Kuta Beach

Kuta Beach

Saturday, 23 October 2010

Rising Private School Costs

I went to private schools when I was a kid and from what I saw there did seem to be a correlation between how much parents paid and the quality of the education. That more expensive schools provide better education should not be surprising since schools that are driven by profit have more incentive to provide better education. However, even though the environment may be right for a kid to succeed in school, ultimately it depends on the determination and work ethic of the kid himself. I have heard many stories of kids going to expensive schools but failed because they were distracted by parties, alcohol, or sports.

A recent article in The Age states that private school fees are rising greater than the rate of inflation in Melbourne (See High Price of Staying Private).

The private schools are blaming this rise in private school fees on reducations in government funding and the rising costs of teachers (driven mainly by rising teacher salaries in public schools). Many parents I know who bring their children to private schools are up in arms about the price rising, claiming that the government should provide more funding to private schools. One particular parent said, "If I choose to send my child to a private school, why should I have to pay more?"

I personally don't see why these parents are complaining. A private school is a private school, and hence government ideally should not be interfering with it. A private school is allowed to set whatever fee it wants simply because it is private. If the government were to dictate prices, then it would hardly be a private school. Can you image if the government suddenly raided the boardroom of BHP and demanded that they change the price of their iron ore exports? Could you imagine if government took control of all private enterprise and ran them? It has happened before in many countries and it has not worked well. When government controls private enterprise, it is called communism.

Saturday, 16 October 2010

Strong Aussie - Time to Buy Foreign ETFs?

The Australian dollar has now reached parity with the US dollar, meaning that one Australian dollar equals one US dollar. This is the first time this has happened since the Australia dollar was floated way back in 1983.

Many Australians are taking advantage of the strong Australian dollar by going on holidays overseas. Perhaps one good idea is to take advantage of the strong Australian dollar by buying other countries' shares. Exposure to foreign shares can easily be achieved via iShares' range of foreign ETFs.

Looking purely at the dividend history of these foreign ETFs, the best is the iShares MSCI Singapore ETF, which has distribution rate of 5.22% so far. The Australian dollar has indeed been strengthening against the Singaporean dollar for the past year. The Singaporean economy has been the fasting growing in the world post-GFC. The country seems to be ruled by very competent people and the population seems to be highly educated, although my discussions with people suggest that the Singaporean education system does not foster critical thinking. This lack of criticial thinking is evident in the fact that even though most Singaporeans have a lot of faith in their country's economy they are mostly unaware that Singapore has one of the world's highest public debt. The size of the public debt is greater than the size of Singaporean GDP. In Singapore's defence, I was told that much of this debt is held by Singapore's pension funds. That is, most of the government debt is held by Singaporeans. In America and Greece, much of the government debt is held by foreigners. I am not entirely sure how this makes a difference. The problem with government debt is that it needs to be paid off in the future, which means higher taxes, which slows economic growth. However, Singapore has a very large sovereign wealth fund (Temasek Holdings), so rather than resorting to high taxation to fund their debt, they can use their investments. Singapore's level of taxation is currently phenomenally low, especially compared to countries like Australia and the US.

Even if Singapore's government debt may not be a problem, there are other risks with investing in Singapore. An investment in iShares MSCI Singapore ETF exposes you heavily to the finance sector. A browse of the holdings of this ETF reveals that many of Singapore's largest listed companies are holding companies, banks, and real estate trusts. Buy buying into Singapore you are not really getting that much diversity in terms of sectors. Singapore's focus on finance takes it heavily dependent on other economies and can even, in my opinion, make Singapore's economy rather correlated to Australia's economy. After the GFC, Australia's economy rebounded strongly and currently interest rates in Australia are very high, much like interest rates in Singapore. Australia and Singapore seem very similar in that both are trade-focused and heavily dominated by the finance sector. Both the countries have increasing real estate prices. The main difference is that Australia has a massive resources sector while Singapore does not.

Unlike Singapore and Australia, Europe and the US has been dropping its interest rates, and the US has resorted to printing money to stimulate its economy. This has led to a devaluation of the US dollar to other currencies. This is a great opportunity then for Australians to buy American shares. Currently corporate America is paying virtually nothing in terms of divdends, so a better alternative is to buy the iShares S&P Global 100, which invests in 100 large, multinational companies. The benefits of investing in this, in my opinion, is that you are investing in very high-quality, internationally recognized companies. Most of these companies are European and American, meaning you buy for cheap in the countries that are hardest hit by the GFC. This then allows you to truly diversify your portfolio if, like mine, it is overweight in the shares of high-risk, high-interest rate countries like Australia. The yield on the Global 100 ETF is around 3 or 4 per cent, which is not bad but not as good as Singapore or Australia. If the Australian dollar does take a hit, investment in this ETF should pay off.

