loans. Student debt amounts for Australian universities are comparably lower than the USA due to government subsidised education. Also, the debt is indexed at CPI, meaning most other debts are more pressing to pay off. As such, paying down student loan is still a priority, just not a high one.
  • Investing in super (retirement) funds. While super is tax effective for now, it isn’t accessible to early retirees and, due to likely government manipulation in the near future, is at risk of being more restrictive to access and becoming taxable for future retirees. As such, it is critical to have enough retirement funds outside of super to fund your interim retirement period until preservation age and to mitigate these risks.

Many of these points just seem off to me.

Living off dividends.  The typical response to this is "Dividends are mathematically equivalent to selling stock", but no one in the thread pointed this out yet...so I thought I'd investigate.  It seems that while they are mathematically equivalent, they have different tax rates when dealing with dividends from Australian stocks.  A "franking tax credit" of 30% is applied.  Let's see how the math works out on that:

I'm going to assume most Australians are in the 32.5% tax bracket.



James owns shares in a company. The company pays him a fully franked dividend of $700. His dividend statement says there is a franking credit of $300. This represents the tax the company has already paid. This means the dividend, before company tax was deducted, would have been $1,000 ($700 + $300).

Come tax time, James must declare $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 32.5%, he would have paid $325 tax on the dividend. Because the company has already paid $300 in tax, James will pay the difference, which is $25.  So his total dividend received is $675.

Vanguard's Total Australia Index currently has a dividend yield of 3.9%.  When we include the franking tax credit for someone in the 32.5% income bracket, that's a 3.8% after tax dividend yield.  Ok that's interesting.  Not spectacular, but interesting.  How does this compare to normal capital gains in Australia?

Australia long-term capital gains are taxed at 50% of your income tax bracket.  So 16.25% for our hypothetical investor James.  He would have to sell $806 worth of stock, to receive $675 after paying capital gains taxes.  While dividends are mathematically equal to selling stock, unlike in the US, their Australian after tax return is not equal.  James has to sell $806 of stock to match the $700 dividend, for a $106 difference, or about 15%.  So now for the big question, how much is this benefit worth?

The best information I can find, shows that Australia's cap weight is about 2% of the world:



Australasia includes a few other countries, so let's just go with 2%.  Is it worth overweighting 2% of the world's economy, to gain a 15% boost on a 3.9% dividend?  I don't think so.  The Australian economy is very small, and very concentrated in a few big industries.  Vanguard's Total Australia Index only holds 300 stocks, while their total world funds (VTS and VEU) hold 6,000 stocks combined (Source: https://www.vanguardinvestments.com.au/institutional/jsp/investments/etfs.jsp#etfstab).  People commonly post strategies which have slightly better dividend yields, much less diversification, and overweight specific sectors.  These strategies are almost universally panned here.  I don't think this is any different.  In my opinion, the comparatively small benefit is not worth the risk of having a portfolio which isn't diversified.

A 3.5%, not 4%, SWR is a more suitable mid-point target for the Australian investing environment.  As Skyrefuge points out above, using 50/50 stocks/bonds doesn't get to a 4% safe withdrawal rate in the US either.  And when you up it to 75/25 stocks/bonds, Australia's SWR is actually better than the US.

Owning rather than renting your home.  This point doesn't make much sense to me.  You aren't doing the right comparison.  First you acknowledge your home will only increase at about the level of inflation, but then instead of comparing that number to the expected stock market return on $550,000, you compare it to rental income?  Then compare that rental income to a 3.5% safe return rate?  You seem to be all over the place here.
  • If you can rent the same house for $550 a week, that's what you need to be comparing it to.  Renting vs Buying.  Is it better to buy a house for $550,000 and live in it, or rent the same house for $550 a week and invest the difference?  The answer will depend on your mortgage interest, downpayment, property taxes, insurance...etc.  A 20% downpayment alone ($110,000) is expected to compound to about $450,000 after 15 years if you invested it instead.  I don't have all the variables, but it looks like renting comes out way ahead here.
  • Using the safe withdrawal rate to calculate yield doesn't make sense, especially when you're in the accumulation phase, which I suspect you are.  If you have $550,000 invested in a world market, you can expect a yearly average return of somewhere between 9-11%.  In other words, your investment is expected to just about double after 7 years.  Throwing money at an asset which only grows with inflation, is nowhere close to this.  When viewed in isolation, paying 5% mortgage interest to throw money at an asset which only grows with inflation, is just silly.  Do the math and see if it makes sense vs renting, but don't trick yourself into thinking of your home as an investment.  Why your house is a terrible investment
« Last Edit: February 22, 2015, 01:14:55 PM by Dodge »

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #34 on: February 22, 2015, 12:39:43 PM »
"Come tax time, James must declare $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 32.5%, he would have paid $325 tax on the dividend. Because the company has already paid $300 in tax, James will receive a refund of the difference, which is $25.  So his total dividend received is $725".


