It started out as a news story about cars, not investing:

“When a Google self-driving car edged into the middle of a lane at just a bit over 3km/h on St Valentine’s Day and hit the side of a passing bus, it was a scrape heard around the world.”

Although the incident was big news in the car industry and at Google, it has no apparent connection to investing. But then the story took a delightful twist:

“The accident illustrates that computers and people make an imperfect combination on the roads. Robots are extremely good at following rules … but they are no better at divining how humans will behave than other humans are.”

Starting to sound familiar? Rather like markets and behavioural economics? Here’s the punch line:

“Google’s car calculated that the bus would stop, while the bus driver thought the car would. Google plans to program its vehicles to more deeply understand the behaviour of bus drivers.”

You gotta laugh. Good luck with that one, Mr Google. Will you be programming the bus driver who is texting, or the one who drank too many beers last night, or the one who fought with his wife as he left for the bus depot, or the one onto his fifth coffee?

Welcome to the world of investing and human behaviour which is anything but rational.

Behavioural finance and the struggle for explanations

Every human emotion plays out when investing, making financial markets unpredictable and struggling for a theory based on scientific evidence. We have covered the subject of behavioural finance many times in Cuffelinks, such as here and here. Often, investment decisions are driven by emotions rather than facts, with common behaviours such as:

• Loss aversion – the desire to avoid the pain of loss
• Anchoring – holding fast to past prices or decisions
• Herding – the tendency to follow the crowd in bursts of optimism or pessimism
• Availability bias – the most recent statistic or trend is the most relevant
• Mental accounting – the value of money varies with the circumstance.

A new book to be published soon, written by Meir Statman, called Finance for Normal People, argues that the four foundation blocks of standard finance theory need rewriting, as follows:

The unfortunate truth is that if an investor went to ten different financial advisers, it’s likely they would end up with ten different investment portfolios. Investors have their own views on issues such as diversification, risk, active versus passive, efficiency, short run versus long run, etc, and often settle for ‘rules of thumb’ as a guide to investing. The bestselling book, Nudge, by distinguished professors, Richard Thaler and Cass Sunstein, quotes the father of modern portfolio theory and Nobel Laureate, Harry Markowitz, confessing about his personal retirement account,

“I should have computed the historic covariance of the asset classes and drawn an efficient frontier. Instead, I split my contributions fifty-fifty between bonds and equities.” (page 133)

That’s it! One of the greatest investment minds of the twentieth century simply goes 50/50. This is all the industry has achieved despite decades of research, complicated theories and multi-million dollar salaries paid to the sharpest minds from the best universities.

Economics as a ‘social science’

Why is investing so imprecise, replete with emotions and strategies with little supporting evidence, when other ‘sciences’ have unified theories? Why does a physicist know how gravity works, an arborist knows how a tree grows and a doctor can treat a patient with cancer, while fund managers around the world have different view on markets, stocks and bonds?

Consider Newton’s third law of motion:

“When one body exerts a force on a second body, the second body simultaneously exerts a force equal in magnitude and opposite in direction on the first body.”

There is no equivalent of this certainty in economics. For example, we do not know how the market will react when a central bank reduces interest rates. Maybe it happened because the economy is slowing, which is bad for the markets, and the hoped-for stimulus does not occur. And so the central bank plunges into unproven QE and even negative interest rates as it runs out of ideas.

Although economics pretends to be a ‘science’, it is a social science of politics, society, culture and human emotions.

It is often said that economics suffers from ‘physics envy’. Economists cannot test a theory in a controlled laboratory-style experiment in the way a physicist or chemist can. Ironically, economists usually earn a lot more than physicists, and are called upon as the experts in almost everything. Economists don’t even need empirical validation of their theories.

Which leaves markets prone to irrational bursts of optimism and pessimism, as we have seen in the last month. January and February 2016 started off with dire predictions on oil, other commodities and China and the market fell heavily, and then in early March, it staged a strong rally as the banks and resource companies recovered some of their losses. Prices were higher despite no apparent improvement in underlying fundamentals. Morgan Stanley analyst Adam Parker advised clients:

“If the consensus is right that we will chop up and down, then by the time we feel a little better, we should take off risk, not add some. Maybe you should do the opposite of what you think you should do. That’s the new risk management.”

Do the opposite of what you think you should do

That’s the advice! Maybe it’s not as crazy as it sounds.

Consider the above chart, courtesy of Ashley Owen. It compares the Westpac Consumer Sentiment Index with the All Ordinaries Index. It shows that bearish sentiment (the blue line for economic conditions in the next 12 months) is usually followed a rising share market. Bullish consumer sentiment is followed by a falling market. It’s why people tend to buy high and sell low, and empirical evidence is that investors usually underperform the index by poorly timing the market.

Let’s leave the final words to Jack Bogle, Founder of the Vanguard Group:

“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in the business, I do not know of anyone who has done it successfully and consistently.”

Good luck with that, Google

I can imagine the scientists and engineers doing what we all do to start a new project, and Googling about human behaviour as they attempt to model how bus drivers might behave. They could do worse than study a good book on behavioural finance.

Graham Hand is Editor of Cuffelinks and confesses his own SMSF has a growth/defensive allocation of about 50/50. If it’s good enough for a Nobel prize winner …

Part 1 of this series on estate planning looked at the decision-making process that should be followed to prepare an effective plan. Parts 2 and 3 outline the documentation required to ensure that your strategy is effectively executed, starting with your will. Given you will not be around (or perhaps not have capacity) to ensure your wishes are met, an estate plan and a will must be carefully drafted by a qualified professional to ensure the outcome is implemented as intended.

Focus on the prime objective

In Part 1, we asked to whom, when and how you would like your assets distributed. Many people are advised to plan around tax minimisation or even prepare simple plans in order to save legal costs, without keeping their primary objectives in mind. Prioritising secondary objectives or trying to minimise costs can lead to adverse and even disastrous consequences for those left behind. Tax laws change and poorly-drafted documentation is more easily challenged (and overturned), and your beneficiaries may be left fighting for what was originally intended. It is critical to draft all your documentation around your original objectives.

Many people will go to a solicitor they know, but it may be better to choose an estate planning specialist if your circumstances are complex or your current solicitor is more of a generalist (if he or she looked after your conveyancing, for example). The Law Society in your state will have a list of qualified solicitors and information regarding specialisations, such as the Wills and Estates Law Specialist Accreditation.

What a will can and cannot address

Your will is the legal document that outlines how the assets that comprise your estate are to be distributed, but some primary assets are not included in your estate:

• any assets you jointly own with another person. Unlike assets that are held as tenants-in-common, these assets automatically revert to the surviving joint owner on your death.
• your superannuation. Superannuation death benefits can only be paid to specific individuals (see below) and the trustee of your super fund generally has discretion as to how these are distributed, unless you instruct otherwise via a binding nomination.
• a reversionary income stream. If you have an income stream (such as a superannuation account-based pension or an annuity) with a reversionary beneficiary, it will not form part of your estate, but continue to be paid to that person.
• life insurance proceeds (including those held in superannuation). These will be paid to the nominated beneficiary on the policy, or according to the discretion of the superannuation trustee.
• assets held in a fixed or discretionary trust of which you are a trustee or beneficiary, or by a company in which you are a director or shareholder. Any shares or units you hold, however, generally will form part of your estate.

Your will deals with the remainder of your assets – cash, shares, property, personal effects and so on. Your solicitor will give guidance as to how your wishes regarding these assets should be documented. Some people are highly prescriptive about each asset, beneficiary and potential scenario (such as a specific bequest of each item to one person), while others avoid ‘ruling from beyond the grave’ and take a more principle-based approach (such as dividing the proceeds of the estate three ways if there are three primary beneficiaries).

Timing of beneficiary receipt

Timing of the receipt of your estate by young or otherwise vulnerable beneficiaries requires care. Some prefer their children to reach a mature age before accessing an inheritance, while others are comfortable with it being made available when they reach 18. Others provide for their children over time, for example, 10% at age 18, 40% at age 25 and so on, or providing for specific expenses such as university fees or a house deposit. A testamentary trust can assist with delivering to these objectives.

There are pros and cons to both the general and specific approaches. While the specific approach offers certainty, it can also create significant challenges if estate equalisation is an objective, as is common when leaving assets to adult children. How do you ensure each beneficiary receives a bequest of equal financial or emotional value? This is particularly difficult if asset valuations have changed dramatically since the will was drafted, or if other issues such as capital gains tax and sale costs have impacted the final value more than expected.

The downside of the general option is that it may require assets to be sold, with adverse tax and valuation consequences, if there are large assets that are not easily divisible. It may also create conflict if more than one beneficiary wishes to receive a particular asset. This is particularly common in rural families where the family farming property is the sole asset and only one beneficiary wishes to continue working on the land. Specialist succession planning assistance should be sought in this scenario.

Ultimately the decision to be highly specific or general in your will falls to you, however it helps to have a solicitor who is supportive of your strategy or who is willing to help you understand any limitations in your approach. A good solicitor will work through multiple scenarios, to check your wishes are met in different circumstances. These could include you pre-deceasing your spouse, you and your spouse dying simultaneously, your whole family dying simultaneously etc. While such scenarios are tough to contemplate, documenting your wishes in each event ensures that you have provided for those who are left behind.

Keep your will up-to-date

Your will should be checked and may require regular updating, either due to the passage of time, value of assets or a change in your circumstances. For example, a marriage or divorce will render your will invalid, but a marriage separation will not. If you do not update your will following a major relationship change, the entire estate may be awarded to a new spouse and children from the previous marriage may miss out. The period prior to a separation or divorce is crucial, because if you pass away unexpectedly, your previous spouse may inherit your estate against your wishes.

