Australian 100% of stash in cash. Ready to invest..can't see any value rightnow?

[mymatenate]

First, some background:

I’m 28 years old, Australian. I’ve been living a Mustachian lifestyle for quite a few years now, and over this time I’ve managed to squirrel away a stash amounting to about $300K, currently all in cash and term deposits. This is not a huge sum for an Australian I know, but I lean more towards the ERE end of the retirement spectrum – my lifestyle is fairly simple and frugal. With this in mind I’m pretty much ready to retire and start deriving an income from my savings (working on a 3-4% SWR). 

During my accumulation phase I’ve been largely ignorant of investing, and it’s only during the past year I’ve attempted to rectify this by reading as many investing/FI/ER websites and books as I can lay my grubby little hands on.

Interest rates on savings accounts and term deposits here have fallen a lot lately, giving me further incentive to diversify for better returns. Currently, an Australian savings account (NAB USaver) will get you about 4.3% variable, and the best term deposit rate can be found on a 5 year which gives you 5% paid annually. With ~2.8% inflation this gives you a real return of 2.2%...which after taxes generally means you’re making a zero or negative real return. That said, once retired I expect I won’t be paying any tax (the tax-free threshold in Australia is $18,200/year) – so my risk-free return (assuming inflation stays in check) is ~2.2% if left in term deposits. With such a small stash, I’d really like to do better than 5% nominal returns though – hence my desire to invest!

My thinking is that I’d like to build a portfolio consisting of something in the ballpark of, say, 40% Aussie stocks (individual stocks and ETFs/LICs), 30% un-hedged international stocks (probably ETFs), and 30% cash/term deposits. My focus in on income generation, so I’m trying to target reliable dividend paying stocks. I’m avoiding Aussie real estate as personally I think it’s overvalued here.

So the problem is…my timing appears to be woeful! :( I finally muster up the courage/knowledge to jump into investing and the stock market is close to hitting all-time highs, both in Australia and abroad!

“Be fearful when others are being greedy, be greedy when others are being fearful”

I’d like to buy an ETF or LIC for the Australian stock market but given the index price/earnings ratio at the moment it is looking like a less-than-ideal time. Alternatively, I thought perhaps I should focus on trying to find some out-of-favour (yet solid) strong dividend paying stocks…but again everything has shot up so much in price there seems to be little value to be found in this space too.

I’m hearing that markets overseas are in a similar state as well. On the other hand, the Aussie dollar is historically very high compared to other currencies right now, and I personally see this as a temporary thing, so in spite of the uppity markets overseas maybe now would be a good time to purchase my international holdings, whilst the AUD is so strong?

What do you think? Should I just sit on my hands for now and wait? Are good-value dividend paying stocks all too pricey right now? Should I use the opportunity to buy my overseas holdings? I guess some day there will be a correction, and that will be the best time to buy, but this could well be a few years from now.

Thoughts?

[bigchrisb]

Agree with your conundrum, particularly as you are sitting on a large cash position!

I'm in a slightly different position, but with the same concerns about the relative value of stocks at the moment. I'm 31, so similar life stage, and Australian. I'm holding assets in my own name, a SMSF, a trust and a company.  Between them, I've got about $330k in un-hedged international stock (etfs), $785k in Australian equities (direct shares, reits and LICs), and about $600k of unlisted shares.  I've also got about $570k of debt against these.  Total gross income from this (dividends plus franking credits) is about $77k, with interest costs of about $39k (i.e. cash flow positive by about $38k/year pre-tax). 

Philosophically, I'm a buy and hold investor.  I intend to keep most of these stocks, with the remaining elements before retirement being clearing the debt against it, and eventually (hopefully post RE crash - I can hope right) buying a modest house outright.  I'm fairly high income, so that's probably a 5 year plan.

However, seeing how strongly stocks have rallied lately, I've been reducing my leverage a bit (selling off some stocks, as well as paying savings into debt reduction).  That said, the income produced from equities is pretty solid - its a much higher yield than cash as the moment, and in theory, should increase at a rate in excess of inflation.

