Pete Wargent blogspot


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Saturday, 31 October 2015

Terms of trade to be clonked again

Export prices steady

The ABS released its International Trade Price Indexes for the September quarter this week, and the "good" news was that export prices did not decline in Q3, coming in flat for the quarter, but import prices rose further by 1.4 per cent.

Looking at the ratio of Australia's export to import price indices, it seems that we are are now not partying like its 2006.

This latest data indicates that Australia's terms of trade likely fell yet again by around 1.4 per cent in the third quarter, plunging nine year depths, which is another tick in the box marked "further interest rate cuts."

Looking at the historical data, the decline in Australia's terms of trade may well have some way to run yet.

Commodities cycle

Many were lulled into believing that Australia's resources boom would run for decades, but this cycle has been a fine example of why commodity prices "never always go up", to steal a phrase used by Chris Caton, Chief Economist of BT Financial.

In commodities markets experiencing a prices boom, sooner or later either the demand which sparked the boom falters, or supply ramps up in response to more attractive pricing.

In this instance we got both.

China's imbalanced growth, once heavily skewed towards construction, is now hopefully rebalancing towards other sectors, while at the same time bulk commodities are now being exported from countries such as Australia in record volumes. 

The result of these shifts will be the end of Australia's resources construction boom, with construction activity now certain to follow the sharp downward trajectory of commodity prices - albeit with an lag - as the last of the mega-projects proceed towards production.

One chapter of the resources boom story that has not yet been written in full is the LNG tale. With LNG exports now being shipped from our shores we know that export volumes have the potential to contribute significantly to Australia's GDP growth over the next year or two, though the question of what will happen to the commodity price remains as yet unanswered.

Two-speed property markets

For property markets in resources regions the labour-intensive construction phase of the boom represented the "the good bit". Now we are faced with the bad bit as the construction phase of the boom fades away.

Unfortunately much of the property market commentary turned bullish on mining regions around 2012, despite commodity prices in SDR terms having peaked back in July 2011 (or September 2011 in Aussie dollar terms).

This has been the subject of increasingly vigorous invective on chat forums from investor folk who were led down the mining hotspot path - which is understandable enough, for the simple artithmetic of portfolio losses determines that many will not be around long enough to get back to breakeven.

This graphic shows why although while property investment is not suitable for everyone, those of us with slightly saner heads were suggesting inner ring Sydney as a safer bet in 2012.

Boom-bust markets are a dangerous game for leveraged speculators, and the fallout from large drawdowns can take decades to recover, assuming that they ever recover. Generally speaking it is better for most investors to stick with capital city markets which offer the long term potential for steady and consistent capital gains.

Queensland recovery

In this context the ongoing recovery in Queensland housing market volumes represents an interesting dynamic.

Despite the dismal performance of many resources regions the latest fortnightly data from the titles registry shows that at the state level Queensland transaction volumes have been continuing to undertake a long, drawn out recovery over the past four years.

Given that we know final demand has been obliterated in a number of resources regions, generally speaking this portends relatively well for parts of Brisbane, and perhaps a number of the tourism regions which are now at last enjoying the fruits of a weaker Aussie dollar. 

On the other hand, there are any number of regional Queensland markets which were recommended by pundits as hotspots just a few years ago that  have been staring down cataclysmic corrections. There's no need to list them all again here, you can look up the 2012 hotspots for yourself. 

There is some evidence that interstate dollars are beginning to pour into Brisbane housing, but even within Greater Brisbane the duality of the market is more pronounced than normal. 

The latest Residex figures showed the median house price in Brisbane increased by 5.2 per cent over the year to September, but those who rushed in to buy pricey off the plan apartments in some of the oversupplied inner city markets may be left gnawing their finger nails over the next year or two.

Must-see articles of the week

Find the must-see articles of the week here at Property Update, as well as the latest from Real Estate Talk (or click the image). 

Friday, 30 October 2015

2016 the greatest ever for foreign students

Record foreign students

The Department of Immigration and Border Protection released its June 2015 figures for international students, which showed the total number of international students in Australia burning more than 10 per cent higher over the past year, partly in response to the lower Australian dollar. 

At the end of April there were some 422,313 student visa holders in the country. 

What is more, visa applications lodged have also surged by more than 10 per cent, thereby all but ensuring that 2016 will be the greatest ever year for international students in Australia, eclipsing even the great spike of 2008/9.

As for where the visa applications are coming from? The answer is Asia, and increasingly the People's Republic of China. The applications on hand data suggests that we can also expect to see an increase in students from India in 2016.

