Most share investors tend to favour large companies, but diversity is the key.
Ever wondered why some people seem to get seriously rich, while the rest of us, who might be on comparable salaries and with similar amounts to invest, never seem to accumulate as much? Well, there are ways to turbo-charge your wealth, and here are five little-known ways to do just that.
1. Forget the big name shares, invest in small caps
Most share investors tend to favour large companies. But for the adventurous, evidence shows far greater long-term returns can be achieved through a well-managed, diversified portfolio of small companies.
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"A good fund manager can make all the difference when it comes to small companies. That's because a lot of small companies can be bought for less than fair value and good fund managers will identify these bargains. In contrast, so many investment professionals are researching large companies there are rarely bargains available," says Greg Einfeld, director of SMSF advisers Lime Super.
For example, in the year to June 30, 2014, Morningstar's figures show the average fund that held small companies outperformed funds investing in large companies by about two per cent. Einfeld's calculations prove the two per cent difference in returns really matters over the long term.
"Suppose two people, aged four today, each had $100,000 to invest. By the age of 65, the one that earned 8 per cent would have $684,000 and the one that earned 10 per cent would have $1,083,000. The second investor would have accumulated an extra 58 per cent."
The lesson? Don't shun the minnows for the massive stocks.
2. Seriously reconsider actively managed funds
"The most financially successful investors I've met aren't the ones who sit in front of computer screens watching their portfolio all day. This is the most counterproductive thing you can do as an investor as it causes you to over-trade because of the temptation to 'do something'," says Chris Brycki, founder of online financial adviser Stockspot.
"Our minds trick us into seeing patterns, which tempts us to act even though this is rarely the right thing to do. Fighting off the urge to act is what will set you apart from other investors and give you the opportunity to generate great amounts of wealth," he argues.
This line of thinking extends into the active management versus passive management debate. Active managers claim they can generate higher than average returns, for a fee. Brycki says an investor who put $10,000 into a passively managed equity index fund 20 years ago would now have $101,200.
"Whereas if that same investor had put $10,000 into an active fund it would be worth just $57,300. This shows how the magic of compounding returns can be severely eroded by the tyranny of compounding costs."
3. Think about insurance bonds
An insurance bond can save you a lot on tax if you're going to be investing for at least 10 years but don't want your money locked up in superannuation, says Michael Miller, financial adviser, MLC Advice Canberra.
"Insurance bonds are taxed at 30 per cent on earnings, and you can withdraw the investment after 10 years without having to pay any further taxes such as capital gains," says Miller. This means they make sense if you earn more than $37,000 a year and are on a marginal tax rate of 34.5 per cent or more.
As an example, assume Doug and Jackie want to invest $5000 a year for 10 years. Doug is in the 39 per cent tax bracket, and Jackie is in the 47 per cent tax bracket. Assume a return of 7 per cent a year for a comparable investment, and a 6.8 per cent return for the insurance bond (this is to reflect the slightly higher administration fees that apply to insurance bonds). Table A shows how their investments would look after 10 years.
4. Pay close attention to platform fees
Most financial advisers will charge you a platform fee – that is, a fee to house your investments with one of the major fund managers – as a matter of course. But not all do, especially those who specialise in administering self-managed super funds.
Table B refers to one couple, Bill and Mary, don't pay platform fees, whereas another couple, Ted and Nancy, do.
It's assumed both couple's advisers charge the same amount for their services and both couples are 25 years away from retirement and currently have an SMSF. Ted and Nancy are exposed to platform and fund management fees, whereas Bill and Nancy don't pay these fees.
"While two per cent extra a year in fees doesn't sound like a lot it clearly makes a massive difference. The key is to shop around and make sure you find a financial adviser who ticks the boxes of low fees, great investment strategy and independence," says Josh Golombick, general manager of White Collar Quotes, an online service that helps consumers find financial advisers.
5. Invest in the bank, not with the bank
Shares that pay fully franked dividends can be much more tax effective than investing in cash and term deposits, according to Graham Chatterton, a financial adviser with Client Focused Financial Planning. "Fully franked dividends mean the company has already paid tax on the earnings at the company tax rate of 30 per cent. The investor then receives a credit for the tax that has been paid by the company," he explains.
Let's assume an investor earns $90,000 a year and has $100,000 to invest. The money is invested in a term deposit paying four per cent a year, generating a before-tax return of $4000 in the first year. Based on this level of taxable income, the investor will pay $1560 in tax on the earnings of $4000. So the investor generates an after-tax return of just 2.44 per cent.
"If that person was to instead spend the same money buying shares in the same bank that paid a fully franked dividend of four per cent, then the tax payable after allowing for the franking credit would be $514. This gives an after-tax return of 3.5 per cent," says Chatterton.