The argument for investing in the US now is that all the money printing will eventually jump start the economy again and once that happens, the American dollar will regain its strength. This is the argument put forth by Peter Switzer, the permabull, who in an piece in Yahoo!7 Finance titled Ignore Bears, But Not History, says the following: "I'm an optimist and trade long only and so I search for confirmation that my investment strategy is right." Is this guy crazy or what? You don't choose to be an optimist and then collect evidence to prove you are right. You look at the evidence first and then based on the evidence make a decision about whether you want to be optimistic or pessimistic. That is how a proper investor should behave.

Monday, 4 October 2010

Chinese Currency Manipulation - What Can You Do?

Many in America are angry about the Chinese government devaluing its currency to make its exports more attractive to buyers. Whether or not this is ethical, I cannot see what in the world the US can do about this.

One solution is to impose sanctions, e.g. the US government could put a tariff on Chinese goods. The major problem with this idea is that the price of goods will go up. Chinese people are willing to work for very little, resulting in goods prices that are very low. Americans have minimum wage laws. Unless the American people are willing to give up minimum wage laws and work for a few dollars a month, prices will rise, which will hurt American consumers, and voters will be outraged by price rises. Some argue that although prices will rise, this will be compensated for because Americans will have more jobs. But price rises destroy jobs as well. Every dollar you spend creates jobs. If all of a sudden I purchased a coffee every day, someone needs to make that, so someone is hired to make that coffee for me. However, if I suddenly had to pay more for t-shirts because Chinese goods were banned, then I would have less money left over to buy other others, and I will cut back on e.g. coffee and this reduces demand for coffee thereby resulting in job destruction.

Another solution is for the American government to continue devaluing its currency by printing more and more US dollars. The Chinese government, however, can easily respond by printing its own currency.

One way the Chinese government maintains its currency peg is to buy US Treasury bonds. One suggestion is to ban the Chinese government from buying US Treasury bonds. This could be a problem the US government because the Chinese government is a major consumer of US debt. If the Chinese do not lend to the US, the US will lose a major customer. Currently the US government relies on Chinese lending to fund its various stimuluses, so what the US needs to do then to depreciate its currency is to stop its stimuluses and replace lose Chinese demand for US sovereign debt by selling Treasury bonds to US citizens, which means US citizens will need to suddenly become thrifty savers. I will let the reader decide whether that is likely to ever happen.

Saturday, 2 October 2010

Legal Tax Minimisation - Work Deductions, Negative Gearing, and Salary Sacrificing

Many people are keen to reduce their taxes, which makes sense. However, in my own experience I find that many methods of reducing tax, although they allow you to reduce your tax, may have other questionable consequences.

I will talk about three methods to reduce tax in Australia, namely business expense deductions, negative gearing, and salary sacrificing.

Any business expense you have can be claimed as a deduction, thereby reducing your taxable income. For example, if you work as an accountant and you subscribe to an accounting-related magazine, you can claim the cost of this subscription and reduce your taxes. Many people subscribe to the magazine and then say, "I don't care about the costs because it's deductable." This is not a good attitude. Suppose the magazine subscription costs $100. Suppose your taxable income is $50,000 per year. Any additional dollar you earn is taxed at 30 per cent. By getting $100 deducted, your taxable income is $49,900, which means that you effectively pay $70 for your magazine and you save $30. Even though you paid less for your magazine, you are not getting it for free. You still have to pay $70 for it. You cannot therefore simply buy useless crap that you don't need to reduce your tax. The stuff you buy needs to actually be something you want or something you need. You will need to make an evaluation as to whether the benefits of subcribing to the accounting magazine is greater than $70 per year. If it is, buy the magazine. Claiming work expenses like crazy reminds me of people who always buys products if they are heavily discounted. If they see that some product is 50 per cent off at the mall, they are highly likely to buy it, even though the discounted product may still be expensive and maybe they didn't really want it in the first place.