It’s important to take control of your estate to ensure not only that your own wishes are met, but that problems are minimised for your beneficiaries at a difficult time.

In Part 3, we will look at other documentation, including powers of attorney, insurance and superannuation benefits.

Gemma Dale is the Head of SMSF Solutions at National Australia Bank. This information is general only and does not take into account the personal circumstances or financial objectives of any reader. Readers should consider consulting an estate planning professional before making any decision.

Time travel is a skill that would dramatically transform the world of the investor. Sadly, despite all the technological advances of the past two decades, the ability to go back or forward in time remains the realm of science fiction novels, not a killer app on an investor’s smartphone. While time travel may still be the domain of TV and film producers, the passage of time is a real-world test for investment ideas even if – as we are constantly reminded – history is not a great predictor of future returns.

What has changed over 20 years?

Twenty years ago, Australia was a country of 18 million people with a median age of 37 and the median weekly household income was $637 while the cash rate was set at 7.5%. The fledgling superannuation system had accumulated assets of $262 billion some four years after the super guarantee contribution had been introduced.

In 1996 a new, more modest undertaking was getting started – it was the year Vanguard established its Australian business which was its first outside the US. It seems an appropriate time to look back and see how the underlying investment principles that Vanguard has used in guidance to clients has stood up to the test of two decades.

The market has changed markedly. Of the top 10 companies by market capitalisation on the Australian share market in 1996, half have either dropped out of the top 10 or are no longer on the ASX.

With help from actuarial firm Rice Warner, we decided to look at the past 20 years through the time capsule of three different investors in 1996 – a 40-year-old, a 20-year-old and a newborn baby – and test how our investment principles have stood up to 20 years of significant geo-political shocks, stunning market rises and dramatic declines that included a global financial crisis.

All our investment strategies are underpinned by four core principles:

1. Goals: Create clear and appropriate investment goals
2. Balance: Develop a suitable asset allocation using broadly diversified funds
3. Cost: Use low-cost, transparent investment options
4. Discipline: Keep perspective and long-term discipline

Outcomes for our three investors over two decades

One of the first lessons is that investors have been rewarded for taking extra risk.

An investor who invested $10,000 at the start of 1996 in cash would have seen the nominal value grow to $26,800. Someone who had invested in the Australian sharemarket index would have seen the portfolio value grow to $51,400. The US sharemarket index was just slightly behind at $48,100 while Australian bonds grew to $37,600.

For our three investors, Rice Warner was asked to model the superannuation outcomes. Remember back in 1996, super was really just getting started, so our 40-year-old did not get the benefit of a full career under the super guarantee nor the higher rate we have today.

The growth in the super system has clearly been one of the major developments in the Australian financial landscape in the past 20 years with it now being the second largest financial asset in average Australian households and the system growing into a savings pool of more than $2 trillion.

Our 40-year-old in 1996 is now turning 60 in 2016 and with retirement firmly in sight, Rice Warner project their super balance at retirement (assuming compulsory Superannuation Guarantee only contributions, average wages and a 7.5% gross return on investments) to be $217,000 in today’s dollars. That is projected to last until they are 74-years-old.

For the person turning 20 in 1996, and effectively just starting out in their working life, who is now 40 in 2016, the projected retirement balance is $395,000 when they reach retirement age. This money is expected to last until they are 83-years-old.

For the baby in our investor trio who is now 20, the projected super account balance accumulated during their working life is $456,000 – more than double what the 40-year-old is likely to get. It should last until they are 87.

Source: Rice Warner. Assumes default super with no additional concessional contributions.

Based on the ASFA comfortable retirement standard, the baby of 1996 could reasonably expect her super to last 13 years longer than their older baby boomer counterpart.

Higher contribution rates and a long-time period to allow compounding to work is driving these outcomes but it is interesting to reflect that even after more than 20 years, our super system is not yet at maturity. The challenge remains for those in the older age bracket to be able to contribute enough to fund their retirement lifestyle.

Robin Bowerman is Principal, Market Strategy and Communications at Vanguard Australia. This article is general information and does not consider the circumstances of any individual.

After a career spanning business, software analysis and the Arts, and now in my late 50’s, a few years ago I decided to reinvent myself as a financial planner. I studied and started applying for jobs. Over many years, even if I made it to the interview stage, I have been amazed to hear the excuses as to why I am not suitable. My favourite is “too creative”. I believe ageism is the real issue.

Eventually, I secured a one year casual contract with a major dealer group looking after their existing superannuation and insurance customers, which I finished in February 2016.

The plight of the ‘renting transitionals’

In dealing with these customers, it became evident that there is a particular group of people who are being ignored by both our political and financial classes. I call them the ‘renting transitionals’. They are in transition between mature-age (50 years-of-age upwards) and age pension age. Not only are they in transition between jobs, but crucially, they do not own their own homes. Surviving on the age pension as a non-homeowner is a topic for another day.

With the superannuation system still evolving into maturity, when these renting transitionals, especially women, lose a job, they do not have sufficient funds to support themselves to preservation age, let alone pension age. Even when they can access their super, perhaps under the ‘hardship case’ provision of release or a Transition to Retirement pension, it is insufficient to pay for both rent and food. The money won’t last the distance.

For those that qualify, the Newstart Allowance for a single person is only $13,717 per annum, which will not cover basic living expenses, and any income earned reduces the Allowance.

Home ownership is a massive issue

Many financial commentators quote the ASFA Retirement Standard as the benchmark for living standards. Their latest annual budget for a ‘modest’ standard is $23,797 for a single person, and $43,184 per annum for a ‘comfortable’ retirement. The crucial qualification is:

“Both budgets assume that the retirees own their own home outright and are relatively healthy.”

I have a colleague who was made redundant after working for Arts and Heritage organisations for many years. The recent cuts to the Australia Council do not come without personal consequences. The types of jobs she has held mean her income has been low, she has been unable to buy a house, her super balance is accordingly smaller and at age 59, she has not been able to find another job. The loss of manufacturing jobs and the downturn in resources and construction have hit others hard. My colleague is increasingly isolated and losing confidence which in turn affects her chances of employment. It causes profound stress, depression and suicidal thoughts.

Now her TTR pension may also be subject to 15% earnings tax further affecting its longevity.

What do we do? This is not an issue that will go away for older workers. It is not that they do not want to work. Often people employed in the Arts are working extremely long hours that are usually underpaid, and they rely on other jobs to get them through. Income protection policies, while highly desirable, are out of the reach of these low income earners. Newstart (again, if they qualify) is a form of entrenched poverty. If it was maintained until their other earnings reached a liveable wage, it may be useful.

Council of the Ageing SA Chief Executive, Jane Mussared, recently said:

“Home ownership was a bedrock for older Australians. Our pensions are low by OECD standards but were propped up by high ownership levels and low mortgage levels. (Federal MP) Mark Butler talks about home ownership rates being in free fall among older people. Put in a period of unemployment prior to aged pension, low levels of super, low earnings over a lifetime and high levels of caring responsibilities and we have a looming problem.”

What do large institutions say about employing older people?

Nearly every major corporation has a public policy on the need for diversity in the work place. Often, there is a heavy focus on gender balance, pushing other diversity issues such as age, disability and religion into the background.

It is common for a policy to state that the company’s employees should reflect the characteristics of its customers. This ensures an empathy with customer problems, leading to greater understanding and hopefully, business retention. For example, the Commonwealth Bank has a microsite devoted to sustainability and the need to ‘reflect community diversity’, stating:

“The Australian community is diverse, dynamic and culturally rich. It is also changing as the population ages and we become more economically and culturally entwined with our Asian neighbours. As one of Australia’s largest employers, with a nationwide branch network, it only makes sense for our workforce to reflect the diversity of the Australian community.”

“Diversity is an essential element of the Commonwealth Bank Group’s new strategic vision: to excel at securing and enhancing the financial wellbeing of people, businesses and communities. A key area of focus over the next 12 months will be further developing our response to the challenge of age diversity.”

A good place to start on age diversity would be employing the number of older people in proportion to the number of older people among CBA’s customers. Now, that would be a big number!

What else can be done?

Luckily, I have sufficient funds and my own home. I will shortly complete my Advanced Diploma in Financial Planning and will continue to look for full-time work. Failing that, I will retire if the government starts taxing my modest transition to retirement pension. The renting transitionals are not so fortunate.

Do we need an education campaign reminding 40-year-olds that they may need to provide for themselves without government assistance from anywhere between the ages of 50 to 70, before the likely age pension kicks in?

We need solutions beyond standard income protection policies. For low paid workers who are aging, many of these favourite insurance solutions do not present themselves. Are there new affordable ‘Living Wage Mutual Income Protection’ insurance policies that could be designed for this demographic?

The alternatives to taking action are mental health issues and homelessness affecting potential workers who do not have the resilience of youth to tide them through. I worry about that my colleague may be among the growing number of older women who experience homelessness for the first time later in life. Older, single women are vulnerable as they may lose their jobs early, lose a spouse or be discriminated against in the housing market. As Jane Mussared said:

“It is your mother, sister or grandmother that is at risk of being forced to sleep rough.”

I would dearly like to hear how we help people get through this period until they can at least qualify for the age pension. Have you survived a similar period? How are advisers helping clients with this potential problem?

Barry French has a BA and is currently completing an Advanced Diploma in Financial Planning. He formerly worked as Technical Support Manager for an international software company. His passion is to provide financial services and education to people in the Arts and the 80% of people who receive the least advice and probably need it most.