Dodge, I think you meant that James would need to pay $25 in tax (the difference between the two), so his total dividend received is $675. His marginal tax rate would need to be less than 30% to receive a refund.

Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #35 on: February 22, 2015, 01:01:04 PM »
"Come tax time, James must declare $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 32.5%, he would have paid $325 tax on the dividend. Because the company has already paid $300 in tax, James will receive a refund of the difference, which is $25.  So his total dividend received is $725".


Dodge, I think you meant that James would need to pay $25 in tax (the difference between the two), so his total dividend received is $675. His marginal tax rate would need to be less than 30% to receive a refund.

Correct!  I thought that sounded weird.  I'll edit the post.  Thanks!

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #36 on: February 22, 2015, 01:51:23 PM »
A couple of points that I can see:-

1. Franked dividends will lead to a rebate up to $37k income. Past that income level you will have to pay back a small percentage. So if you earned $40k in dividends you could receive an additional tax rebate every year.
2. Housing in Australia has had really good returns. I'm not sure if you can compare house price rises just to inflation. I'd add that owning your own house adds to a diversified portfolio. In the stock market drops in value you still have your house.
3. I never realized that the 4% rule was a 72/25 stock/bonds asset allocation. This probably means that for anyone contemplating ER they need to have some buffer in there figures somehow. That might mean owning property, getting to a lower WR or having the ability to cut expenses if required. It could also mean going to a 100% stock allocation however my issue with this is twofold. One - if the market tanks you might not be able to ride it out and the drawdown at that point could mean going back to work. Two - I like having some cash in your portfolio in order to re-balance as I think it will help you sell high and buy low even if it is a small percentage of your portfolio.
« Last Edit: February 22, 2015, 01:54:49 PM by steveo »

Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #37 on: February 22, 2015, 02:23:30 PM »
A couple of points that I can see:-

1. Franked dividends will lead to a rebate up to $37k income. Past that income level you will have to pay back a small percentage. So if you earned $40k in dividends you could receive an additional tax rebate every year.
2. Housing in Australia has had really good returns. I'm not sure if you can compare house price rises just to inflation. I'd add that owning your own house adds to a diversified portfolio. In the stock market drops in value you still have your house.
3. I never realized that the 4% rule was a 72/25 stock/bonds asset allocation. This probably means that for anyone contemplating ER they need to have some buffer in there figures somehow. That might mean owning property, getting to a lower WR or having the ability to cut expenses if required. It could also mean going to a 100% stock allocation however my issue with this is twofold. One - if the market tanks you might not be able to ride it out and the drawdown at that point could mean going back to work. Two - I like having some cash in your portfolio in order to re-balance as I think it will help you sell high and buy low even if it is a small percentage of your portfolio.

2.  Expecting a higher than inflation return, from an asset class which over the long term rises only with inflation, is a recipe for disaster.  If the stock market drops in value you still have your stocks.  And your bonds.  Don't trick yourself into thinking your house is an investment.  It's not.  It can act as an inflation hedge, and it can make sense to buy instead of rent in some areas, but it's not part of your investment portfolio.

3.  Why would you need an additional buffer?  When the 4% rule is calculated, there is no additional buffer, and it works out fine.  This is the whole point of the Trinity Study, to determine a worst-case-scenario withdrawal rate.  The vast majority of retirement years can support a higher than 4% withdrawal rate, the 4% is the buffer.

dungoofed

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #38 on: February 22, 2015, 02:31:53 PM »
Hi Dodge - thanks for the post highlighting the difference in returns thanks to dividend franking. I'd only add that there are other reasons for having a slight home bias, eg as a hedge against the case where your home economy is the only economy doing well on the global scale at the time you retire.

Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #39 on: February 22, 2015, 02:41:34 PM »
Hi Dodge - thanks for the post highlighting the difference in returns thanks to dividend franking. I'd only add that there are other reasons for having a slight home bias, eg as a hedge against the case where your home economy is the only economy doing well on the global scale at the time you retire.

The most compelling reason for a home bias, is to avoid currency risk.  When your home country only represents 2% of the world economy, I believe the risks outweigh the benefits.  Any attempt to overweight your home country, because you think it might outperform, is just market timing. 

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #40 on: February 22, 2015, 05:47:02 PM »
Living off dividends.  The typical response to this is "Dividends are mathematically equivalent to selling stock", but no one in the thread pointed this out yet...so I thought I'd investigate.  It seems that while they are mathematically equivalent, they have different tax rates when dealing with dividends from Australian stocks.  A "franking tax credit" of 30% is applied.  Let's see how the math works out on that:

I'm going to assume most Australians are in the 32.5% tax bracket.



James owns shares in a company. The company pays him a fully franked dividend of $700. His dividend statement says there is a franking credit of $300. This represents the tax the company has already paid. This means the dividend, before company tax was deducted, would have been $1,000 ($700 + $300).

Come tax time, James must declare $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 32.5%, he would have paid $325 tax on the dividend. Because the company has already paid $300 in tax, James will pay the difference, which is $25.  So his total dividend received is $675.

Vanguard's Total Australia Index currently has a dividend yield of 3.9%.  When we include the franking tax credit for someone in the 32.5% income bracket, that's a 3.8% after tax dividend yield.  Ok that's interesting.  Not spectacular, but interesting.  How does this compare to normal capital gains in Australia?

Australia long-term capital gains are taxed at 50% of your income tax bracket.  So 16.25% for our hypothetical investor James.  He would have to sell $806 worth of stock, to receive $675 after paying capital gains taxes.  While dividends are mathematically equal to selling stock, unlike in the US, their Australian after tax return is not equal.  James has to sell $806 of stock to match the $700 dividend, for a $106 difference, or about 15%.  So now for the big question, how much is this benefit worth?

The best information I can find, shows that Australia's cap weight is about 2% of the world:



Australasia includes a few other countries, so let's just go with 2%.  Is it worth overweighting 2% of the world's economy, to gain a 15% boost on a 3.9% dividend?  I don't think so.  The Australian economy is very small, and very concentrated in a few big industries.  Vanguard's Total Australia Index only holds 300 stocks, while their total world funds (VTS and VEU) hold 6,000 stocks combined (Source: https://www.vanguardinvestments.com.au/institutional/jsp/investments/etfs.jsp#etfstab).  People commonly post strategies which have slightly better dividend yields, much less diversification, and overweight specific sectors.  These strategies are almost universally panned here.  I don't think this is any different.  In my opinion, the comparatively small benefit is not worth the risk of having a portfolio which isn't diversified.

While most Australians are likely in higher tax brackets during the accumulation phase, thus validating your point, they should drop a bracket or two in the retirement phase. In my case, our dividend paying shares are in my wife's name and she is in the 19c tax bracket. As such, she actually receives an 11% tax credit on the dividends she receives, pushing that 3.9% yield up to 4.3%. When my wife retires too, she will be under the tax free threshold meaning a 30% tax credit giving a 5.1% equivalent yield. In short, the less you earn and the more you can balance your dividends out to favour the most tax-advantage partner in a couple, the more amplified the benefits of franking become.

Your point about Australia only representing about 2% of world stocks is also noted, however currency risk (which you note in a later post), the 'unknown' of international markets and tax implications of capital gains and dividends from international shares deter Aussies from diversifying too much into them. Furthermore, if you are already achieving your desired SWR, and then, some using tax-advantaged dividends from a stock market that is small but has proven to be diversified enough to withstand the world's major financial shocks over the last century, why take on much more risk and complexity than you have to? Sure, past performance doesn't necessarily indicate future performance, but the same can be said for all world stock markets. (FWIW, I hold about 16.5% international shares in my portfolio, compliments of the balanced mix in my super fund, and am comfortable with this)

In summary, I still consider that living off dividends sourced mainly from the Australian share market is a relevant retirement income strategy for Australians.
« Last Edit: February 22, 2015, 07:10:42 PM by Ozstache »