Second visas

The pace of growth in applications lodged implies that 2016 will see another surge in student numbers to record levels.

It is important to recognise that a large and now increasing number of students go on to apply for second visas and often find a path to Australian residency.

The visa types that students move on to include post study work visas, 457 visas, working holiday visas, permanent points-test visas, and other substantive visas.

Migration experts see this opening up of the higher education field as one of the most production and effective shifts in economic policy in recent times. 

Where to?

With the relaxation of visa rules in the higher education system and a strong push from Universities for greater access to post study work visas, Reserve Bank forecasts show a huge surge in net immigration related to student visas.

The student visa boom is overwhelmingly set to be a capital city phenomenon, and RBA forecasts show a projected jump in the net immigration of students into Sydney, Melbourne, and to a lesser extent Brisbane.

Thursday, 29 October 2015

Average London house price £500,000

Fresh high for UK house prices

Nationwide released its latest UK House Price Index data which showed the average house price hitting a fresh high of £196,807 having recorded an increase of 0.6 per cent in October for a 3.9 per cent annual gain.

Nationwide noted that recent stamp duty changes would be beneficial to some 86 per cent of transactions in London and the South East, while two year fixed interest rates have declined to hit the lowest level on record, now averaging well under 2 per cent. 

Understandably, the overwhelmingly majority of borrowers and particualrly first home buyers in the UK are now choosing to fix rates at historic lows.

Natiowide's long run average house price data since 1952 showed the sharp impact of the recession and subsequent recovery.

London leads

Also today the UK Land Registry released its September 2015 data, the only index to be based upon repeat sales. 

The Land Registry figures showed a 1.0 per cent gain for the month, once again driven by London (+1.8 per cent). 

Annual gains at the national level of 5.3 per cent were unsurprisingly led by London (+9.6 per cent) and the South East (+8.5 per cent).

Meanwhile at the County/unitary authority level house price gains were weighted towards those areas located around London, such as Luton (+14.2 per cent), Hertfordshire (+11.8 per cent), Central Bedfordshire (+8.8 per cent), Buckinghamsghire (+8.4 per cent), Essex (+7.7 per cent), Surrey (+8.8 per cent), and Cambridgeshire (+8.2 per cent). 

There has also been strong price growth in the London commuter towns such as Slough, Windsor, and Wokingham. 

Over the past year price growth has been considerably weaker the further one travels from the capital city, with the notable and honourable exception of Bristol.

Indeed this has now become an entrenched trend.

Charting the Land Registry data since January 1995 reveals how while house prices have broadly speaking doubled over the past two decades in most regions away from the capital city, average London prices have increased by more than fivefold (up by 5.44 times from £91,400 to half a million pounds).

Of the London boroughs notable performers over the past year have included Croydon and Greenwich. There has been a significant 16 per cent decline in the number of transactions taking place above £1 million, with stamp duty changes adding to the pain at the top end.

Finally, repossessions continued to decline across the UK from close to 3,000 per month in Q3 2009 to an average of just 519 per month in the quarter to July 2015. Year-on-year repossessions have fallen dramatically.

Rental inflation soft

Rental growth soft

Delving into the detail behind yesterday's Consumer Price Index figures for the third quarter reveals that annual rental price growth in Australia is now tracking at its lowest level since June 1995, with rents up nationally by just +1.5 per cent over the year to September 2015.

The data series captured at the capital city level shows the cylical nature of property prices and rents.

The national level figures show the marked contrast beteween rental price inflation in periods when investors and housing starts were knocked out of the market (1985-1987) and those where investors have flooded the market with rentals and construction has boomed (2012-date).

Naturally significant variances are evident across the capital cities.

Annual rental growth remained steady in Sydney (+2.5 per cent), but was softer in Melbourne (+2.2 per cent) and Brisbane (+1.1 per cent), while Perth has now slipped into negative territory on this series (-1.6 per cent) after a big run-up through the resources boom. 

Looking at the annualised data reveals the softening trend, particularly in Perth.

In the smaller capital cities, Hobart appears likely to play host to a level of rental growth over the year ahead with vacancy rates in the Tasmanian capital having tightened sharply.

On the other hand Darwin has the opposite problem and has now sunk into negative territory, joining Canberra where annual rents have been negative since the first quarter of calendar year 2014.

Finally, a look at rental growth across 5 and 10 year time periods by capital city shows how the resources capitals enjoyed the bulk of rental growth until the end of the resources boom.