Quick and simple digital advice makes investing easy, but do the long-term consequences outweigh the short-term benefits? A new report by US market regulator, the Financial Industry Regulatory Authority (FINRA), draws attention to this question by sharing the digital investment advice practices employed across the securities industry. It’s a reminder of the obligations that come with robo advice and the standards FINRA expects to underpin a financial advice service.

FINRA CEO Richard Katchum questions the adequacy of robo risk tolerance practices when he contrasts them with personal advice delivered by a human advisor:

“The same requirements are in place — the same expectations that you understand your customer, both from the standpoint of what their risk appetites are, and also that you have asked enough questions to really understand their financial situation and that they can accept risk and the risk of loss.”

Furthermore, advisors need to be able to explain both to clients and the regulator how their tools and products work. There is no defence in the argument that ‘I’m just following instructions from head office.’ Black-box solutions are not acceptable.

Undergoing a complete investor profile

Many robo advisors do not develop an appropriate investor profile of clients. One of the most fundamental aspects of delivering suitable advice is to ascertain the level of risk that a client is willing to take. This is referenced as ‘risk willingness’ in the FINRA report and is commonly referred to as risk tolerance. The regulator questions whether it’s possible to accurately measure the amount of risk that an investor is willing to take by asking a small number of risk tolerance questions – in some cases just one.

There are no lower standards expected for robo advice compared to human advice. FINRA’s ultimate concern is investor protection, and the importance of accurately assessing risk tolerance cannot be ignored. When investors take more risk than they are comfortable with, they are more likely to bail-out of the market when the going gets tough and then wait too long to get back in. This pattern of buy high and sell low makes it difficult for investors to achieve their financial goals. Furthermore, over-exposed investors suffer adverse behavioural reactions to financial loss such as anxiety, loss of sleep, and relationship problems.

It is common industry practice to treat investment time horizon as a sub-factor of risk tolerance when, in fact, time horizon is an aspect of risk required (the level of risk needed to achieve your goals). Simply put, this requirement is a catalyst for change. Most risk tests used in the market place would be non-compliant according to these principles.

FINRA also makes a distinction between risk tolerance and investors’ capacity for loss, making customer profiling critical because it drives recommendations to customers. The message is clearly aimed at the executives at the top of the enterprise:

“Two other areas of digital investment advice – customer risk tolerance assessment and portfolio analysis – reinforces the need for broker-dealers to establish and implement effective governance and supervision of their digital investment advice tool. Good governance involves understanding if the approach to assessing customer risk tolerance is consistent with the firm’s approach. Firms must apply good practices across all distribution channels, not just robo advice.”

Analysis of seven robo recommendations

FINRA details seven robo advisors’ portfolio recommendations for a young worker. Let’s call him Michael. Of particular concern is the wide range of 60% to 90% in growth asset recommendations and how they match to his risk tolerance. If growth exposures are greater than what is consistent with risk tolerance, then the likelihood increases that the investor will be disturbed by a market correction. If not satisfied by the advice, clients may sell down growth assets at the wrong time, and in the worst cases, seek legal redress. Dissatisfied clients are a blight to all businesses, more so in financial services in the last few years.

Let’s assume that Michael has a FinaMetrica risk tolerance score of 50 (out of 100) and is placed in Risk Group 4. Based on a score of 50, Michael would be comfortable with between 39% to 58% growth asset exposure. Most people in Michael’s Risk Group would typically be discomforted when the value of their entire investment fell by 20%.

If we look at the seven portfolios illustrated in the FINRA report from the standpoint of who would be comfortable based on risk tolerance alone, the riskiest portfolio with a 90% exposure to growth assets matches the risk tolerance score of just the top 5% of the population. This rarefied group generally includes hedge fund managers, bankers, entrepreneurs and high risk tolerant individuals.

When we map the seven recommendations (shown by the vertical bars below) on to Michael comfort zones, none of the portfolios is consistent with Michael’s risk tolerance and all but one are in the ‘Too Much Risk’ red zone.

To test sensitivity, we look at four broadly diversified portfolios with 60%, 70%, 80% and 90% growth assets. These portfolios were back-tested to 1972 using indices rebalanced once a year. Even the 60% equity-exposed portfolio exceeded the 20% drawdown that investors whose risk score is 50 typically tell us they are comfortable with.

We are regularly reminded that the past is not a precursor of the future in terms of investment performance, so we don’t need to be reminded that unhappy investors are a scourge on our industry’s/profession’s successful and profitable future. If we don’t manage the matching of investments to investors’ needs effectively, we can be assured that regulators will continue to do it for us. Risk tolerance is not hard to assess accurately, it just needs a little science and a dash of common sense.

Paul Resnik is Co-Founder and Director of Finametrica, a risk profiling system that guides ‘best-fit’ investment decisions.

The Australian regulator, ASIC, recently completed its consultation feedback for its own policies on robo advice.

A concise definition of roboadvice is an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners. The question is, will this form of advice become dominant, exterminating traditional financial planners (to use a Dalek analogy)?

The answer is yes, of course, but only when robots take over the world. Between now and becoming slaves to the machines, financial advisers will be greatly assisted by changing technology. But not every planner will benefit. Roboadvice will vastly increase the market size through offering inexpensive advice, but some planners will fail, unable to deal with the ever-increasing pace of technological change.

Winners and losers

Many people lack confidence in managing their money and they will want face-to-face advice, but that does not mean technology will not materially disrupt the industry. Winners will be non-aligned financial planners, planning groups in small superannuation funds, and smaller banks. Losers will include major banks and bank-employed and aligned planners.

While always open to debate, my selection for winners and losers is based on:

• Ability and willingness of organisations to adopt new technology
• Burden of legacy systems holding back implementing new technology
• Restrictions from having a valuable brand – companies who are very protective of their brand are often slow to adopt new technology, waiting for all bugs to be removed
• Degree of ‘creative destruction’ occurring within the industry – those at risk of losing market share are more likely to look to innovation to remain competitive.

Australian banks have large IT budgets but most of it is spent on maintaining legacy systems or meeting changes in regulations and compliance. When banks do turn their hand to system development, it frequently fails, incurs major cost and time over-runs, and becomes prohibitively expensive.

Major banks are unwilling to risk their brand with start-up technology. A Chief Investment Officer of a very large super fund once told me that systems development now either costs less than $2 million or more than $200 million. There is nothing in between. Smaller start-ups are so nimble and inexpensive that new technology from this source is amazingly cost-effective. But a large organisation is unwilling to risk tarnishing its brand with a small start-up. Major banks are more willing to risk their brand from expensive technology failures so long as the developer is a well-known company.

Major bank wealth management groups risk placing too much reliance on building new platforms. The disruptor to platforms is the predicted increase in open APIs (application programming interfaces). Open APIs will mean:

• Client investment and personal data can be sourced cheaply and safely. The planner, at almost no cost, can see their client’s position, in almost real time, with data presented in a useful manner with recommendations based on previously-agreed financial objectives and constraints.
• Fund (and SMSF) administration and tax will be commoditised, driving down price.
• Planners can execute transactions where they like. Planners will no longer be restricted to what the platform offers.

Bank platforms are yesterday’s technology. My winners are selected because they are organisationally smaller and experiencing some ‘creative destruction’ in their industry.

Size is important. If you are not the lion in the jungle, you better wake up running. Smaller organisations will have to be nimble to survive. Those who do survive, and there will be many who do not, will have an ability to make quick decisions with a high degree of management accountability. They are likely to have less to lose by realising that their historical technology spend has little to no residual value. Cheaper more powerful technology means smaller organisations can quickly develop a technological advantage over larger organisations. A smaller technology spend will not mean less capability. It might mean more.

Younger planners are also big winners with technology, not because their minds are youthful but because they need the business. Younger or new financial planners will see technology as a way of growing their list of clients, including those clients which more established planners thought were uneconomic.

Creative destruction refers to the incessant product and process innovation mechanism by which new production units replace out-dated ones.

The reason Australia is slow to adopt financial technology is the absence of creative destruction in many parts of the industry. Traditionally, superannuation funds do not go out of business because members are attracted to another fund with better products and services. But that is no longer the case. Many small and mid-size superfunds are losing members or are under pressure to merge with larger funds.

These smaller funds must adapt or lose their purpose for being in business. They have to adopt ways to improve member engagement and offer higher quality services at an ever-decreasing cost. They will have to engage with emerging technologies, as they don’t have the budget or capabilities to build their own systems. Their size, rather than being a weakness, will actually make them competitive, offering superior products.

Where are the financial planners?

Financial planners must decide where they are as technology emerges. There are warning signs that they are not prepared for the technology changes, including:

• Their main browser is Internet Explorer or Safari rather than Chrome or Firefox.
• They have a fax number on their business card.
• They have just replaced their server in the office.
• They have not yet tested or had any experience with a roboadvice product.

Technology is moving to a Netflix / Spotify business model. It can be tested for a very small amount of money. If it works, users can increase the subscription and if it doesn’t, they can terminate the service.

Financial planners must at least experiment with roboadvice and related technology, or they are at risk of not developing the management skills to deal with what will be a material change in the industry.

Conclusion

Technology will only get better. Information will become cheaper and more available. A financial planner will spend materially less time collecting and summarising data and more time with clients discussing important issues. Technology will release them from the cost and limitations of large platforms. Those contractually obliged to use platforms will be at a material cost and flexibility disadvantage.

Size and brand will be a disadvantage. Small flexible organisations will be the winners with more clients, higher margins and providing greater service.