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #41 on: February 22, 2015, 06:36:46 PM »
Owning rather than renting your home.  This point doesn't make much sense to me.  You aren't doing the right comparison.  First you acknowledge your home will only increase at about the level of inflation, but then instead of comparing that number to the expected stock market return on $550,000, you compare it to rental income?  Then compare that rental income to a 3.5% safe return rate?  You seem to be all over the place here.
  • If you can rent the same house for $550 a week, that's what you need to be comparing it to.  Renting vs Buying.  Is it better to buy a house for $550,000 and live in it, or rent the same house for $550 a week and invest the difference?  The answer will depend on your mortgage interest, downpayment, property taxes, insurance...etc.  A 20% downpayment alone ($110,000) is expected to compound to about $450,000 after 15 years if you invested it instead.  I don't have all the variables, but it looks like renting comes out way ahead here.
  • Using the safe withdrawal rate to calculate yield doesn't make sense, especially when you're in the accumulation phase, which I suspect you are.  If you have $550,000 invested in a world market, you can expect a yearly average return of somewhere between 9-11%.  In other words, your investment is expected to just about double after 7 years.  Throwing money at an asset which only grows with inflation, is nowhere close to this.  When viewed in isolation, paying 5% mortgage interest to throw money at an asset which only grows with inflation, is just silly.  Do the math and see if it makes sense vs renting, but don't trick yourself into thinking of your home as an investment.  Why your house is a terrible investment

The reason I chose SWR as the opportunity cost 'opponent' was firstly because it removes the ability to cherry pick the best performing part of your portfolio to compare against housing and hence bias the comparison in renting's favour. Secondly, I was primarily considering the retirement phase, where it would be your SWR funding either your rent or, if you owned, your overheads.

Also, it seems I implied that Aussie housing only barely beats inflation. Over the last decade at least, Australian property has actually bettered inflation by more than 3% pa (Reference: http://www.asx.com.au/documents/resources/russell-asx-2014-long-term-investing-report.pdf page 3 exhibit 1). While I personally believe that this is unsustainable long term, I continue to be proven wrong and therefore cannot ignore the wealth-enhancing impact it has had on Australians.

Re doing the math, I have read that JL Collins webpage and I have had a good play with Australian numbers against those assessment parameters and have found that the Australian owning argument is more favourable than our USA counterparts, hence me posting this point in my list. Let me go back and re-crunch the numbers and have another go at trying to illustrate this with a representative example for  both the accummulation and retirement phases.

FFA

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #42 on: February 22, 2015, 07:04:11 PM »
Hi Dodge - thanks for the post highlighting the difference in returns thanks to dividend franking. I'd only add that there are other reasons for having a slight home bias, eg as a hedge against the case where your home economy is the only economy doing well on the global scale at the time you retire.

The most compelling reason for a home bias, is to avoid currency risk.  When your home country only represents 2% of the world economy, I believe the risks outweigh the benefits.  Any attempt to overweight your home country, because you think it might outperform, is just market timing.
I thought this vanguard paper does a good job of covering home bias and conveniently has a "hypothetical" case of an Australian investor deciding on foreign equity allocation (figure 11). While this is only illustrative, I think the outcome is probably realistic for many people and ends up somewhere in the middle between typical allocation and market proportional.

https://pressroom.vanguard.com/content/nonindexed/6.26.2012_The_Role_of_Home_Bias.pdf

Taking a look at Self Managed Super Fund (SMSF) asset allocations as of sep'14 : 42% Australian shares / 12% international. This data is consistent with Vanguards, showing people are having massive home bias in their super portfolio. And international shares were only 9% in sep'13, so it's actually been improving too (most likely due to AUD depreciation rather than investors intentionally investing more capital into international shares!).

Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #43 on: February 22, 2015, 07:11:22 PM »
While most Australians are likely in higher tax brackets during the accumulation phase, thus validating your point, they should drop a bracket or two in the retirement phase. In my case, our dividend paying shares are in my wife's name and she is in the 19c tax bracket. As such, she actually receives an 11% tax credit on the dividends she receives, pushing that 3.9% yield up to 4.3%. When my wife retires too, she will be under the tax free threshold meaning a 30% tax credit giving a 5.1% equivalent yield. In short, the less you earn and the more you can balance your dividends out to favour the most tax-advantage partner in a couple, the more amplified the benefits of franking become.