Economists are split on next Tuesday's interest rate decision, with a fair number now plumping for further easing, though economists of the 'big four' banks are yet to join that particular party. 

Wednesday, 28 October 2015

Inflation surprise!

Inflation soft

Well, gosh.

A surprisingly soft inflation result today, and one which puts further interest rate cuts right back in the frame, if indeed they ever snuck out of shot.

Headline CPI printed at 0.5 per cent for the June quarter for an annual result of just 1.5 per cent, well beneath the target range of inflation, thereby locking in the weakest run of inflation results we have seen in years.

Indeed the index numbers show that the headline result was weaker still, and only rounding took the headline figure up to 0.5 per cent for the September quarter.

The soft result was influenced by the declining price of vegetables (!), telco quipment & services, and perhaps more predictably, automotive fuel. 

Non tradables or domestic inflation came in at a soft 0.4 per cent for the quarter and 2.6 per cent for the year, suggesting that domestic price pressures are fairly subdued, while tradables inflation remained very soft. 

Despite the Aussie dollar having tanked all the way from above parity against the US dollar to around 71.3 cents after this release, there still seems to be little evidence of inflationary pressure.

This is generally viewed as a sign of weakness for the economy, with wages growth sundued and sentiment too weak to see the higher prices of imports to be passed on to consumers.

Most significantly of all the underlying measures of inflation - the trimmed mean and weighted median - both came in at just 0.3 per cent for the quarter, for annual prints of  2.1 and 2.2 per cent respectively.

These figures will be seen to add to the case for further interest rate cuts with inflation sinking towards the bottom end of the target range and unemployment remaining above 6 per cent.

Futures markets are undecided about an interest rate cut on Melbourne Cup Day next week (62 per cent chance), but hav priced in a high probability of the cash rate being dropped once again before the Christmas break.

Time lapse

35 years of Sydney house prices

Bravo Eliza Owen of On the House for this fabulous time lapse video presentation of Sydney median house values over the past 35 years. Enjoy watching it. 

There are a number of fascinating aspects to this piece, which suggested to me that home buyers and investors seeking long term capital growth should aim to buy in the best-located suburb that they can afford, and should also look for scarcity value.

Bellevue Hill had a median price which broke through $200,000 in 1980 - around double Sydney's median house price at that time - yet the median house price in the suburb has exploded to $4.2 million today, more than four times the median house price in the harbour city.

How so? A combination of a lack of new building - the result being scarcity value - combined with gross income and equity growth, with buyers and wealthy residents at the premium end of the market rarely reliant upon linear salary income for their house purchases. 

Other well located inner suburbs have demonstrated massively strong price growth as they have gentrified. 

Note how housing booms and corrections have been recurrent and have repeatedly been characterised by massive boosts in price in locations close to the city, with suburbs on the north shore and close to the water leading price booms and the western suburbs lagging behind.

Being located near a train line with a direct city link can help, particularly it seems on the north shore (cf. Killara, Gordon, which have historically led price growth in previous cycles).

On the other hand being in an industrial suburb under a flight path, historically at least, has been a negative, with inner western suburbs such as Mascot having lagged through the cycle. 

Due to this disparate nature of capital growth which has favoured suburbs closer to the city, the On the House figures show that today there is a significantly wider range of median house price values by suburb across Sydney than there was in the past.

I expect this widening of prices to continue. 

With a good deal of building having taken place on Sydney's outer south western fringe, median home values have increased sharply in that sub-region since 2011.

However, recent auction results (or more accurately, should one say, the dearth of positive results at auction, with the outer south west recording a worrying preliminary clearance rate of "n/a" this week) suggest that a sharp correction could be in the post for that sub-region.

Very interesting stuff.


Huge day ahead for interest rate twitchers with the pending release of the third quarter inflation figures later this morning. 

Tuesday, 27 October 2015


ANZ-Roy Morgan consumer confidence was little unchanged this week rising by 0.1 per cent to 113.4, now sitting a little above its average level since 1990 of 112.7.

The potential for a slightly higher mortgage repayment may have hit something of a nerve with households, but overall confidence seems to have consolidated at just above its long run average.

The Roy Morgan release is here.

Monday, 26 October 2015

Auctions fading to black in Sydney outer

Auctions fade

Auction clearance rates are still booming along in Sydney's eastern suburbs, with a preliminary clearance rate of 84.3 per cent recorded, with the inner west also on fire at 83.8 per cent, according to CoreLogic-RP Data.