Donald Hellyer is the former Global Head of Funds and Insurance at National Australia Bank and Chief Executive of BigFuture.

In 2015, Brookvine ran a workshop modestly entitled ‘WhiteBoarding 2.0’ where advisors and Chief Investment Officers to High Net Worth (HNW) clients and Family Offices (FO) assessed the role of diversification in their thinking and practice.

The wisdom of diversifying is ancient: Warren Buffett has stated that it’s a hedge against ignorance and a modern version of the biblical instruction to ‘divide investments among many places, for you know not what risks might lie ahead’. A millennium later, the Talmud offered an explicit and not unreasonable uniform diversification, to divide equally across ‘buying and selling things’ (equity), ‘gold coins’ (cash) and ‘land’ (real estate).

Selling diversification to HNWs

Until Modern Portfolio Theory (MPT) came along, diversification was justified by the slogan ‘don’t put all your eggs in one basket’ as opposed to the less common but for some equally valid, ‘put all your eggs in one basket but watch it very carefully.’ By quantifying risk, Nobel Prize winner Harry Markowitz transformed diversification from a slogan to an explanatory and operational tool. Diversification went from theoretical insight to black letter law in a mere 20 years and became an investment truism, the ‘single most important thing’ in portfolio construction. Superannuation funds must ‘have regard to’ diversification and for MySuper funds, it is compulsory. Yet many private wealth portfolios and SMSFs are less than ‘optimally’ diversified … often for sound reasons.

Most wealth is created by HNWs through direct investment in a single business. That makes it hard for wealth creators to appreciate the logic of diversification in their investment portfolios as they transition from getting-rich to staying-rich. Sensitive advocacy is needed to convince HNW families of the efficacy of diversification in preserving capital, especially in explaining the need for unconventional asset classes such as private real estate lending, catastrophe bonds, real assets like agriculture and timber, infrastructure, oil/gas, and collectibles including art that are unfamiliar and hard to access. Advocacy can be re-enforced through ‘diversification’ of a different type in which portfolios are structured around different purposeful ‘themes’ such as income, aspirational/opportunistic, security, legacy/philanthropic, and fun/trading.

Whether diversification is a free lunch led to vigorous discussion among participants at the workshop. Forceful comments were made on the cost and risk of ‘diworseifying’, a consequence of agents minimising business risk, consistent with Berkshire Hathaway’s Charlie Munger’s statement that “diversification is a veil to hide behind”. A more direct cost flows from the added complexity of more asset classes demanding more advisor time, thus making fees an issue. Costs led to an engaging debate around the perceived recent failure of diversification exacerbated by the one-way path in asset prices clients have experienced for almost a generation. Some advisors saw a consequent need for more dynamic approaches to diversification.

Two brothers with different goals

A case study involved two brothers who were distinctly different investor types with different goals and objectives. Because decisions have financial as well as emotional or psychological dimensions, advisors need to appreciate families’ experiences, expectations and idiosyncrasies lest diversification remain an abstract notion. These include:

• any relevant friction within families
• what they most worry about
• the time horizon they think in terms of
• the level of control they want
• any roles they want to play in decision-making
• their biases and strength of their convictions
• the extent to which unrealised taxable gains are an impediment to change
• their personality types
• how they think about and describe risk
• any comparative advantages the trusts have.

These can be partly expressed in a ‘family governance document’ that can help link investment strategies to financial and emotional well-being.

Klyde, an entrepreneurial businessman who created his wealth by building a narrowly focused business, established a trust for the benefit of his immediate family and future generations. He struggles to relinquish control, making the trust’s implicit purpose somewhat ambiguous and therefore a challenge for an advisor wedded to the tenets of MPT. His brother, Cerry, a delegator with minimal interest in investing, established a perpetual philanthropic trust to support the arts with an explicit objective: spend 5% per annum to maintain its tax-free status.

Klyde had tried to diversify his businesses with disastrous results, an evident source of resistance to portfolio diversification. His trust’s initial configuration, dominated by the idiosyncratic risk of a single business, was seen as dangerously under-diversified, exposed to a meaningful risk of a sizeable capital loss that could be materially reduced through diversification. Advisors favoured slowly but tax-effectively reducing the weight of legacy assets and crafting a portfolio with more calculated bets, and direct ownership of some other assets. They recognised cash as a very active component of the portfolio and favoured a program of sizeable shifts in allocations.

Alternative investment models: entrepreneurial and transitional

The entrepreneurial model favours a concentrated set of investments familiar to Klyde, combined with interests in operating businesses aligned to his experience a bias away from co-mingled funds. This model needs to be managed by an in-house team supplemented by external advisors. The initial lack of diversity may be partly compensated for by its unique deal-flow advantages.

The transitional model reduced the weight of the legacy business and favoured a far higher weight to non-operating assets with a more conventional notion of diversification through a planned transition to a broader array of assets. This model is more accepting of co-mingled funds, and of public markets and alternative assets. Nonetheless, it is avowedly opportunistic and ready to work with Klyde in vetting opportunities originated through his networks. It demands more sophisticated external advice for origination, due diligence and monitoring.

Cerry’s philanthropic trust was less problematic. Its purpose is explicit and tax plays a marginal role, while on the psychological side Cerry is unlikely to argue for greater concentration or control. Advisors saw the initial configuration, dominated by Australian real-estate, as dangerously under-diversified, exposed to a meaningful risk of a sizeable capital loss which could be materially reduced through sales, with the proceeds directed towards diversification. Cerry’s trust also has paintings: legacy assets where he has a strong emotional attachment. Such collectibles can play a powerful diversifying role.

For Cerry, a third outsourced model was preferred where management is primarily delegated to an investment advisor with a portfolio that blends traditional public markets with a heavy mix of alternative assets. Benchmarks and tracking error were, by institutional standards, irrelevant because, being perpetual, the trust should have considerable tolerance for short-term variability and should favour long-duration and particularly real assets such as infrastructure and timber.

Conclusion

WB2.0 re-enforced the view that diversification is an effective way of reducing risk of capital loss and of lowering volatility. It is almost a free lunch. For large institutional funds it should be weakened only under justifiable circumstances. For smaller Australian private wealth funds its full benefits are harder to achieve due to tax, liquidity needs, access to unfamiliar assets and the technical nature of arguments. It is difficult for advisors to convince clients of the need for some diversification given the concentrated approach founders relied on to accumulate wealth and their strong emotional attachment to their businesses.

WB2.0 did show that the nuances of diversification are not fully understood. Its value will be questioned again if the next crisis sees all assets go down together. Nonetheless, thinking and practice have evolved. Advisors are seeking unconventional assets that offer stronger diversification benefits; they are questioning the ‘optimal’ level and type of diversification, thinking about diversifying across risk factors and exploring more dynamic approaches to asset allocation. As one participant wisely observed, “diversification is harder to deliver, but the results are better and you have happier clients.”

Jack Gray is a Director and Advisor, and Steve Hall is the Chief Executive Officer of investment manager and advisor Brookvine. Whiteboarding 1.0 and 2.0 are available on request via www.brookvine.com.au. Jack has been voted one of the Top 10 most influential academics in the world for institutional investing.

A note from ASIC to Cuffelinks readers

In March this year, ASIC launched the Financial Advisers Register (FAR), the first comprehensive register of people who provide personal advice on investments, superannuation and life insurance.

The Register, which now has around 22,500 appointments, makes it easier for investors, employers and ASIC to find out where a financial adviser has worked, their qualifications, training, memberships of professional bodies and what products they can advise on.

In the last six months more than 150,000 people have searched the register to find out about a financial adviser. If you haven’t had a look yet, you can search on ASIC’s MoneySmart website. There is also information on MoneySmart about what questions to ask when choosing a financial adviser. If you have any questions regarding the FAR, please email far@asic.gov.au.

Licensees alert

The register is a major undertaking and has relied on licensees providing up to date information on their financial advisers. During the transition period ASIC did not impose late fees for changes.

Licensees should be aware that the transitional arrangements for the Financial Advisers Register and Authorised Representatives Register ended on 30 September 2015.

From 1 October 2015, new fees and notification periods will apply:

• Licensees will have 30 business days from the date of change to notify appointments
  .
• A fee of $29 will apply to update details or cease a representative
  .
• A $75 late fee will apply when a notification is less than one (calendar) month late
  .
• A $312 late fee will apply when a notification is over one (calendar) month late

Improvements to ASIC Connect

ASIC is also implementing some system improvements to ASIC Connect. From October 1 2015, licensees will be able to update all financial adviser and authorised representative details online.

This includes the ability to:

• update addresses
• nominate a business name
• update names and ABNs

There are also some changes to the invoice: fees will now show a representative’s name, and include the type of fee applied.

Further information about the end of transitional arrangements for the Financial Advisers Register are on www.asic.gov.au/far from 1 October 2015.

A few weeks ago, our article, Scenes from a roboadvice pitch to angel investors, presented a fictitious pitch by a roboadviser startup to venture capitalists. Judging by the thousands of times it has been read, it was passed around much of the roboadvice industry.

A Reader Survey was attached asking questions on the potential attraction of the investment, the features of a good roboadvice offer, who the likely providers of roboadvice will be and the background of the respondents.

We attach the full survey results linked here.

Thanks to all the people who responded. The numbers were not as big as expected due to a dodgy survey link on the first day.

We have opened the full text of the responses because the comments are at least as valuable as the bare statistics.