Your point about Australia only representing about 2% of world stocks is also noted, however currency risk (which you note in a later post) and tax implications of capital gains and dividends from international shares deter Aussies from significantly diversifying too much into them. Furthermore, if you are already achieving your desired SWR, and then, some using tax-advantaged dividends from a stock market that is small but has proven to be diversified enough to withstand the world's major financial shocks over the last century, why take on much more risk and complexity than you have to? Sure, past performance doesn't necessarily indicate future performance, but the same can be said for all world stock markets. (FWIW, I hold about 16.5% international shares in my portfolio, compliments of the balanced mix in my super fund, and am comfortable with this)

In summary, I still consider that living off dividends sourced mainly from the Australian share market is a relevant retirement income strategy for Australians.

We'll just have to agree to disagree then :)

Can you name an economy that didn't withstand the world's major financial shocks over the last century?  I don't think that's a very good qualifier.  Looking at how the Australian stock index handled our last financial shock:



I don't see anything special here.  It fell 50% just like everyone else, but it hasn't caught back up yet.  If the Australian stock index rises 15% this year, it will still only match the pre-crash level.  Had you been invested in a world portfolio, you would have already recovered from the biggest financial shock of our generation back in 2013, and your portfolio would now be seeing record highs.

Australia's economy is very heavily weighted towards a few sectors.  68% of Australia's economy is its Services sector (mostly Finance), while 19% is its Mining sector.  These are very heavy bets, which I wouldn't be comfortable taking, especially for the sake of an extra 1.2 percentage points of dividend.  It doesn't really matter how the returns get to you, dividend or selling stock, does't matter.  It seems you think you're taking the safe route by using dividends, but you couldn't be further from the truth.  Seriously, look through the many threads here with newbies proposing ideas for 100% high-dividend-yield sector-weighted un-diversified dividend stocks for their retirement portfolio.  They are unanimously shut down.  All the same arguments apply here.

Let's examine her situation more closely.  It looks like only 63% of dividends from the Australian Stock Index included Frank credits last year:



Source: http://www.watoday.com.au/business/markets/quotes/dividends/VAS/vanguard-australian-shares-index-etf

If she's in the 19% tax bracket, a $700 dividend would end up paying her $810 with a full franking credit, but using the 2014 numbers, the dividend would've been $699 (yes she would've ended up owing $1).  To receive $699 by selling stocks, she'd have to sell $772 worth of stocks.  That's about a 10% boost in dividends.  It looks like I'm going to have to redo the numbers from my previous post!

In my opinion, you are not being compensated for the incredible risk you're taking.  Considering this is an early retirement portfolio, I'd think long and hard before committing to that bet.

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #44 on: February 22, 2015, 07:18:39 PM »
In summary, I still consider that living off dividends sourced mainly from the Australian share market is a relevant retirement income strategy for Australians.

When you add the possible benefit of franking credits I think its a solid strategy.

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #45 on: February 22, 2015, 07:25:18 PM »
2.  Expecting a higher than inflation return, from an asset class which over the long term rises only with inflation, is a recipe for disaster.  If the stock market drops in value you still have your stocks.  And your bonds.  Don't trick yourself into thinking your house is an investment.  It's not.  It can act as an inflation hedge, and it can make sense to buy instead of rent in some areas, but it's not part of your investment portfolio.

I don't believe that these comments are really accurate. I'm not sure that housing has returned historically the rate of inflation. Housing has made people rich in Australia.

As for your house not being an investment of course it is. If I sell my house for $1 million dollars does that money count as an investment ? I'm not stating that you count it as part of your FI asset portfolio but its definitely an investment. The question is really how good of an investment is housing. I'm not sure about this however I think owning the house you live in has several advantages over renting. On the flip side I can't see myself ever buying an investment property. I don't believe it makes sense in Australia.

3.  Why would you need an additional buffer?  When the 4% rule is calculated, there is no additional buffer, and it works out fine.  This is the whole point of the Trinity Study, to determine a worst-case-scenario withdrawal rate.  The vast majority of retirement years can support a higher than 4% withdrawal rate, the 4% is the buffer.