Cameron Kusher of CoreLogic-RP Data has pointed out that every sub-region of Sydney has recorded auction clearance rates of above 80 per cent at some point this year.

How then has the city-wide clearance rate slipped all the way back to 64.4 per cent?

Source: CoreLogic-RP Data

The unfortunate truth is that those suckered in to buying late in the cycle in outer western (30 per cent) and south-western Sydney (52.8 per cent) may well soon be sitting on a pile of negative equity, while home loan arrears have tended to be more elevated too.

No real surprises here. 

Soft preliminary clearance rates were also recorded for the Central Coast (30 per cent), Baulkham Hills & Hawkesbury (38.5 per cent), Blacktown (42.1 per cent), and Parramatta (39.7 per cent), while the outer south-west may fail to record a single auction sale.

Of course, not all properties are sold at auction, and preliminary clearance rates by sub-region are essentially only an indicator of market sentiment. 

Deutsche Bank has put out a research note which indicates that historically Sydney auction clearance rates have needed to decline to around 45 per cent in order to be accompanied by year-on-year price declines (h/t Colgo/Business Insider).

While certain inner suburban clearance rates remain very high as noted above, the above figures represent further evidence that in many areas away from the inner suburbs the investor market has been knocked for six by increased deposit requirements, and stock on market is now rising.

Sydney will have some big auction weekends to muddle through before the Christmas break, in the meantime watch out for any handover to owner-occupier mortgage lending.

The detailed report by capital city from CoreLogic-RP Data can be found here

The week ahead

Brought to you in the format of motion pictures.

The ABS Lending Finance series has lately hinted at a slowing in commercial finance - see here for my analysis - we may see this reflected in figures from the Reserve Bank this week.

Watch the video for more thoughts on the week ahead...

Saturday, 24 October 2015

Bear traps snap shut

UK mortgage lending surges

While the news and debate in Australia is focused on banks increasing their interest rates, the latest Bank of England figures showed UK mortgage rates continuing to compress to extraordinarily cheap levels.

Small wonder then that the latest figures from the UK Council of Mortgage Lenders revealed Gross Mortgage Lending surging 12 per cent higher year-on-year to an estimated £20 billion in September, with first home buyers returning to the market in droves.

Cambridge booms on

Also this week Hometrack released its UK Cities House Prices Index for September 2015, with quarterly house price growth once again driven by Cambridge (with a thumping +4.9 per cent growth over the quarter) and London (+4.2 per cent).

Annual house price growth was also led by, um, Cambridge (+12.1 per cent) and London (+11.0 per cent). Since the preceding market peak of 2007, price growth has been driven by, erm, well, Cambridge (+46.6 per cent) and London (+43 per cent).

Bear trap (but only in the south-east)

In fact, the financial crisis correction proved to be the mother of all bear traps for would-be buyers in London and its satellite University cities of Oxford and Cambridge, with prices pausing for breath before burning up to new record heights.

Although the 20 cities index is notionally now nearly +20 per cent above its 2007 pre-correction peak, this figure is clearly skewed by London, Cambridge and Oxford. As the above chart shows most regional cities have house prices sitting either close to - or in many cases  below - their levels of eight years ago, despite rock bottom interest rates and a post-crisis burst of inflation.

In fact, the chart could hardly be a better illustration of the importance of asset selection, with cities such as Cambridge and London outperforming most regions by an enormous margin over the past 20 years.

Property crash predictions have always been around in the UK in one way, shape or form, but it was around the turn of the century with the advent of online media that the word "bubble" really started to be thrown around in earnest, and indeed it has been every year since.

It was widely predicted that the "bubble would burst" and house prices would fall to around £100,000 with London and Oxford the areas "most at risk from a slump". Although eventually there was a lull and slight decline between November 2007 and August 2009, London asking prices are now above £630,000 and rising.

London housing policy is a mess, with dramatic shifts in stamp duty policy, recently announced curbs on buy-to-let taxation relief, woeful under-construction, and average rents up by 11.6 per cent over the past year.

If Australia can learn anything at all from this, it's that cramming millions of people into capital city locations won't work in tandem with affordable housing.

Ireland's long road to recovery

At the bottom end of the Hometrack scale, house prices in Belfast remain a whopping -46.8 per cent below their 2007 levels. 

It's worth noting, however, that house prices in Northern Ireland (deemed to be one region by the Office for National Statistics) had almost tripled on the ONS series in the five years to 2007 from £88,062 in February 2002 to a peak of £249,264 by August 2007.

You could therefore safely say that a major correction was due, and come it did.