A few highlights:

• 75% of respondents said they would not invest, while 24% said they would at a lower entry price than the initial valuation. This seems like a promising result for the availability of venture capital at a price.
• The negative comments focus on competitors undercutting the offer and the lack of a ‘moat’.
• The requirements of a good robo offer are extensive, with 88% expecting portfolio allocation recommendations, 62% wanting educational material and 66% investment implementation.
• There was no consensus on who is most likely to succeed in this space, although only 18% responded ‘nobody’.

A software developer advised us last week that he has a list of 41 ‘roboadvice’ offers either in the market or under development in Australia. There will be a lot of activity in this space, in many different forms.

Graham Hand is Editor of Cuffelinks. The Survey is released for general information and no responsibility is accepted for any of the opinions.

Trust. It’s at the heart of finance. Trust is that special property that bends time, allowing for the provision of a good, service or facility today on the strength of a belief that the other party will honour its financial obligation to make payment at or before some later date.

So central is trust to finance that the word ‘credit’ has its origin in the Latin crédere, which means to believe (and from which credo is also derived). The sudden collapse of trust in finance can be catastrophic, as demonstrated dramatically by the demise of the 158-year-old Lehman Brothers in the space of a few short months during 2008.

If the existence of trust lubricates the wheels of commerce and its absence acts as a retardant, then clearly being ‘trusted’ is economically advantageous. So just what makes one profession more trusted in the eyes of the public when compared to another?

Trust across professions – a survey approach

Unlike temperature or barometric pressure the measurement of trust resides not in the domain of physics but in sociology. Trust tends therefore to be measured by surveys that rank occupations across a scale from least trusted to most. One Australian example is the annual Roy Morgan Image of Professions Survey, run continuously since 1987 and expanding from an original 19 occupations to 30 now.

The Roy Morgan Survey respondents score people in various occupations for honesty and ethical standards using one of five possible responses; Very High, High, Average, Low or Very Low. A selection of these occupations appears in the table below, ranked highest to lowest for 2015.

The percentage of respondents rating each occupation as “Very High” or “High” for ethics and honesty for 2015 were:

Source: Roy Morgan Image of Professions Survey.

The results are unequivocal. Nursing is the most ethical and honest profession for the 21st year in a row. It’s quite a gap to the next most trusted professions at 84%, jointly held by pharmacists and doctors, with teachers rounding out the top four.

And what of professions connected to finance, commerce and investing?  Accountants fare relatively well, sitting in the top half in 11^th spot. Lawyers sit mid-pack, holding 15^th on 31%, whilst financial planners sit two below lawyers in 17^th place on an ‘approval’ score of 24%.

Other professions are clearly perceived as being less trustworthy. Amongst these are stockbrokers (26^th), insurance brokers (27^th) and finally in last place, car salespeople at a score of 4, a position held for 28 years in succession.

Why are nurses so trusted?

Part of the answer might lie in the high standard of training and education required. Most states require a minimum three year tertiary qualification to become a registered nurse. Further, once qualified, trainee nurses are under strict supervision, gradually increasing the range of treatments and medication they are allowed to administer as their experience builds.

Nursing is also a profession with a rich history of compassion, empathy and service. From Florence Nightingale tending the wounded in the Crimean War to the volunteers who battled the recent Ebola outbreak, nursing is a profession emphatically linked to the service of others over the advancement of self.

Can financial planners bridge the gap to nurses?

It’s clearly a long haul from 24% to 92%. Financial planning’s cause hasn’t been helped by a series of advice scandals over the past several years, some involving Australia’s largest financial institutions. In the wake of these scandals, the laws governing the provision of advice have been strengthened. Yet these are only part of a greater shift that must occur if financial planning is to sit amongst the truly trusted professions.

If you’re in a profession struggling with trust and credibility, nursing is a model of professionalism worth aspiring to. Modern nursing has a clear and unbroken lineage to the pioneering work of The Lady with the Lamp, as Florence Nightingale came affectionately to be known.

Nightingale was not a nurse by training. How could she be when no such training existed in mid-1800s Britain? She was in equal parts social reformer and statistician. Among her many contributions was the development of the pie chart to illustrate numerical proportion. With this and other novel data visualisation techniques she conveyed information vital to both the Crimean War effort and public hygiene more generally, and for her efforts became the first female member of the esteemed Royal Statistical Society.

Nightingale is best remembered, however, for establishing the foundations of the nursing profession in 1860. The principles she espoused; of service, diligence and compassion, together with a body of knowledge based on scientific observation and measurement, still resonates in the Nightingale Pledge which, although modernised since its first incarnation in 1893, remains at the core of nursing’s code of ethics in most jurisdictions.

Earning trust, and keeping it

Professions who find themselves not as universally trusted as nursing might first seek to focus on finding their reason for being, a reason other than the accrual of monetary benefits and material possessions. Unlike financial planning, nursing suffers little in the way of principal/agent effects. These effects present themselves when a person tries to simultaneously serve two parties with opposing interests. It is fair to surmise that in any hospital the patient, loved one, doctor, nurse and hospital board are all pulling in the same direction – a speedy recovery and discharge.

Perhaps the last word on trust is best left to the father of modern economics, Adam Smith, who in his 1759 work The Theory of Moral Sentiments, suggested that one should seek not to be praised but instead first to be worthy of praise.

In a similar vein, if financial planners wish to emulate the trusted status of nurses they should seek first not to be trusted, but to be worthy of trust. The pie chart, a tool used by financial planners the world over to sell complex investment concepts to clients, was after all first perfected by the lady who wrote the book on trust.

Harry Chemay is a former Certified Financial Planner who previously practised as a specialist SMSF advisor and as a consultant to APRA-regulated superannuation funds. He is CEO and co-founder of the automated investment service at www.clover.com.au.

Cuffelinks’ article, “Scenes from a roboadvice pitch to angle investors” provoked much comment. There was an air of cynicism in the feedback that roboadvice would never really replace current incumbents. The client acquisition costs (CAC) were too high and those with existing franchises would prevail.

But predicting the future is very difficult and even futurists, while entertaining at corporate conferences, have limited success. The Washington Post recently ran an article about what people in the 1900s thought the 2000s would look like. Their predictions were comical.

The financial industry is locked in its current mindset and sees no immediate danger. But we forget that there are many more institutions that touch the mass market, probably materially more effectively than financial service companies. Who said Coles, Qantas or Telstra can’t take a crack at our industry? Roboadvice will materially reduce the cost of entry for many players. Traditional providers will need to be wary of disrupters buying a minority stake in a roboadvice start-up and offering very low-cost product to their sizeable client base.

Here is my prediction how an ordinary person may relate to financial services in the near future, having been tempted away from traditional providers. As with the people in the 1900s, my imagination is constrained by what I know is technologically available now. But there is a huge amount being refined by the day.

A glimpse at a possible future for Tracy

It’s raining outside as Tracy catches the 400 bus from Randwick Hospital to Bondi Junction. It’s been a long shift as a nurse, her energy spent on a full ward with the usual number of distressed patients and family.

Sitting on the bus Tracy looks at her iPhone and sees a few messages from friends and a couple of notifications on NursePlus. The first notification advises Tracy of new job positions at the nearby St Vincent’s Hospital and the second notification tells her that her total wealth changed by $3000 last month and to click through to see why.

The NursePlus app is an increasing favourite of Tracy’s since she downloaded it three months ago. Her friend recommended it to her and by registering Tracy was in the draw for two tickets to the upcoming Cold Chisel concert.

NursePlus keeps Tracy in touch with the major events occurring in her industry including changes in accreditation rules, union activity, and nurse discussion blogs and chats. Tracy particularly likes the special deals, including discounted tickets, Coles specials and women’s fashion.

NursePlus shows how Tracy and her husband spend their money in an easy to understand way. She is impressed with NursePlus’s ability to combine transaction data from her Credit Union with those from her husband’s Westpac account. As she thumbs through the expenditure categories Tracy realises how much repairs and maintenance are now costing on the second car. “Time to sell”, she thinks.

No wonder NursePlus is prompting her to save more if she wants to retire at 65. That’s only five years away. Tracy has played with NursePlus’s retirement tool and realised she could come up short. NursePlus has shown her she has at least a 25% chance of not having sufficient superannuation if she wants to go on her overseas trips every three years and give $50,000 to her daughter to help with her house deposit in a couple of years’ time.

Tracy decides to transfer her super to NursePlus. She thinks, “Why not?” Tracy never visits her old superannuation fund website and NursePlus seems more in tune with her personal and financial needs. Tracy could never afford one of those fancy financial planners and NursePlus provides all she needed.

To move her super, Tracy uploads a picture of her driver’s licence and Nurse’s ID. She electronically signs her authorisation to allow NursePlus to manage the funds transfer. With a push of a button Tracy knows NursePlus will handle all of the paperwork. These days, electronic signing and authorisation make life so much easier, she thinks.

Tracy feels in control

For the first time in her life, Tracy feels in control of her finances. She can see where she can make savings and if she is on track to retire. She can see on one screen what she has in the bank, super fund, term deposits and that rental property she owns. She can even see her frequent flyer miles and flybuys.

Tracy sees another notification from NursePlus. There is a ‘two-for-one’ offer at the Event Cinema at Bondi Junction. She hits the button to buy the tickets. Tired as she is, a night out at the movies sounds great. As Tracy relaxes on the bus, she wonders if her husband has signed up to BusinessPlus, the accounting app she showed him.

Donald Hellyer is Chief Executive of BigFuture. See www.bigfuture.com.au.

The impact of digital innovation has been felt in many parts of the global economy and the financial planning sector is not immune. Recent turbulence in the advice industry, coupled with an increasingly engaged and digitally-aware public, has created the perfect environment for digital disruption. Technology has a key role to play in improving the availability and consistency of financial advice and one area in particular that has been receiving a lot of interest is the use of roboadvice.

