Our Investment Philosophy

Before we can become your financial advisor, it is very important that you understand and agree with our investment philosophy and approach. If our philosophies are not aligned, it is very difficult to cultivate an effective long term working relationship.

Please read the summary of our approach below and we invite any questions or comments that you may have. Importantly, we ask you discuss anything outlined below that you do not fully understand or agree with.

A)   How to invest safely and successfully

Successful investing is very simple. The financial services industry tends to make it a lot more complex that it really is. There are only a few ingredients required to invest successfully, being:

  1. Regular allocation of surplus cash flow towards building your investments (net worth). In simple term, this means spend less than you earn and invest the difference on a regular basis. Start this as early in life as you possible can – but it’s never too late to begin.
  2. The quality of your assets will determine your returns. That is, above average quality assets will normally always produce above average returns – the reverse is true also. If all you do is focus 100% of your energy in investing in the highest quality assets you can find, you will be successful.
  3. Let the compounding nature of capital returns do all the hard work for you. You cannot earn your way to financial freedom i.e. more income is not the answer. You need to invest in assets that produce strong capital returns – click here to read a blog that explains this further.

Our goal when it comes to financial advice is to keep things as simple as possible whilst still maximising your opportunities. Simple strategies tend to be lower cost and lower risk. Complexity typically makes the implementation your plans a lot more difficult, time consuming and is often hard to understand. Simplicity works.

B)    Investing in property

Property is a growth asset. That is, it should deliver most of its total return in the form of capital growth and a small proportion of the total return in income. We define investment-grade returns as a combination of a long-term capital growth rate of 7% to 10% p.a. plus a gross income yield of 3% to 4% p.a. (therefore total return of 10% to 14% which is a long-term average).

Asset selection is absolutely key to be able to achieve these returns. That is, we need to invest in the highest quality properties we can find. The higher the quality, the greater the likelihood of (or put differently, the lower the risk of not) achieving investment-grade returns. Therefore, it is very important that we engage the services of an expert to advise you on which property/s has the highest probability of achieving investment-grade returns.

We believe that there are three attributes or characteristics of investment-grade property. These are discussed in this blog which I invite you to have a quick read of. If you have time, listen to this 30-minute presentation – click here.

Take 57 Donald Street for an example

Some people wonder in investment-grade property actually exists. I can reassure you that it does but probably less than 3% of properties are investment-grade so you need to be diligent. Here is an example.

I used to own an investment property at 57 Donald Street, Prahran, Victoria, but regrettably I had to sell it due to personal circumstances. This property (Donald St) sold in December 1986 for $79,600 (this is the oldest sale recorded by RP Data). It’s most recent sale was in December 2014 for $1,050,000. This equates to a compounding annual growth rate of 9.6% p.a. over a 28 year period. Remember, this is only one real-life example and there are plenty more examples of properties growing at 9.6% p.a. or more over the past 20 to 30 years. A few select properties will achieve the same growth rates over the next 20 to 30 years too.


C)    Investing in the share market and bonds

Two types of fund managers

Generally, managed funds can be classified into two types; actively managed and passively managed. Actively managed funds employ professionals who decide which stocks to invest in, how much and when. Each fund sets a target return and most try to outperform the general stock market. Active funds can be classified as ‘value managers’ and ‘growth managers’. Value managers aim to invest in undervalued stocks. Growth managers try to invest in high growth companies. The theory is; if they invest in undervalued stocks or high growth stocks, they will achieve above average returns.

Passively managed funds (often referred to as index funds), aim to achieve the “market” return by investing in the stocks which make up a certain index such as the ASX300 or All Ordinaries Index. Essentially, they replicate the index and invest in the top 300 stocks (for an ASX300 index fund) weighted by market capitalisation. This investment strategy is based on the efficient market hypothesis which suggests that the market is very efficient and therefore there are very few opportunities (if any) to buy stocks for less than fair market value. Therefore, trying to identify a stock that’s “cheap” is fraught with danger because there is often a reason why that particular stock may have a low price.

3 advantages of passively managed funds (index funds)

  1. Superior returns over the long term – Industry expert Robert Arnott, founder of US-based firm Research Affiliates, spent two decades studying the top 200 active US fund managers that have at least $100 million under management. They concluded that from 1984 to 1998, a full 15 years, only eight out of 200 fund managers beat the Vanguard 500 Index. That is, 96% of active fund managers fail to beat the market over the 15 year period. The median Australian active manager return (after fees) for the 5 years to 2006 was 13.7%. The ASX300 index’s return for the same period was 15.9%. That said, the 5 years to 2006 was a very strong bull market. Theoretically, active managers skills should be more obvious in a falling market because let’s face it, anyone can make money in a rising market. Let’s look at the year ended 30 June 2008. The median active fund manager lost 14.05% in the year to 30 June 2008 compared to the ASX200 which lost 13.75% over the same period according to Mercer (after adjusting for fees per Morningstar). I’m sure that you agree that active fund managers don’t appear to be demonstrating much investment skill. In addition, historic data shows that active managers that perform well in one decade are often some of the worst performers in the following decade – it’s near impossible to beat the market each year over the long term.Given that there is only a small chance of picking an active fund which will outperform the index by a material margin, why would you take the risk? It’s like looking for a needle in a haystack. It’s probably better to buy the haystack (or index fund). In fact, many high profile investors like Warren Buffet suggest that it’s not worth the risk and that people should just invest in a cheap indexed fund.
  2. Significantly lower fees – The cost of an actively managed fund in Australia ranges from 1.0% to 2.5% per annum (average per Morningstar, an independent investment research house, is 1.75% p.a.). A passively managed Exchange Traded Fund (ETF) charges an investment management fee of approximately 0.20% p.a. – 5 to 20 times lower than actively managed funds. The main reason for this is active fund managers often pay financial planners commission whereas passive funds often don’t pay financial planners any commission (although sometimes planners can include their commission in the passive funds fee). In addition, active fund managers have to employ highly paid (maybe overpaid?) investment managers to determine how and where the money is to be invested.
  3. Less tax to pay – Actively managed funds tend to buy and sell stocks more often which is very tax inefficient for investors as it crystallises more ‘income’ returns. Morningstar compared the average returns from the top 14 actively managed funds in Australia (by size) over the 5 years ended 30 June 2007. The average actively managed fund returned 11.7% in income and 7.3% in capital growth. Vanguard’s Australian Share Index Fund (for example) returned 5% in income and 14% in capital growth over the same period (note same overall return of 19%). An investor has to pay tax on the income return in the year it’s earned. They don’t pay tax on the capital return until the investment is sold. Therefore, it’s important to invest in a low transactional (read: index) fund to maximise the capital return proportion as this is able to be reinvested (essentially) tax-free because you don’t pay tax on it unless you sell the investment.

Research reports

Click here to read a report prepared by Vanguard in July 2015. Each year, research house S&P Dow Jones Indices prepares a comparison between active and passive fund mangers in Australia – click here for the latest report. For more, read this blog.

In summary

So why don’t more financial planners recommend index funds? I suspect it’s because they are either relying on commissions from active fund managers or they need to justify the fees they are charging clients. That is, they pitch themselves as experts in “picking” the best active funds and switch fund managers every now and then. History shows this does not work out well for the client.

In summary, we are strong believers in the decades of research and analysis behind the index fund philosophy (passive management) for shares and bonds. We employ this passive investing approach when investing our client’s monies as we believe it will minimise fees and maximise long-term returns.