(Note that the ABS Sydney dwelling price index series only runs back to 2003, thus cropping off a boom in prices in the years leading up to that time).

Must-see articles of the week

Find them all right here at Property Update...

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Friday, 23 October 2015

Brisbane looking up

Brisbane looking well

'Tis an odd thing, by but the Detailed Labour Force figures are so often overlooked or ignored by market commentary, though fortunately not by everybody. Here's ex-Reserve Bank boffin and now ANZ market economist Justin Fabo.

Indeed so, the employment data has improved significantly for Brisbane over the year to September 2015. Let's take a look at the latest figures in 3 short parts.

Part 1 - Large states

Most employment growth over the last 12 months has taken place in Sydney (+68k) and Melbourne (+55k)...but lookee here, because hey presto, regional New South Wales is now creating jobs again (+55k)!

Regional New South Wales has seen jobs created particularly in Newcastle & Lake Macquarie, the Hunter Valley and the Illawarra. On the other hand regional Victoria has seen total employment decline.

Looking at employment growth cumulatively in the two most populous states, we can see that the outlook in regional New South Wales has certainly improved, although the most employment is still created in the Greater Metropolitan area. 

Better still, the total figures reported for regional unemployment now seems to be declining again after a worrying surge through 2014.

This represents evidence that at least some of the fallout from mining and construction contract layoffs is now in the rear view mirror, at least from an employment perspective. While aggregate demand may still be in declining in some mining regions, many of those contracted for the construction phase of mining projects have now returned to the capital cities. 

Part 2 - Brisbane bounce

The other location which created a material number of jobs over the past year was Brisbane (+34k).

In fairness - while not charted here due to immateriality - Hobart's small labour market has also been picking up very nicely (+3k).

Not so much doing elsewhere.

Piecing the jobs growth data together, over the past year the growth in employment has been almost entirely accounted for by Greater Sydney (30 per cent), Greater Melbourne (25 per cent), Greater Brisbane (15 per cent), and regional New South Wales (24 per cent).

Part 3 - Unemployment dispersion

The dispersion of unemployment rates across Australia continues.

Amazingly enough Hobart recorded an unemployment rate of just 4.9 per cent in September, a remarkable turnaround as the Aussie dollar has depreciated, evidently boosting the local economy.

Unemployment has also declined steadily in Greater Brisbane (5.4 per cent) and Melbourne (6.3 per cent).

Meanwhile in Greater Sydney unemployment remains relatively low (5.3 per cent), though the Sydney result has been skewed higher by rising unemployment rates on the Central Coast, and in Blacktown.

On the other hand, Perth (6.1 per cent) and Adelaide (7.6 per cent) have unemployment rates that remain in a clear uptrend.

Smoothing the original data on a rolling annual basis reveals the dispersion more clearly, with Hobart, Brisbane, and Melbourne showing the greatest improvement.

I've been concerned about unemployment rates in a number of regional centres of the last year or two, so it has been pleasing to see the reported unemployment rates falling sharply in cities such as Geelong (4.8 per cent), Newcastle (5.1 per cent), the Hunter (7.3 per cent), though unemployment rates remain too high for comfort in a number of Queensland regions.

Greater Brisbane's unemployment rate has ticked down to 5.9 per cent on a 12mMA basis after some elevated readings at the beginning of 2015, despite an unemployment rate of above 9 per cent in Logan-Beaudesert.

On the other hand Greater Adelaide's unemployment rate is now tracking consistently at around 7.6 per cent or above, and has ticked up to 7.3 per cent on a 12mMA basis. 

From a property market perspective, of the cities outside Sydney and Melbourne, Hobart and Brisbane look to have the brightest outlook over the year ahead, in spite a looming supply overhang of units in some inner locations in Brisbane's case.

Sydney boom slows in Q3 (+21.7 per cent y/y)

Sydney house prices rose by a more sedate +3.2 per cent in the September quarter to be up by +21.7 per cent over the year to a median price of $1,032,422 reported Domain.

This followed on from a much faster +8.4 per cent boom in Sydney house prices over the June quarter. 

Sydney's median unit price increased by a little over $10,000 to $673,182 over the September quarter. 

Meanwhile, Brisbane's median house price increased from $493,227 to $497,143 over the three months to September.

Thursday, 22 October 2015

Exceedingly good fakes


Some bad news, I'm afraid.

The Reserve Bank's 2015 Annual Report "noted" that more than 37,000 counterfeit banknotes were detected in circulation on 2014/15, a 63 per cent increase on the preceding financial year!