This is a tougher one. My understanding from the above posts is that the 4% wr does not provide a 95% or above success for a retirement equal to 40 years if you have a 50/50 stock bond asset allocation. Therefore you need to have an asset allocation of 75% stocks and 25% bonds/cash. Having a different asset allocation increases your risk of some form of failure. For those of use looking to retire for longer than 40 years I think we need some increased buffer. I can see your point on this but I suppose it comes down to how each of us feel with regards to the risk and our retirement portfolio.
« Last Edit: February 22, 2015, 07:30:11 PM by steveo »

Dodge

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #46 on: February 22, 2015, 07:30:05 PM »
Owning rather than renting your home.  This point doesn't make much sense to me.  You aren't doing the right comparison.  First you acknowledge your home will only increase at about the level of inflation, but then instead of comparing that number to the expected stock market return on $550,000, you compare it to rental income?  Then compare that rental income to a 3.5% safe return rate?  You seem to be all over the place here.
  • If you can rent the same house for $550 a week, that's what you need to be comparing it to.  Renting vs Buying.  Is it better to buy a house for $550,000 and live in it, or rent the same house for $550 a week and invest the difference?  The answer will depend on your mortgage interest, downpayment, property taxes, insurance...etc.  A 20% downpayment alone ($110,000) is expected to compound to about $450,000 after 15 years if you invested it instead.  I don't have all the variables, but it looks like renting comes out way ahead here.
  • Using the safe withdrawal rate to calculate yield doesn't make sense, especially when you're in the accumulation phase, which I suspect you are.  If you have $550,000 invested in a world market, you can expect a yearly average return of somewhere between 9-11%.  In other words, your investment is expected to just about double after 7 years.  Throwing money at an asset which only grows with inflation, is nowhere close to this.  When viewed in isolation, paying 5% mortgage interest to throw money at an asset which only grows with inflation, is just silly.  Do the math and see if it makes sense vs renting, but don't trick yourself into thinking of your home as an investment.  Why your house is a terrible investment

The reason I chose SWR as the opportunity cost 'opponent' was firstly because it removes the ability to cherry pick the best performing part of your portfolio to compare against housing and hence bias the comparison in renting's favour. Secondly, I was primarily considering the retirement phase, where it would be your SWR funding either your rent or, if you owned, your overheads.

Also, it seems I implied that Aussie housing only barely beats inflation. Over the last decade at least, Australian property has actually bettered inflation by more than 3% pa (Reference: http://www.asx.com.au/documents/resources/russell-asx-2014-long-term-investing-report.pdf page 3 exhibit 1). While I personally believe that this is unsustainable long term, I continue to be proven wrong and therefore cannot ignore the wealth-enhancing impact it has had on Australians.

Re doing the math, I have read that JL Collins webpage and I have had a good play with Australian numbers against those assessment parameters and have found that the Australian owning argument is more favourable than our USA counterparts, hence me posting this point in my list. Let me go back and re-crunch the numbers and have another go at trying to illustrate this with a representative example for  both the accummulation and retirement phases.

I don't think it's wise to count on the last decade of housing gains, when over the long term it has only risen with inflation.

"Secondly, I was primarily considering the retirement phase, where it would be your SWR funding either your rent or, if you owned, your overheads."

It's still not a valid comparison.  If you own a $550,000 house, the maintenance alone is estimated to be 1-2% ($5,500 - 11,000).  Then you add insurance and property taxes...etc, on top of that.  Do the math, and you'll see that investing the full $550,000 and renting, beats spending $550,000 on a house and finding alternate income to pay for maintenance...etc.  Especially when you consider the portfolio would likely grow much faster than inflation, even with the 4% withdrawals.
« Last Edit: February 22, 2015, 07:33:37 PM by Dodge »

FFA

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #47 on: February 22, 2015, 07:48:12 PM »
  • Owning rather than renting your home. .....

A debate that seems to polarise! We own our own home but all the research I have read tends to suggest that residential property is not a good investment long-term, compared to alternatives. I don't count our home as an asset, but then I don't count implied rent as an expense either.

Conversely, security of tenure, the psychological benefits of ownership, family stability, enforced savings (for less well disciplined money managers) and creative license are very good reasons to own.
For the rent vs own, obviously it depends on personal circumstances, marginal tax rate etc as others pointed out.

If we are generalizing, I'd agree with the above points. Pen and paper exercise usually favours renting, but for my own case and if asked by others, I would usually suggest to own for the list of reasons above (IMO enforced savings is the key benefit for most people, it doesn't show up in the pen & paper exercise though!)