Your asset allocation sounds pretty good to me.  While it will open a can of worms, maybe if you are worried you could dollar cost average to get your asset allocation over the next year or two?  I'm not sure if you are intending on pulling the plug immediately, but if you are intending on accumulating for a bit longer, you might want to think about structures to invest through?  I've got some of the wrong assets in the wrong entities from a tax optimization perspective.  If working for a few more years, and in the 37% tax rate (39% with medicare/disability care levies) maybe think about investing through a company.  That way you can limit the tax on your earnings in the short term to 30% (in theory soon to drop to 28.5%) in the accumulation phase.  The neat thing is that the tax you have paid during this time will stay as franking credits in the company, so if you draw them when you are in retirement and on a lower tax rate, you will get them refunded.  A way to shift tax between your earning and retirement years.

[bigchrisb]

And because I forgot before, well done on accumulating a $300k stash by 28!!!  That's a great achievement in itself.

[marty998]

Yep frankings credits are god's gift to Aussie investors*.

Investing through a company is an interesting one, I agree with all the benefits you listed bigchrisb, but you need to list the downside too.

Losing access to the 50% CGT discount that individuals can claim is the real kick in the pants of that strategy.

The important thing is to make a choice, not sit on your hands forever. If you think realestate is overvalued then my guess is that you'll be waiting for a very long time. The (long anticipated) crash just won't happen imho. Loan defaults are hovering around 1% and most borrowers are well ahead and well clear of debt servicing limits.

Good luck with your decision mymatenate.

*Bankrupting the government one SMSF at a time.

[limeandpepper]

In terms of the stock market, if you're worried that it's high, then I suggest you still invest, but gradually, and using a small percentage of your stash at a time. Dollar cost averaging, as has been mentioned. I'm also largely in term deposits but have started investing in stocks a bit. It's interesting to watch the figures go up and down but because I'm slowly dipping my toes in and only a small fraction of my money is in the market, it doesn't affect me too much.

Well done by the way! I am really curious about how you are doing it closer to the ERE end of the spectrum... so you are able to live on about AUD12k a year? Personally for me the biggest hurdle is housing costs... I am currently lucky to have cheap rent in a share house and can probably swing it at AUD12k if I am super frugal and cut out almost everything that is non-essential... but I don't count on having such cheap rent forever. Just wondering how you deal with this.

[superannuationfreak]

Firstly, well done on reaching this milestone!

I suggest reading this series (from the first post) by Jim Collins: jlcollinsnh.com/category/stock-investing-series/
(Obviously the stuff about 401k plans and the individual investments won't be entirely applicable)
Particularly this one: http://jlcollinsnh.com/2012/04/15/stocks-part-1-theres-a-major-market-crash-coming-and-dr-lo-cant-save-you/

The key point is, our guess is you're going to live another 40 - 60 years.  The market will probably crash a number of times in your lifetime.  But to the best of our ability to estimate, based on the last 100 years of boom and bust, war, depression, inflation and everything in between, it is likely that stocks will outperform cash by a decent margin.  It will take time and experience, maybe some more reading, but you'll live a happier life if you can accept that the price of your stocks will fluctuate (although if history is any guide dividends in a diversified portfolio will fluctuate less).

If you're nervous it's completely valid (perhaps not statistically optimal but still often recommended from a behavioural perspective) to start with a slightly lower equity allocation and raise it over time/after you've gone through a downturn and you know (from experience) how you respond (i.e. if you can stay the course).

Your taxes are likely to remain well below the 28.5% mark soon so I'm not so sure about using a company.

In terms of investments, we don't quite have the range of options our US brethren do but we do now have a decent range of low-cost options.  You're already on top of Cash/Term deposits available (although check out uBank with an automatic savings plan for cash) so you're mainly looking for equity investments.

