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Five simple checks when investing long term

The investment vehicles you choose can make a huge difference to returns, especially for long-term investments. Retirement is perhaps the most common long-term financial goal, but it is far from the only one. Investing to pay for a child or grandchild’s education, to buy a house, or fund some other dream are expensive goals that need to be planned for. The best way to do so is with a long-term investment plan, started as early as possible and contributed to regularly.

For most of us, superannuation is the best long-term investment plan. It is only taxed at 15% in accumulation phase, and because contributing is mandatory, there is no need for discipline in terms of regular contributions. The problem with super is that you can’t access it until you reach retirement age (i.e. between 55 and 67, depending on your age now), so it usually is not a suitable vehicle for any goal other than retirement.

Recent legislative changes have also capped the amounts that you can contribute to super on a pre-tax basis to just $25,000 per annum. There is also now a cap of $1.6 million on how much you can have in an allocated pension for retirement. Another factor seldom discussed is that, in the event of death resulting in the passing of superannuation or pension funds to a non-dependant, there are significant tax penalties incurred by the beneficiaries. This is a form of inheritance tax that many retirees are unaware of until it is too late.

Managed funds, on the other hand, are a good way to invest for the long term. The challenge is that you need to include any returns in your annual tax return, which means that all distributions or dividends you receive are taxed at your personal rate, which can be up to 45%.

Choosing how to invest long term

There are five features that should be considered when choosing new investments:

1. Risk profile

Risk is a fundamental consideration in investing. Identifying, quantifying and assessing your risk appetite against the risk category of the investment options should be the first step in any investment process. It will influence your investment decisions and impact the time required for you to meet your objectives.

2. Investment timeframe

Generally, the longer the investment timeframe, the higher the level of risk you can typically take. Conversely, if you have a short investment timeframe and may need to access your money, then investing in riskier or growth assets like equities may not be the best option.

3. Returns required to achieve goal

Once you have decided on your financial goal, the next step is a realistic assessment of how much it is going to cost, how much you need to invest, and the return you will require to get there. This will help you determine which investment assets or the mix of assets to suit you.

4. Tax effectiveness of the vehicle

The amount of tax you pay makes a big difference to the money you end up with in your pocket, particularly if you are on a high personal tax rate. When and how you pay the tax can also be important.

For example, investment bonds can be tax-effective because tax on returns from the underlying portfolio is paid from within the bond at the company tax rate of 30%. The effective tax rate can be even less if the underlying investment portfolio generates franking credits.

Returns from the bond are not distributed but are re-invested into the bond. This means that the investment bond or any returns from the bond do not need to be included in your tax return.

Another advantage of investment bonds is the lack of capital gains tax liability. Because earnings are automatically reinvested in the bond, there is no capital gain tax liability and reinvestment dates do not need to be tracked for capital gains tax purposes. Investment bonds are tax-effective on an ongoing basis, but the biggest advantage they have over other investment structures comes if they are held for 10 years, in which case, all the proceeds, principal and investment returns are distributed to the investor entirely tax free.

5. Flexibility of the investment structure

Despite your best-laid plans, you may need to withdraw funds from a long-term investment or switch investments due to changed requirements. It is important to compare the flexibility of the various investment options you may be considering.

It is possible to withdraw funds from an investment bond at any time within its 10-year tax-free period for example, although you may lose some or all of the tax benefits if funds are withdrawn early. It is also possible to switch between investment options without triggering personal capital gains tax.

What is an investment bond and how does it work?

An investment bond is like a tax-paid managed fund: investors choose from an underlying portfolio of assets that differ in terms of their risk profile and likely investment returns, and can include different asset classes – including equities, fixed interest, real estate or a mixture.

Investment bonds are simple to set up and can be started with as little as $500 or as much as you like, and additional contributions can be made up to 125% of the previous year’s contribution.

Due to their unique structure, investment bonds can make powerful estate planning tools. You can nominate a beneficiary, and if you die, this beneficiary will receive the proceeds of the bond tax-free, regardless of when this occurs. An insurance bond does not form part of your estate for the purposes of you will, so cannot be challenged.

Conclusion

The sooner we all begin contributing to our financial future, or to any long-term financial goal, the more likely we are to achieve it. The superannuation system is predicated on exactly this fact and super remains the most tax-effective investment strategy available when it comes to planning for retirement.

If, on the other hand, you are working towards a different, and not quite so long-term financial goal, like paying for tertiary education for your children or retiring early, then super may not be the best choice, because you won’t be able to access it when you need it. Investment bonds may have a role to play to meet this type of investment goal.

 

Michael Blake is Head of Centuria Life, a provider of investment bonds. This article is general sponsored information and does not consider the circumstances of any investor.

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