Ozstache

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #48 on: February 22, 2015, 08:01:35 PM »
Owning rather than renting your home.  This point doesn't make much sense to me.  You aren't doing the right comparison.  First you acknowledge your home will only increase at about the level of inflation, but then instead of comparing that number to the expected stock market return on $550,000, you compare it to rental income?  Then compare that rental income to a 3.5% safe return rate?  You seem to be all over the place here.
  • If you can rent the same house for $550 a week, that's what you need to be comparing it to.  Renting vs Buying.  Is it better to buy a house for $550,000 and live in it, or rent the same house for $550 a week and invest the difference?  The answer will depend on your mortgage interest, downpayment, property taxes, insurance...etc.  A 20% downpayment alone ($110,000) is expected to compound to about $450,000 after 15 years if you invested it instead.  I don't have all the variables, but it looks like renting comes out way ahead here.
  • Using the safe withdrawal rate to calculate yield doesn't make sense, especially when you're in the accumulation phase, which I suspect you are.  If you have $550,000 invested in a world market, you can expect a yearly average return of somewhere between 9-11%.  In other words, your investment is expected to just about double after 7 years.  Throwing money at an asset which only grows with inflation, is nowhere close to this.  When viewed in isolation, paying 5% mortgage interest to throw money at an asset which only grows with inflation, is just silly.  Do the math and see if it makes sense vs renting, but don't trick yourself into thinking of your home as an investment.  Why your house is a terrible investment

The reason I chose SWR as the opportunity cost 'opponent' was firstly because it removes the ability to cherry pick the best performing part of your portfolio to compare against housing and hence bias the comparison in renting's favour. Secondly, I was primarily considering the retirement phase, where it would be your SWR funding either your rent or, if you owned, your overheads.

Also, it seems I implied that Aussie housing only barely beats inflation. Over the last decade at least, Australian property has actually bettered inflation by more than 3% pa (Reference: http://www.asx.com.au/documents/resources/russell-asx-2014-long-term-investing-report.pdf page 3 exhibit 1). While I personally believe that this is unsustainable long term, I continue to be proven wrong and therefore cannot ignore the wealth-enhancing impact it has had on Australians.

Re doing the math, I have read that JL Collins webpage and I have had a good play with Australian numbers against those assessment parameters and have found that the Australian owning argument is more favourable than our USA counterparts, hence me posting this point in my list. Let me go back and re-crunch the numbers and have another go at trying to illustrate this with a representative example for  both the accummulation and retirement phases.

I don't think it's wise to count on the last decade of housing gains, when over the long term it has only risen with inflation.

"Secondly, I was primarily considering the retirement phase, where it would be your SWR funding either your rent or, if you owned, your overheads."

It's still not a valid comparison.  If you own a $550,000 house, the maintenance alone is estimated to be 1-2% ($5,500 - 11,000).  Then you add insurance and property taxes...etc, on top of that.  Do the math, and you'll see that investing the full $550,000 and renting, beats spending $550,000 on a house and finding alternate income to pay for maintenance...etc.  Especially when you consider the portfolio would likely grow much faster than inflation, even with the 4% withdrawals.

It has been far more than a decade that housing gains in Australia have outstripped inflation ie. more like half a century. The capital gains tax free treatment of your own home has gone a long way towards contributing to this. In any case, I use inflation as future house price growth rate in my calculations, as I expect it will one day become a reality.

You need to take your USA hat off when looking at Australian property overhead costs. There are no property taxes on your own home in Australia and maintenance costs being 1-2% of a property value becomes far too high an estimate when housing is just more expensive as a procurement number rather than physically costing that much to maintain. There are not too many people, myself included, who would spend over $5000 TOTAL for all housing overheads in a year for a house around $550K in value they own outright. As I said, I will run some representative calculations to demonstrate my point and post them up later.
« Last Edit: February 22, 2015, 08:29:22 PM by Ozstache »

steveo

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Re: Australia/USA Mustachian Philosophy Differences
« Reply #49 on: February 22, 2015, 08:28:17 PM »
It has been far more than a decade that housing gains in Australia have outstripped inflation ie. more like half a century. The capital gains tax free treatment of your own home has gone a long way towards contributing to this.

I don't have the stats but I think it must be much more like a 50 year out performance. Expecting the return to be inflation like is unrealistic based on past performance. You may as well state stocks should never outperform inflation.

I'm not really a fan of property investment mainly due to the massive cost involved in purchasing property however I think owning your own home has several advantages. If property continues to perform as it has in the past I think its a great hedge against rising rents.