While the term robo-advisor could be taken to imply a robot or algorithmic digital tool designed to perform all of the tasks of an adviser, Australia has yet to see a roboadvice tool which comes close to offering the full services of a traditional financial adviser. The scope and sophistication of financial planning software and online calculators is increasing, but they are still essentially support tools or algorithms. If we look to the US, where the phrase robo-advisor was coined and where they have had the most success, we see that the majority of these services focus on portfolio construction and rebalancing. However, this activity is a very narrow subset of what is usually referred to in Australia as advice – that is, assessing an individual’s financial position and proposing holistic strategies to improve that position – so we are a long way from replacing human advisers with machines.

Benefits and limitations of the robo-advice model

Complex advice algorithms have many benefits, but they also have their limitations. To illustrate the challenges in bridging the gap between algorithmic roboadvice tools and the more holistic work of a financial adviser, we have explored a typical, seemingly simple, advice scenario.

Suppose an advice client currently has a mortgage on their family home and is considering the following two options:

• Making prepayments on the mortgage to pay if off sooner; or
• Entering into a salary sacrifice arrangement to build up their superannuation savings.

To provide insight into the level of complexity required to deal with what appears to be a relatively simple question, we illustrate the results of our algorithmic calculations in the figure below.

Note: This chart was constructed using many different assumptions about various client types and economic assumptions and should not be relied upon for financial advice. It is provided for illustration only. For example, we have assumed that client age is a proxy for remaining mortgage term.

As the chart shows, there is no one-size-fits-all solution. For many people – such as those who are closer to paying off their mortgage and are on higher marginal tax rates – paying off their mortgage with free cash flow may not be the optimal strategy. They could stand to be in a better financial position at retirement if they were to salary sacrifice this free cash flow instead. Conversely, younger individuals on lower marginal tax rates may be better off financially if they elect to prioritise paying off their mortgage.

Not a trivial calculation

Even by restricting our analysis purely to the objective of maximising net wealth at retirement, arriving at the best solution for the client is not a trivial task and requires the exploration of multiple scenarios to arrive at an appropriate strategy. While this can be achieved with commonly available planning tools, it is a time-consuming process, especially if a high degree of accuracy and consistency is required. This provides an opportunity for ‘next-generation’ algorithmic tools that can perform the mechanical operations quickly and in a way that gives the adviser confidence in the accuracy and consistency of the results. The adviser would then be able to generate a reliable strategy and talk the client through it in one sitting.

However quick and accurate they may be, algorithms on their own are not enough as there are many variables that must be addressed, some of which are subjective. For example, the algorithm used to generate the output above does not capture liquidity preferences, the risk of breaks in employment, possible changes in salary, bequest motives or other sources of uncertainty, such as a potential spike in interest rates. While some of these considerations can be addressed by developing smarter algorithms, others require higher level thinking. An example of this would be factoring in an individual’s preference to reduce their leverage as quickly as possible, to achieve greater peace of mind. This is more than a numerical optimisation exercise; it requires human-like intelligence.

Who will be the winners?

What does this mean for the future of robo-advisors? We expect to see the development of greatly enhanced algorithmic tools to support advisers, with benefits including:

• Speed and efficiency of advice
• Reduced cost to serve and increased proportion of the population serviced by the advice industry
• Increased consistency of advice and the potential to enhance documentation and record keeping
• The retention of advice data in readily-accessible digital formats to assist with compliance functions, client engagement and trend identification.

As for the term roboadvice, while great for headlines, it is a little unhelpful when it comes to understanding the reality of the advantages that automated algorithms can bring to the advice industry.

We are still many years away from robo-advisors having sufficient artificial intelligence to replace financial advisers. However advisers do need to acknowledge that they are part of a rapidly changing industry which is adopting algorithmic tools of increasing sophistication. This is both a great opportunity, as well as a threat to those unable to adapt quickly. Early movers who take advantage of these advances in technology will attract more clients, increase productivity, drive down costs and serve previously unadvised segments of the market.

As with many technological advances, the ultimate winners are likely to be the end consumers. With such a large portion of the population currently unadvised, and no let-up in the complexity of our financial system, this can only be a good thing.

Steven Nagle is a partner in EY’s Oceania financial services practice. Anthony Saliba is a manager in EY’s Oceania actuarial services practice.

The views expressed in this article are the views of the authors, not Ernst & Young. The article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.

The stories of people moving into a retirement community and suffering buyer regret years later when they realise what they get back have been well told. The ABC’s 7.30 programme highlighted the issue again recently with a story about children who had seemingly done the right thing and read the agreement yet were shocked at the actual cost when their mother’s unit was sold six years later and the village operator received circa $76,000.

Such stories also contribute to the other type of buyer regret – people who wish they had made the move sooner.

Understand the arrangements before you move

No matter which type of regret, it is too late to do anything about it now. You can’t wind back the clock and move into the village sooner and if you are at the point of leaving the village it is too late to negotiate a different financial arrangement. What they needed was to identify the village or villages that would meet their lifestyle needs and have the legal and financial aspects explained to them well before they moved in.

Of course, that’s easier said than done as many of the legal and financial arrangements are complicated.

Let’s start at the start.

Retirement communities can be broadly grouped into Retirement Villages and Over 55 Communities (sometimes called Manufactured Home Parks). Retirement Villages operate under the relevant state or territory legislation, often The Retirement Villages Act, which sets age requirements and deals with some but not all financial arrangements. A small number operate under residential tenancy laws. Over 55’s, on the other hand, operate under caravan park or residential tenancies arrangements or a combination of the two.

The legal contract for a Retirement Village unit can take a number of forms, from strata title to the more common leasehold and licence arrangements. In some cases, company share and unit trust arrangements give the right to occupy a unit in exchange for the purchase of shares in a company or units in a trust. In an Over 55’s community, the contract is over the land rather than the unit – the purchaser owns the unit and has a leasehold or lease over the land. Of course, there is a big difference between having a 12 month lease and having a 99 year leasehold arrangement. It also creates the interesting situation of being a homeowner and a tenant at exactly the same time.

Costs associated with different structures

Whether the person lives in a Retirement Village or an Over 55’s community, the form of legal ownership will dictate their rights and responsibilities in relation to their unit and the costs associated with it while they live in the community and after they leave – so it’s important to understand.

The costs can be broken down into the ingoing, the ongoing and the outgoing.

The ingoing is the amount the person pays for their right to occupy their unit together with other costs such as contract preparation fees or stamp duty.

The ongoing costs will include the expenses associated with the facilities and management of the community. In a Retirement Village, these are often called general service charges or recurrent charges and in Over 55 communities they are known as site fees as well as the resident’s own personal expenses. In many retirement communities the operator delivers (or engages with external providers to deliver) extra services, such as domestic help, meals and in some cases, care. These services are normally offered on a user pays basis and are in addition to the other costs. Residents are normally responsible for their own utilities as well. Making a budget that incorporates all the costs including pension entitlements, rent assistance and other income is a good idea.

The cost of leaving a retirement community normally causes the greatest confusion. There are many different exit fee models, most based on either the purchase price or the sale price and are for a percentage multiplied by the number of years the resident stays in the village. A common model historically has been 3% per year for 10 years based on the sale price. In more recent times, exit fee models have tended to be higher, and anywhere between 35% and 45% is not uncommon.

What many people fail to appreciate is that there is more to the exit fee calculation than just the percentage-based cost, often referred to as the Deferred Management Fee or DMF. There can be sales commissions to the village or to an agent and refurbishment costs to bring the unit up to the current standard within the village. Understanding all of the fees and charges and putting them into dollar terms is important, although it often involves the imperfect science of predicting how long the resident will live in the village and what their unit will be worth when they sell.

The Retirement Living Handbook

To help people navigate the maze and avoid some of the traps, Noel Whittaker and I have teamed up again to write The Retirement Living Handbook. It covers the important aspects of moving to a retirement community from finding the right retirement community to the different forms of legal contract and financial arrangements through to the impacts on pension entitlement and eligibility for rent assistance. There’s more than a dozen case studies from Australian retirement communities so you can see how the theory plays out in practice.

We will be hosting a book launch in Sydney on Monday 19 October 2015 and would like to extend a personal invitation to Cuffelinks readers to attend. The event will be held at 2pm at Club Central, 2 Crofts Ave in Hurstville. Noel and I will be sharing our top tips and you can have your copy of the book signed. To rsvp call 1300 855 770.

Rachel Lane is the Principal of Aged Care Gurus and oversees a national network of financial advisers specialising in aged care. This article is for general educational purposes and does not address anyone’s specific needs.

Fights over wills provide an appalling insight into the bitterness, anger, and recrimination that can tear families apart. Even when quite small sums are at stake, adult children, ex-spouses, stepchildren and others will stop at nothing. It’s enough to make a person turn in her grave.

A recent report shows why increasing numbers of Australians are challenging wills in court: they’ve a good chance of success. Judges and mediators are able, in effect, to re-write a person’s will. They can even ignore a parent’s written statement that explains why this ingrate daughter or that callous son is to get nothing.

The report called Having the Last Word? is the result of a major investigation under the aegis of the University of Queensland into will-making and contesting wills. (It’s fascinating reading). It found 74% of cases challenged in court resulted in the will being changed, and 87% of those that went before a mediator. No wonder law firms appeal to would-be clients with advertisements that ask “Have you been left out of a will?”