Pretty much all the academic and practitioner evidence out there suggests that stock-picking, market timing, basically active funds management in general, won't (in expectation) produce better results than holding an equivalent index.  So I use index funds and ETFs.

If you want to have more in Australian dividend-producing stocks there are now a few low-fee dividend-focused ETFs available (most of the ETF providers have one).  I personally like the iShares one IHD as it caps the percentage in any individual stock as well as to any broad sector (for example, financials - mostly banks - are over 35% of the ASX200 but IHD caps each sector at 20%).  I haven't yet pulled the trigger on it myself.  You could then diversify further with, for example, a broader index ETF such as Vanguard's incredibly low cost VAS (roughly the top 300).

For International if you want to keep it simple there's WXOZ (Developed Markets ex-Australia) or there are lower cost options if you don't mind having multiple ETFs (in particular vanguard have VTS, which is the Australian cross-listing of MMM's beloved US Total Stock Market fund, and VEU which is developed world ex-US: full disclosure, I have holdings in these two).  iShares have a variety of other funds if you want to slice and dice further (e.g. emerging markets, US Small Cap, etc.) but some of those options are a little pricey and you may be more comfortable starting with just a few funds.

If you decide to go the ETF route, when you're ready to start, do a Google search to find offers for free brokerage for the first ~10 trades or 2-3 months.  For example if you search for "commsec $600 free brokerage" you'll find such an offer, similar for NAB trade and there are probably others.  The nice thing for those of us who buy for the long term is once you set up your few ETFs you'll rarely need to pay brokerage - if you're comfortable you can do the bulk of your purchases with the free trades and you probably won't need to sell for a very long time.

I have some more options on my blog (including non-ETF funds if preferred) but I think those basic funds will give you a decent degree of diversification with rock-bottom expenses.  If you have some super don't forget to include that in your overall high-level asset allocation (and there are sure to be low-cost funds available that can complement the choices you include in your non-super allocation).  Hope that helps!

[steveo]

Great advice superannuationfreak.

I am not ready to invest because my focus is now to pay off my mortgage however despite agreeing with low cost investing I would much rather buy at a level that provides good value.

I also find it a tough one when it comes to deciding whether to invest in Australian companies predominantly or to invest everywhere. Franked dividends are a huge thing to bypass in order to gain greater exposure to a much bigger market.

[Anatidae V]

Superannuationfreak, I don't think I saw this, but for someone  building their stash, what would you recommend as the minimum value of an ETF to buy at a time (approx)?

Also, off to learn more about super on your blog!

[superannuationfreak]

Re: buying ETFs, buying around $5,000 or more at a time works for me.  The minimum brokerage of $10-20 (0.2-0.4%) is a bit higher than buy-sell spreads in a typical index managed fund (0.1 - 0.3%) but the cost savings of an ETF usually 'cover' that within the first year.  Maybe down to $3,000 minimum if paying only $10 or $15 in brokerage but less than that and the costs mount up.



I'd also like to buy at a level that provides good value.  The difficulty is I don't know what will happen to returns over any given time period.  Look at returns over the past 30 years (which may not represent the next 30 years but are what I have at hand): https://static.vgcontent.info/crp/intl/auw/docs/resources/index_chart.pdf?20131025|093000
I don't know if the ASX200 will rise another 30% before the next time it drops 20% or if it will drop next year.  Nobody does.
[Incidentally, the ASX200 hasn't even reached its previous peak yet, even though that ignores both dividends and inflation]

So I try to control the things I can: the costs of investing, the asset classes I invest in and my own behaviour.

If partly investing now and partly investing later/over time will make you more comfortable with the process then by all means do that.  It might not be optimal based on history but that's not the end of the world - it's much better than not investing at all or investing it all and then pulling it out again in a panic if the market drops.  Best to come up with a plan that you can execute well and stick to it.

[mymatenate]

@bigchrisb

Thanks for the kind words of encouragement!