On a positive note, if you'll pardon the second awful pun, a single production source was identified which accounted for the increase, and a number of arrests have been made in relation thereto.

The police are continuing to look into the matter, while the Reserve Bank has strengthened its combative procedures and educational workshops in response.

But what can you do to protect yourself?

Well, firstly, don't lose too much sleep over this, because with only 28 counterfeit notes detected per million genuine banknotes, in spite the surge over the past financial year the level of counterfeiting in Australia remains low by international standards.

Secondly, watch out for those fifities, because of the 37,134 counterfeit notes detected in circulation, 33,292 of them were of the yellow variety with the southern cross motif!

Green $100 banknotes accounted for most of the remainder, with 2,943 counterfeit notes detected.

Common cents

Common sense should tell you to watch out for those green notes with the lyrebird image on them, because they are more costly if you do accidentally pick up a wrong 'un!

In dollar value terms, there were nearly $2 million of counterfeit notes with around $1.7 million of those being fifty dollar notes or 84 per cent by value, and $300,000 in hundred dollar notes.

Although there were quite a few twenties that were found to be counterfeits - and even a handful of fives and tens - in dollar value terms these accounted for a total of only around $16,000 of the fakes. 

Finally, if you're a keen bridge player and you like to skew the odds in your favour, then you'll know to use lower dollar banknotes wherever possible, for the odds of them being counterfeit per million notes is proportionately much lower. 

Thus be a little vigilant with the higher dollar value notes over the next year and on balance you will have more to worry about from the legal printing of money devaluing the notes in your pocket than illegal counterfeits!

8 steps to financial freedom

8 steps to financial freedom

A monster topic to cover in one blog post, for sure! But let's see what I can squeeze in to one entry - for more details and ideas on these subjects, grab a copy of my latest book

Step 1 - Be mindful of your money mantras

We all hold internal dialogues and tell ourselves stories about all different aspects of life, and money is no exception, with many of our scripts ingrained in our subconscious during our youth.

Each of us has a range of "scripts" or what I call money mantras, an unconscious code of beliefs about money which in turn determine our thoughts, emotions, feelings, and actions. These can cover anything from our beliefs about wealth and wealthy people, to our attitudes towards giving and receiving, spending, investing, how much is "enough", and a whole host of other related issues. 

"Taking risks is a bad idea" is just one possible example of a money mantra. "Most rich people inherited their wealth" is another, or "I don't trust anyone when it comes to money". In fact there are thousands of potential money mantras or beliefs which you might hold unconsciously. 

Some people say "money isn't that important to me", while others believe that "if you want more money, you have to work harder." Higher income earners might say that "I always buy the best of everything", while those of a more parsimonious bent might believe that "a penny saved is tuppence earned" (or they might have done in post-war Britain, at least).

Most of us have a belief, for example, about how much an hour of our time is worth, and your figure is likely to be based to some extent on your self-esteem and self-belief in your expertise. Note that whether or not these money scripts are true, they are inevitably vitally important since unconscious beliefs determine emotions, feelings, and in turn behaviours and actions.

It is almost certain that you hold some disempowering money mantras which are holding you back from achieving your ultimate financial goals, for the simple reason that we all do. 

I barely have the space to breach the surface of this subject in a single blog post, but you will need to become mindful of your money mantras, delete the disempowering beliefs, and replace them over time with a more practical and empowering code of beliefs.

Step 2 - Change your thinking

Most employees picture their consumption life cycle as looking something like the graphic below. Often people start out adult life in the workforce with some debt from higher education, which they eventually get paid off, and then steadily they build some wealth through owning a home and in their pension fund. At some point around the retirement date they aim to take out a lump sum or buy an annuity. 

Often folk have a plan to spend most of their money before they pass on, hence phrases such as "SKI holiday", "you can't take it with you", or "hopefully I'll spend the last dollar on the day I die!".

Through using compounding growth in your favour, you may try to think a little differently. Instead of aiming simply to get by in retirement, if you can build an investment portfolio which reaches a critical mass - whereby passive income exceeds expenses - then you can continue to grow your net worth in perpetuity. 

Compound growth is always the key to building wealth over time. Try to remember that $5,000 invested at a compounding annual return of 8 per cent over 45 years could be worth nearly $160,000, before adjusting for inflation. Therefore consider that each time you opt for discretionary expenditure or the buying of luxury items, the cumulative opportunity cost of each decision could be momentous! 