The high level of contesting wills – particularly evident in NSW – can destroy family harmony forever and for generations, and whittle away the estate’s value in costly legal fees. Many of you probably know this. The study found 18% of those involved in a dispute said family relations had been poor before the contents of the will were disclosed but this rose to 26% afterwards. The report’s authors recommend measures to reduce the level of fights over wills. But the lawyers and others consulted were pessimistic.

“Some people have an unhealthy sense of entitlement and don’t respect the wishes of the will maker,” one told them. “You can’t draft documents or legislation to change that.”

Trawling through some cases that went before the NSW Supreme Court in recent years, I was mesmerised by the ghastly family dynamics on display. In one case a woman cut her stepdaughter out of her will, and explained in a statement: “I make no provision in my will for [DM] who claims to be a daughter of my late husband as she has ill-treated both myself and my late husband for many years and has made no attempt to contact or have anything to do with me.”

In this case DM convinced the judge it was her father’s and stepmother’s conduct that had caused the rift. [“My stepmother] is a horrible person,” DM said. “They [shut] the door in my face for 47 years.” She was awarded $75,000. Her legal costs that came out of the estate were $55,000.

In another case two daughters were cut out of their father’s will because, according to the statement he left, “they make no attempt to contact me either by telephone or in person. No cards are sent to me either at Christmas or my birthday… I do not feel obliged in any way to make any provision out of my estate for their benefit.” The daughters were awarded $9,665 and $7,750 because the judge did not believe the father’s complaints were valid. The father’s friend, who was to inherit the small estate, spent $16,500 or 25% of its value, defending the action. This is madness.

It turns out we’re not entirely free to give away the family silver to whomever we want. Our freedom is balanced by laws that allow courts to ensure family members (and others) who fit the criteria are adequately provided for out of the estate.

Irrational and punitive parents and spouses can treat family members unfairly in their will, or come under malign influences. But lawyers such as Lesa Bransgrove, of Bransgroves Lawyers, believe the balance has tilted too far against the will maker. “What we’re seeing is a view in the courts that the responsibility of parents goes beyond the time when children are dependants,” she said.

Judges had expressed a view that the community expected estates could be used to help adult children in retirement if they had no superannuation, provide them with a deposit on a home, or assist with the education of grandchildren.

The Queensland University study found a will is widely regarded as a means to distribute “family money”. Not many Australians leave bequests to charity in their will (Muslims are the exception here); and if they do, charities report court challenges from family members are common. The view of wills as “family money” may be fostering a “sense of entitlement” by family members, and fuelling the challenges, the report says. There’s some evidence “some family members are greedy rather than being in need.”

Professor Linda Rosenman, one of the report’s authors, said: “It’s probably almost impossible to draw up a ‘contest proof’ will. It would be more useful to address the family dynamics at the time of making the will rather than leaving it for the family to ‘fight out’ after death.”

Elder law specialist Rodney Lewis says he didn’t believe it was too easy to contest a will and attributed the high success rate to lawyers having already screened out weak cases. To avoid feuds, Lewis urges will makers to communicate with their family. Where they’re departing from equal distribution – or giving a motza to the dog home – make sure everyone understands the reasons. Writing a statement of explanation is not a total waste of effort in the event of court action, he says. “But any defects in logic or errors of fact will undermine its authority.”  So take care.

Adele Horin was the social issues journalist with the Sydney Morning Herald for 18 years prior to her ‘retirement’. This article was first published on Adele’s blog (adelehorin.com.au), and is reproduced with her permission. Adele is recovering from an operation for cancer and we wish her the best.

A Cuffelinks reader has asked about the options and opportunities for the younger generation to financially assist their parents. He says:

“People in my situation would be curious about tax-effective ways of giving money to parents:

• Any tax schemes (such as spouse contributions) applicable between parents and their adult children
• Centrelink implications of any strategies
• Ensuring that in the event of early death/TPD of an adult child, that parents receive some or all of the insurance/inheritance/estate payouts regardless of the marital status of the child.

Using myself as an example, let’s say I die – my understanding is that my wife would receive all of my assets and any insurance payouts as she is my spouse. However, my wish is that my mother, father and wife each receive an equal share of my wealth if I die early. How do I ensure this?”

This question is not addressed much in Australia as it’s usually the other way around with parents helping out or passing on wealth to their adult children. However, this reader is Asian where the younger, working generation is pulling out of poverty and gaining affluence, so more people will want or need to assist financially-strained parents. Please note, I only refer to Australian laws for the purposes of this article.

There are no specific strategies or tax-effective schemes that I can think of to gift money to your parents. Tax is not payable on gifts either by the receiver (the parent) or the giver (you). Of course, if you need to sell assets to make the gift, then capital gains tax could apply.

It is probably the estate planning and Centrelink effects that are more important than the tax issues in most cases.

An important starting point would be to determine the reason for the gift. Is it to help with everyday expenses, to give them a roof over their head, to buy a specific item such as a car or a holiday, to provide an income stream or to pay for aged care?

Next, ask what should happen with the money or gift if or when they die? If you want to ensure that it flows back to you or to your beneficiaries such as your spouse and children, then this should be provided for in your parents’ will.

Money into superannuation

If they meet the required age and work test criteria, superannuation is a tax effective way to give money to your parents. It can be used to provide a tax-free income stream in an ‘account-based’ pension.

However, super comes with two major problems:

• Once the money is in your parents’ superannuation account, you lose control over it. Your parents nominate where the money goes on their death, and they can change this nomination any time. Even if you hold an Enduring Power of Attorney for your parents, if they still have capacity, you must act in accordance with their wishes, so this does not give you the power to make or change a nomination without their consent.
  .
• If your parents are over age 65 OR start an income stream with the superannuation balance, it will be counted in in Income and Assets tests and could affect their age or other pensions.

Since a parent must satisfy the work test to make contributions if they are over 65, it may be better to help with super before this time.

Buying your parents a home

Joint Tenants

If you buy your parents a home and want to retain some control, one option is to buy it in joint names with you as one of the owners. This means it is held by each of you jointly and equally and does not form part of your parent(s) estate, so long as they predecease you. On the death of one joint tenant, the surviving joint tenant(s) split the shares equally. If there’s only one other tenant, they inherit the whole share.

In theory this means that you will own the asset entirely upon the death of your parents. However, if you predecease one or both of them, your share goes to them and you have lost control. There is no guarantee that it will end up back in your estate.

From a Centrelink point of view, your parents will be treated as ‘homeowners’ and the property will be exempt from the Income and Assets test.

Owning the property yourself

Buying a home in your own name and allowing your parents to live there rent free would provide more certainty in terms of where the asset ends up.

Centrelink would treat your parents as ‘non-homeowners’ which imposes a higher Asset Test threshold than homeowners. The property is not assessed as an asset of theirs.

On balance, from both an estate planning and Centrelink point of view, it may be best to own the house yourself rather than buy it in their name, however be aware that if you have borrowed to buy the house, negative gearing benefits may not be available as you are not receiving market rate rental income from the property.

Gifts and paying expenses

A simpler way to help out may be to give occasional gifts or pay their ad hoc expenses from time to time. From the “Guide to Social Security Law”:

Buying a gift such as a car in your parent’s name will be treated as an asset by Centrelink/DVA.

Paying for aged care

It is not unusual for family members such as adult children to pay for their parents’ accommodation costs in an aged care facility. These facilities charge an upfront amount called a Refundable Accommodation Deposit (RAD) often amounting in the hundreds of thousands. Whilst paying this RAD for a parent won’t affect their age pension, it may result in them paying higher ongoing fees in the facility known as ‘means-tested’ fees as the RAD is counted for the calculation of this fee, so take that into account.

Your early death

Now to briefly address the final question of distributing wealth to parents in the event of your early death. The first step is to make sure you have an up to date will. If you have a will and then get married, the will may be invalid so make sure it is updated after marriage.

Take care here. If your wife and family have not been adequately provided for, there may be grounds for a Family Provision claim. In the drafting of your will, make sure your wishes and the reasons for them are very clear, and ideally you should explain the context to your spouse and children.

Insurance and superannuation payouts are generally dealt with by beneficiary nomination forms rather than the will. Unless your parents are considered your ‘dependants’ under both the superannuation and tax laws, it is generally more tax effective for your spouse to receive your super balances.

It’s best to seek advice if looking to provide substantial financial assistance to your parents. There are other important issues which we will explore in a subsequent article.

Alex Denham is a Financial Services Consultant and Freelance Writer. This article is general information and does not consider the personal circumstances of any individual and professional advice should be obtained before taking any action.

We believe robo-advisers will be paradigm-changing, but that doesn’t mean they have a free pass to success. They must overcome six significant challenges if they are to evolve into profitable financial services businesses:

1. Changing perceptions of financial advice

For a large group of consumers, investment advisers are self-interested and greedy, financial markets are rigged and corrupt and their money is better off being self-invested into real estate, gold and other real assets. This widely-held perception of the finance industry is deserved.

There have been far too many financial services scandals that prove these theories, from an outright fraud like Bernie Madoff through to a local adviser churning an unsophisticated client through a procession of high brokerage-fee products. Meanwhile, the global markets collapse of 2008 left many investors wary and untrusting of the entire financial market framework. They would rather buy real estate that they can see and touch.

The financial advice industry has failed to make a convincing argument to justify its value to consumers. The industry has struggled with the intangibility of advice, the potential uncertainties of outcomes should markets crash and perceptions of greed among the people running the ‘system’. The impact is that most people don’t want to pay for financial advice.

2. Establishing trust

In financial planning, human interaction has traditionally been vitally important. As many a salesperson knows, selling something that is intangible requires the establishment of trust. This is problematic, because trust in the planning industry is low.

