Shares are one of the best long-term investments around. No other investment offers the tax benefits of shares, or the ability to sell quickly in whole or in part.
However, this flexibility has a downside - it gives "investors" the ability to get out quickly if they don't stay the course when the market has one of its normal downturns.
Our stock market plunged to 4546 points on March 23, and many inexperienced investors ran for the hills. Since then, our market has had a strong rebound and is up 43 per cent in just seven months.
This week's report from behavioural finance experts Oxford Risk claims that on an average year, the decisions retail investors make for "emotional comfort" typically costs them 3 per cent a year in returns. Worse still, thanks to Covid, bad decisions may cost even more.
Oxford Risk says many investors have increased their allocation to cash during these volatile times, and the cost of this 'reluctance' to invest may be around 4 to 5 per cent a year over the long-term.
In addition, it estimates that the cost of the "behaviour gap" - losses due to timing decisions caused by investing more money when times are good for stock markets and less when they are not - i.e. buy high and sell low - is on average around 1.5 to 2 per cent a year over time.
In my new book Retirement Made Simple I discuss a report by Barclays Wealth in Britain based on interviews with thousands of wealthy investors, which explores how they overcame their inbuilt cognitive biases.
Trying to time the market is one of the main problems. There is extensive research that people who try to time entry and exit into the market end up with a 20 per cent drop in returns over a ten-year period.
Despite the fact that a majority of investors acknowledged this to be true, they still confessed that it didn't stop them having a go.
Younger wealthy investors admitted to needing more self-discipline than older investors, but those who made joint decisions with a partner generally achieved better returns, as two people were involved in the decision-making.
Barclays identified several strategies that were helpful in taking emotions out of the investment process. These included :
1. Avoiding the trap of being involved in day-to-day gossip about the markets, to lessen the chance of being distracted.
2. Delegating to fund managers who would be responsible for investment decisions.
3. Conferring with other people, such as financial advisers or stockbrokers, for input.
4. Setting financial deadlines to create accountability and overcome inertia.
5. Cooling off - waiting a few days before implementing a major financial decision once it has been made.
6. Establishing strict rules, such as re-balancing the portfolio twice a year, and setting up and down price limits.
According to Dr Greg Davies, head of behavioural and quantitative finance at Barclays Wealth, a key reason why individual investors systematically underperform professional investors is not that they are inherently worse investors, but simply that "professional investors are aided by a strong set of institutional rules that ensure greater control of their knee-jerk reactions."
The report points out that humans did not evolve to be good long term investors, but to be great short term risk avoiders. The impulse to avoid risk is apparently more than twice as strong as the impulse to seek reward. And to make it worse, we instinctively want to follow the herd for protection.
Just remember, the major factor that determines how much you will have in your portfolio when you retire is the rate of return you can achieve on your assets. A long-term reduction of 3 per cent per annum could cost you hundreds of thousands of dollars over the long-term. Adopting smart strategies, can be a life changer.
Noel answers your money questions
My in-laws have approximately $140,000 after selling their house and moving into a retirement village. They are both in their mid 80s and their sole income is from the aged pension. What options would you suggest to provide income to supplement the pension.
One option would be to contribute say $100,000 to superannuation using the downsizing rules, which would leave them with $40,000 for a cash reserve on top of the income stream from the account-based pension which would come from the superannuation fund.
At their age, I would suggest a conservative option in the asset allocation in the superannuation fund. However, I appreciate that $100,000 is a small sum to have in superannuation, especially as the fees may be at least 1 per cent per annum which could take the net return to possibly 4 per cent per annum.
If they are not comfortable putting money into superannuation, they could probably earn around 1.5 per cent per annum from bank deposits.
But keep in mind that if the term is relatively short rate the return is not of major importance. Let's assume they are 85 now. If we run the numbers through the Retirement Drawdown calculator on my website, using a lump sum of $140,000 and drawings of $20,000 a year with no indexation, we discover that the money would last for just over seven years at 1.5 per cent.
If the rate of return was increased to 4 per cent by using superannuation the money may last for just a year longer.
I have aged parents in interstate social housing and need to move them closer to me. A friend recommended that I purchase a property, and rent that property to them at market rates. Is this legal? I intend to borrow to buy the property. Also, can I gift them some money to help with their living expenses?
There is nothing illegal about your purchasing a property, and renting it out to relatives at a reasonable market rate. It need not be a high market rate - just a fair one. And provided you show the income on your tax return, you can also claim the cost associated with the purchase including interest and maintenance.
There is also no restrictions on people giving money to people on the age pension but, in this case as you intend to rent the property to them, you would need to make sure that there was some separation between money being gifted for living expenses, and the rent they were paying.
Could you please tell me how the taxable amount is calculated on my superannuation, does the taxable portion stay the same or does it increase or decrease in line with the total balance.
There are two types of contributions you can make to superannuation. The first is concessional contributions for which somebody claims a tax deduction - often the employer, and the other are non-concessional contributions which are made from after tax dollars.
The non-concessional contributions form part of the non-taxable component but normally the number does not grow - the earnings on those non-concessional contributions become part of the taxable component. In short, all concessional contributions, as well as earnings of all contributions become the taxable component; non-taxable component is the amount of the non-concessional contributions.
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We are a married, aged-pensioner couple aged 82 and 80. We have a combined annual income of $47,500. Do we qualify for a pension tax offset or a rebate? We find this a bit confusing. Will we have to pay tax on our combined income?
Pensioners are eligible for three tax offsets. The first is the Low Income Tax offset (LITO), the next is the Low And Middle Income Tax offset (LMITO) and the last one is the Seniors And Pensioners Tax offset (SAPTO).
When all these are taken into account a single person could earn $33,088 a year and pay no tax, and a couple could earn $29,783 each and pay no tax. This means a couple could earn $59,566 combined, and still pay no tax if their income was split 50:50.
Once individual taxable income exceeds these numbers some tax may become payable. You have not advised details of each individual income, so to have a tax-free income you will need to ensure that neither income is in excess of $29,783 a year.
- Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. firstname.lastname@example.org