Step 3 - Resolve to buy assets

While businesses prepare a number of key financial statements such as a cash flow statement, and another which looks at changes in equity, arguably the two most important financial statements are:

(i) the income statement (what we used to call back in my day a "profit and loss account", before we adopted International Accounting Standards) which summarises income and expenditure; and

(ii) the statement of financial position or the balance sheet, which summarises assets and liabilities.

Try to think of your own personal finances as being just like a business. Most employees today are consumers in the economy, earning money from wages, paying some taxes, and then using the rest of their money to live, consume, and buy things, as indeed is their right.

While consumers may have some assets (home, pension), they may also have liabilities (credit cards debt, car loans) which attract interest expenses. The consumer's cash flow profile may therefore look something like the one below, with money flowing in monthly from a salary, but then flowing straight back out again in the form of tax, interest payments, and other expenditure.

If you want to achieve financial freedom then instead of being only a consumer in the economy you ultimately need to become a stakeholder, owner or investor, and the easiest way for most employees to do this is to resolve to acquire income-producing assets (and not consumer liabilities). 

The cash flow profile of an investor sees their assets generating income in the form of dividends, rental income, and interest. When passive income exceeds monthly expenditure, the investor becomes financially free, no longer reliant upon their salary income to survive from month to month.

Step 4 - Design a spending plan

OK, OK, I's way too boring and you aren't going to spend any of your valuable time drawing up a budget. I get that! I've been a Chartered Accountant for a decade-and-a-half, spent half my career drawing up budgets and forecasts (shudder), and I couldn't be bothered to do a detailed budget either. A busman's holiday if ever there was one, and not a very interesting one at that.

As a compromise, however, may I suggest instead drawing up a simple spending plan, which quickly summarises your key monthly expenditure, including your fixed essential costs (mortgage, rent, insurance, loan repayments etc.), your variable essential costs (food, fuel & transport, repairs, phone & internet), and your discretionary expenditure (meals out, nights out, movies, footie).

If you want to move ahead financially you need to find a way to drop more of your after-tax income into a fourth bucket, that being for investments, ideally 20 per cent or more of your net income.

Now, yes, I get that too, 20 per cent is impossible. I know, I was a 20 year old with an Olympic standard thirst myself not quite so many years ago, and I would have told you then that saving any money at all was an impossibility, let alone 20 per cent of it. 

But like any goal, this can be achieved over time. How? One step at a time! One of the most effective methods is to not increase your expenditure each time you receive a pay rise or bonus, instead opting to increase your savings steadily as you can afford to do so.

Saving 20 per cent of your income may not be possible for you immediately, but it certainly can be achieved over time. The savings are there somewhere, and if you want it badly enough you can and will find them, even if it takes some years. 

Step 5 - Choose your weapons

Asset allocation - it's your ultimate bucket list! It has been said that asset allocation accounts for more than 100 per cent of investment returns. Why? Because fund management fees, transaction costs and taxes act as a drag on most investment portfolios. 

If you instead choose to invest in low cost investments which you can hold in perpetuity instead of continually trading in order to beat the market, then you can lose this painful drag on your portfolio.

Of course, the internet is chock full of young #experts who reckon they can time the market expertly (not that most of them ever make any money from doing so - lol), but just as most drivers believe they are of above average ability, in reality sadly it cannot be so!

It has also been said that asset allocation is the only free lunch in investment. Meaning? Spreading your risk helps. It's a good thing! This is another way of saying "don't put all of your eggs in one basket". No matter how appealing any investment seems, all asset classes go through highs, lows, winter and summer seasons, so spread your risk through diversifying your investments. 

There are a number of ways to diversify investment risk: through holding different equities (e.g. buying a diversified product such as a low cost index fund or LIC, by investing across different markets (e.g. Australia, US, UK), by investing in different asset classes (property, shares, bonds), or by diversifying across time (by investing at regular intervals, rather than in a lump sum).

Balancing a portfolio

There is no such thing as the perfect asset allocation for we all have different goals, time horizons, preferred asset classes, and tolerances for risk.

Speak to a licensed financial advisor who can help you to decide on the right strategy for you - by which I mean an independent professional who will charge you a straight fee for service, not some slimeball that recommends buying an off-the-plan apartment in your self-managed super fund in order to cream off a fat 6 per cent commission for himself!

As an industry we have done rather a fine job of making investment sound more complex than it needs to be, partly, the sceptic might say, so that average investors feel the need to engage professionals to manage their money for them. Investment types are no exception, particularly with the growth of hybrid investments such as convertible bonds, derivatives, and contract instruments such as CFDs.