Negative gearing is another tax dodge that people like to talk about, especially in Australia where it is very fashionable to invest in real estate. Negative gearing involves borrowing money from the bank to buy some income-producing asset (e.g. a house). If the repayments to the bank is greater than the income coming from the asset, then the difference can be used to reduce your taxable income. Many people think that by negative gearing they can simply borrow heaps of money, buy heaps of houses, and pay no taxes. But you should be very careful about doing this. To keep it simple, even though negative gearing allows you to reduce your tax per se, this reduction in tax is more than made up for by the increase in other expenses, most notably interest repayments. That is, even though you have reduced your tax debt to the government, you now have a loan debt to the bank. Even though you are paying less tax to the government, you are effectively paying a tax to the bank in the form of interest repayments. The government is happy to allow this tax dodge. Even though they lose money by allow citizens to pay less income tax, they make a lot of money simply by allowing bankers to make more money collecting interest and then taxing the profits of the banks to recoup their lost cash. There is nothing wrong with borrowing money to buy something for investment purposes. However, most people do not realize how difficult it is to come out ahead when borrowing to invest. Interest rates in Australia are very high. Mortgage interest rates are about 7 per cent now. If you borrow to invest, the banks will charge you more, probably 8 per cent or more. For you to break even, your investment will need to produce 8 per cent or more per year. This is highly unlikely. I do not know of any investment that gives 8 per cent per year with low risk. In fact, any investment that gives 8 per cent per year with low risk is probably a ponzi scheme or some other similar investment scam. Most people also underestimate just how much of a burden paying back a massive loan is. Einstein claimed that compounding interest is one of the major wonders of the world. It is definitely wonderful and pleasant if your savings or investment value went up in value exponentially due to compunding interest. However, compounding can work against you if you have debt because debt can compound over time.

Anohter tax minimisation strategy is salary sacrificing. You can salary sacrifice for many things, e.g. for a car or to put into your superannuation fund (retirement fund). I am a fan of this method as it delivers instant results and it is perfectly legal. It is also very simple as well. If you want to reduce the tax you pay, you can salary sacrifice into your super fund simply by talking to HR. A simple email can often do the job. Salary sacrificing into super works because the tax you pay in your super fund is 15 per cent. As of this year, if you earn over $37,000 per year, each additional dollar you earn is taxed by 30 per cent. If you salary sacrifice, say, $100 then that $100 will bypass income tax and go into your super fund where it will be taxed at 15 per cent rather than 30 per cent. You therefore save $15 for each $100 you salary sacrificing into your super fund. If you earn more money and each additional dollar you earn is taxed at the highest rate of income tax, which I think is 45 per cent, then paying 15 per cent instead is a massive saving.

There are three main problems with salary sacrificing into your super fund:

(1) Access to Money - The first and most obvious problem is that you will not be able to access your money until retirement. If you are in your mid-twenties (like I am) then retirement will be a long way off. You will have to wait another 40 years or thereabouts to get a hand on your money. However, super law dictates that if you are experiencing "hardship" then you allowed to access your money. When I save or invest money, much of the reason for why I do is to save for a rainy day, i.e. to save money so that I can use it if I am going through hardship. If money I earn normally is being used for that purpose (as insurance against hard times) and if it goes into super it will have tax benefits and I will still be able to use it for the same purpose, then I think it is worthwhile to put more money into super where it has a better chance of growing more with greater tax benefits.

(2) Limits on Super Salary Sacrifice - Salary sacrificing into your super fund was such a great way to reduce income tax that many people got into it. That is why the government eventually stepped in and put limits on the amount your can salary sacrifice into super. Young people can now only salary sacrifice a maximum of $25,000 per year into their super funds. Some people criticize this and say that this makes it not worth it. But I think that a little bit of a good thing is better than nothing at all.

(3) Government Risk - The biggest and most worrying risk with super is the performance. Many people are worried that super is an underperforming investment because much of super is invested in the stock market and after GFC, stock markts around the world tanked thereby destroying super wealth. However, I do not believe this is a major issue. Super funds allow you to switch your money from shares into other investments like cash. You can also start up a self-managed super fund (SMSF) and invest in anything you want, e.g. art, wine, antiques, gold, and real estate (rules may change regarding investment in exotic assets like wine). The biggest risk to performance, in my opinion, is government risk. Government may make superannuation a great investment today by giving it tax breaks, but government can also take away these benefits in the future. If the government is desperate for cash one year, who is to say it won't raid citizens' super funds? It would be politically unpopular, certainly, but it is definitely a risk. However, money outside your super fund in other investments, e.g. shares and real estate, is also subject to government risk as government can change capital gains tax, land tax, stamp duty, and so forth. Therefore, the only way you can get risk of government risk is to move your money outside of the country, which is most cases is illegal if you are doing so to dodge taxes.