There’s a chance I might keep working for another year or two, so I will certainly give this company structure idea some consideration if it looks like this will be the case.
 
So, if I am understanding you correctly, you’re saying that although the relative value of stocks is high at the moment, assuming a long-term buy and hold approach, if it were you you would probably still get started buying into Aussie equities regardless?


@marty998

Yes I wish I understood franking credits sooner in my working/accumulation phase. Then again same could be said for investing generally! Better late than never :)


@limeandpepper

With regards to ERE and living on ~$12K a year. I agree housing is a bit of an issue for those trying to ERE in Australia. I'm currently renting cheaply too. For me, if house prices did decide to defy gravity indefinitely, then I simply get a bit more creative about housing. There are lots of alternatives to buying an average home in an average city in Australia if you think about it. Jacob over at ERE is already on to a few, and I've got other ideas as well.
I'll start another thread soon where I'll give you the full run down of my specific situation - so we can discuss this more there if you like :)


@superannuationfreak

Still digesting your post/link. I'll respond shortly!



@all

With regards to international stocks. Although the AUD has come off from it's USD/AUD $1.10 highs, it's still very high by historical standards ($.95). My gut feeling is that I should be capitalising on this increased foreign buying power some how (e.g. buying foreign ETFs). Is it this simple in real life, or am I missing something? Were you all buying up big-time when the AUD was at $1.10? And, all other things being equal, are your international holdings up by the same proportion as the AUD has fallen against that particluar currency now?

[bigchrisb]

I've certainly been buying international stocks over the past few years, as part of my asset allocation. I'm currently invested in veu, ivv and vts. I've also held iem and ive in the past, but swapped them into veu to harvest a capital loss during gfc.

My experience has been pretty much as expected with them. They fell much less than my aus stocks during gfc, as the dollar tumbled. But rose less in the recovery as the dollar came back up past parity. Have done really well in last six months with combined increase in stock value and drop in currency.

One thing that took me a while to get my head around was the forum tax offset credits. They are a bit like franking credits, but are only refunded if you are paying tax. I.e. They can increase a refund, but they can't put your total tax for the year below zero.

[stevewisc]

Congrats on the big stasche of cash!

When I was in a similar situation I used a big chunk to buy a tiny business. I have seen the return on that be many times higher then the market. 

When I put money in the market I have done some dollar cost averaging in index funds in both the US and foreign (to me).  I am a fairly bright guy but market timing is not my thing.  I could see the Y2k bubble a mile away but still couldn't tell exactly when those programming companies would slaughtered.

So I try to find investments that suit my style. Reits for real estate for example - my make much more doing it myself but though I flirt with ionce in a while have yet to decide to try it.

The peer to peer thing is interesting - may really get some great returns over time.

Right now I am looking at mezzanine financing. Similar rates to middle peer to peer projects 15-18%.  With new US laws this may become more open but now seems a little more like do it yourself real estate.

[mymatenate]

Thanks very kindly all for the advice.

I've plucked up the courage to dive in to some ETFs via dollar cost averaging, even if this might be suboptimal...it should at least placate my nerves some with respect to timing my entry :)

I've picked up 12 free trades before Christmas with Westpac, and I think I will start with that iShares IHD dividend-focused ETF...thanks for the tips Superannuationfreak!

[alanwbaker]

@bigchrisb

With regards to international stocks. Although the AUD has come off from it's USD/AUD $1.10 highs, it's still very high by historical standards ($.95). My gut feeling is that I should be capitalising on this increased foreign buying power some how (e.g. buying foreign ETFs). Is it this simple in real life, or am I missing something? Were you all buying up big-time when the AUD was at $1.10? And, all other things being equal, are your international holdings up by the same proportion as the AUD has fallen against that particluar currency now?

Yes, you should buy international equities, but for a different reason.  Regardless of currency fluctuations (and partly because of them) you should endeavor to hold the whole (world-wide) market, not just the domestic one.  This is especially true for you because Australia is a relatively small component of the global market.