In simple terms there are essentially only TWO types of investments - ownership investments (e.g. real estate, equities, commodities), and lending investments (e.g. bonds, notes, deposits). 

Lending investments help to balance a portfolio and can provide certainty of income, but ownership investments generally offer the greater opportunity to compound your wealth over the long term through increasing income streams and the potential for growth.

A balanced portfolio should include property, shares, fixed interest investments, and cash - and if you are so inclined gold and silver (while providing no income) can act as an effective hedge. If all of this is starting to make your head spin, try to again think of four buckets for your investments, which you will top up over time and as you can afford to do so.

Instead of trying to rebalance your portfolio in a complicated manner each year - which can be inefficient since buying and selling generates transaction costs and taxes - consider whether you can simply top up the lagging asset classes. When buying quality assets which you never have to sell, then this can work efficiently and effectively.

If you were to back-test an ideal portfolio using the past few decades as a guide, the exercise may tell you to have more than half your portfolio invested in bonds (fixed interest), but this only really helps if you think next next few decades will be anything like the few decades just gone, which they may not. 

With interest rates at rock bottom, globally many fixed interest investments have gone from guaranteeing a "risk free return" to practically offering "return free risk". And while cash as a buffer is an important safety net - as well as allowing you to pounce on great opportunities which may come along - holding too much cash will act as a drag on returns.

You can see why asset allocation is such a challenging proposition today, and why using an independent financial advisor to build you a workable long term plan is likely to be a smart idea. 

Step 6 - Snowball your wealth

Use time as your greatest ally, not an enemy, by allowing compounding growth to work its magic. The below chart shows the fearsome impact that a 2 per cent per annum difference on returns can make to your long term results. 

While stock brokers and fund managers will of course suggest that you invest with them, if they are charging significant fund management fees or managing your portfolio actively, they need to have a proven track record of doing something pretty darned good to make it worth your while. 

Buying and selling investments generates transaction costs and taxes, and larger funds can suffer from market impact, as well as the usual challenges of the bid-ask spread or slippage. Thus whatecer you do don't pay 2 per cent of your money every year to an index hugger!

While it might seem contradictory to suggest that you use a market professional when investing in property, the key difference is that a buyer's agent charges a fee-for-service as a one-off cost, whereas a fund manager typically charges their fees annually, often based upon the balance you have invested with them (meaning that their fees increase over time, which is compound growth of sorts, but the type of compounding that helps them, not you).

Of course, your goals may seem very far away and daunting when you are just starting out. Take a deep breath, and resolve to take it one step at a time without worrying about what your peers are up to. 

Whether you start out small or with a larger lump sum, the principles of successful investment don't change too much: spend less than you earn, invest the difference in assets which have a proven track record of generating a wealth-creating rate of return, re-invest the profits, and allow compound growth to work its magic over the long term.

Step 7 - Invest counter-cyclically

Penultimately, while time in the market may notionally be more important than timing the market, that doesn't mean that you shouldn't try to buy more assets when they are cheap.

In equities markets Dow Theorists will tell you that this means aiming to buy more during the accumulation phase of the cycle, rather than the public participation phase or distribution phase. In plain English, this means aiming to buy more when sentiment is low and stock markets are cheap, generally punctuated by lower price/earnings (P/E) ratios, and higher dividend yields.

Not dissimilarly, property investors should aim to do the same, though at the time of writing in the residential sector rental yields are fairly dismal in some capital city locations. The property market cycles do tend to recur over time - as rising demand pushes up prices, construction and supply respond, in turn dampening rents and then prices. Rinse and repeat.

Naturally property investors aim to buy in the period before prices increase. Note that while the graphic below may be representative of what might happen to property prices through a cycle, it shouldn't necessarily be taken too literally. 

For example, prices can and do sometimes fall below previous troughs, as property owners in many mining towns and resources regions will discover to their regret over the next couple of years. 

Step 8 - Protect your wealth

There are several different aspects to protecting your wealth ranging from holding the appropriate insurances, to not getting divorced, to owning your assets within the appropriate structures (e.g. companies, trusts etc.), and more. 

One thing I would stress the importance of is the importance of finding a higher purpose for your financial goals, a means of contribution, or 'giving back'. If you lack a higher purpose or chase wealth for wealth's sake, one day you might achieve your financial goals, and what happens then?


Disclaimer: This blog is not specifical financial advice. Speak to a licensed financial advisor about your ideal portfolio allocation and the investments that are appropriate for you.