Trust is defined as “a psychological state comprising the intention to accept vulnerability based upon positive expectations of the intentions or behaviours of another” (Rousseau, Sitkin, Burt, & Camerer, 1998).

Repeated surveys around the world show financial advisers sit towards the bottom of the trust ladder. How do robo-advisers show they are trustworthy? To show you are trustworthy, you must display the behaviours that will lead people to trust you.

Three important requirements are:

• Competence in the matters in which competence is claimed and required
• Reliability, by doing the things as expected and promised, and
• Honesty and transparency in dealings with customers.

To convince the broad public that it can be trusted, a robo-adviser will be required to invest in processes and marketing to tell the story of how and why they are trustworthy.

Established brands and the large end of town already have customer bases into which to market to achieve scale while also having the marketing budgets and communication channels needed to attract new business to a robo-adviser.

3. Advice and guidance gaps

‘Advice gaps’ arise when people who could benefit from financial advice do not receive it because:

• Their level of assets is too low to viably warrant the attention of a financial adviser, or
• They are not prepared to pay a fee to receive advice.

In the US, the desire to maximise planner profits makes accessing a financial planner high compared with the rest of the world. US advisers focus almost exclusively on what would be regarded as high wealth clients in the rest of the world.

In the UK, financial advice is generally more readily available to the middle classes – what might be termed the ‘mass affluent’. The dollar figure required to access a basic service is driven significantly by the regulatory framework. Ironically, rules that were introduced to protect consumers now deny many of those people any service at all as the costs of regulatory compliance are too high to make them financially viable clients.

It is, perhaps, a logical conclusion to see robo-advisers as the solution to the advice gap as they have scalability and can service customers at low cost. Some people see robo-advisers ‘democratising’ financial advice, making it available to all.

By definition, those in advice gaps have lower investable asset balances, which means, per customer, lower income for the robo operator. Robo-advisers need profitable clients, but to acquire them as clients they need to invest serious marketing money, which is why existing big players have advantages over new entrant start-ups no matter how well funded. The exception is perhaps those providing a B2B robo white-label platform for existing distributors.

4. Economic influences

Around the world, wealth is being squeezed into upper economic groups, with corresponding falls in income and wealth for the middle and lower economic groups.

The loss of the middle range investor means that an increasing number of service providers are marketing to a shrinking pool of affluent investors, albeit that each of those customers comes bearing a larger pool of assets.

At the same time, there might be increased demand for robo-advisers that focus on providing budgeting tools and cash-flow forecasting, as these issues are of more significance to lower economic groups than questions of investment.

5. Cost of acquiring clients

Robo-advisers need clients to operate and the cost of acquiring (CAC) clients in financial services is high.

To us, this is the elephant in the robo-adviser room that is seldom discussed – which we believe is a strategic failure of the highest order.

Acquisition costs include the costs of initially finding a prospect and then converting those prospects into clients, with the inevitable attrition rate that those conversions incur. When total costs are compared to clients gained the results can be surprisingly high. Lucian Camp calculates the cost of acquiring a client in the UK to be around £200 (US$312).

This cost is beyond the means of many advisory firms, which is why they grow slowly – largely through word-of-mouth referral. In the past, they might have relied on product manufacturers and distributors to provide them with marketing support. Under new regulations in the UK, such supports are now largely no longer possible. But they continue to thrive in the US marketplace. In a world where former specialties have become commoditised, being able to make a financial product or service no longer makes you special as it once did.

Where, in the past, you may have been able to extract an economic rent because you occupied a position of advantage, market forces have now equalised you. Today, the ability (knowledge) and capacity (cash-flow) to quickly market financial products to scale is what separates successful financial services businesses from the ‘also-rans’.

It does not matter if you arrive at the marketplace with a better mousetrap if that trap is hidden where the mice cannot find it. Cheese – in the form of marketing, advertising and promotion – will help to attract them. But cheese isn’t cheap. Robo-advisers are very good at servicing customers, but do nothing to attract customers.

6. Behavioural biases

It is human nature to want it now. But it is also human nature to make plans for the future, including saving money. Of course, the two natures quickly come into conflict. You want a holiday now – but spending the money will reduce your pension in 30 years’ time.

More often than not your ‘present’ self will defeat your ‘future’ self. The future loss is so far away that it is diminished, but the present benefit is NOW! “Pack your swimsuit, honey, we are going to the beach.”

There is good reason to believe that robo-advice systems might do a much better job than human systems at helping people confront and manage this ‘present-day’ bias, by allowing them to visualise the impact of financial decisions made now projected into the future.

As ever when there are challenges, those who are successful will find new solutions and build the scale critical for success, while many others will fall by the side.

Paul Resnik is a co-founder of FinaMetrica, which provides psychometric risk tolerance testing tools and investment suitability methodologies to financial advisers in 23 countries.

This article continues from Alex Denham’s, ‘Providing financial assistance to parents’, and is in response to a reader’s request to delve further into this little-explored theme. It focusses on what happens when circumstances change or where financial arrangements are challenged by other family members.

Parents are often giving a ‘leg up’ to their children, whether a gift to put a deposit on a house, guarantee a bank loan for a new business or the like. What happens if the ‘leg up’ is from the child to the parent, particularly in the event of marital or family breakdown? The following scenarios illustrate the main considerations:

Marital breakdown

Suppose a son has supported his parents by purchasing an investment property with them, and he has paid their bills and other essentials on an ad hoc basis. The son’s marriage has broken down. Will his now ex-wife be able to make a ‘claim’ on the assets or money given to the son’s parents?

The answer is mixed. The issue in a marital breakdown is a division of assets based on a number of factors and largely depends on the facts of the marriage, such as length, earning capacity of each spouse, whether there are children of the marriage dependant on one spouse and so on.

The paying of bills ad hoc in this scenario is unlikely to be included in calculating the ‘pool of assets’.

It is arguable that the investment property, as it is held as joint tenants, might not form part of the ‘pool of assets’. However, I am of the opinion it would be difficult if not impossible for the son’s share of the property not to be included in a calculation of the ‘pool of assets’.

This doesn’t give the wife a claim on the property however, when all the assets are being divided. I would be of the view that the value of the son’s share in the property would be included in calculating the pool and may affect how other assets, such as money held in bank accounts, are divided. 

Changes among siblings’ own financial circumstances

Suppose three siblings purchase a property for their parents to live in. What happens if, due to loss of employment, one of the siblings stops making the mortgage payments, or one wishes to exit and be bought out?

To answer these questions, it is essential to examine the agreement when the siblings entered into this purchase.

Unfortunately, few people think about this at the time of purchase but they really should. There should be an agreement in writing and with each party obtaining proper and independent legal advice. This may sound unnecessary in family situations, but it is not uncommon for people’s circumstances to change through no fault of their own, leading to family discord.

As I often say to my clients, if everyone knows the rules beforehand, then disputes later are minimised or avoided all together.

So the answer to these questions will depend on the agreement in place. If nothing is in writing, then what was discussed before the property was purchased cannot be verified. If no discussions were had, then it’s an even bigger mess.

Essentially, if there is a mortgage over the property then all owners will have agreed to be liable for the mortgage, usually jointly and severally, and one or all are liable. So if some siblings aren’t paying the mortgage then the other siblings will need to make up the difference. If the mortgage goes into default, it will affect all of the sibling’s credit rating.

If one sibling wishes to exit the situation, then usually the other siblings will buy their share. It is usually based on a market value of the property at the time of the sale and requires the agreement of all owners.

Can they sell to someone else? Yes, but only with the consent of the other owners. If there is a mortgage, then the mortgagee’s consent will be required as well.

If agreement cannot be reached, then I see little choice but for the property to be sold and the proceeds divided amongst the siblings. The obvious problem is that mum and dad will be homeless.

Planning at the beginning is the key to avoiding headaches and arguments at a later date.

Unequal contributions within the family and inheritance

Another common issue is where one child helps the parents out more financially than the other children. On death, one child may feel entitled to more of the estate. This feeling of entitlement however, is not entirely accurate when it comes to administering the estate.

The parents’ will should largely address these issues. If the child gave money to the parent, then that is a nice gesture, but it was a gift. It is not intended to be repaid by that child inheriting a larger portion of the estate.

If it’s a loan, then the loan should be in writing before death and be reflected in the parents’ will, recording that the estate will repay the loan.

A parent may leave a larger portion to one child over another to reflect the contributions made before death, but this situation usually causes more trouble than it is worth. It is likely that unless there was careful discussion and agreement before death, a claim on the estate by the child with the smaller portion will eventuate, which will lead to unnecessary stress and legal fees.

I again would say planning is the key with prior agreement as to what the money means and whether it will be ‘repaid’ by the estate of the parents.

If property is involved, then the child’s investment or loan to the parents should be reflected in the ownership. For instance, where the child owns a share of the property or there is a mortgage granted over the property in favour of the child, the death of the parents will not affect that child’s investment.

In the absence of documentation to outline the situation, in my view, the money will be treated as a ‘gift’ and recovery from the estate would be difficult if not impossible.

Summary

Not all situations are straightforward and each matter will be determined on the facts. Documents outlining the intention and agreement of all parties may seem unnecessary when family is involved, however, courts are full of family members fighting about money.

If everyone knows their obligations and rights from the beginning, in my experience, most disputes are quickly resolved, or avoided all together.

Melanie Palmer is a Partner of Palmers Legal. This article contains general information only and does not consider the personal circumstances of any individual. Professional advice should be obtained before taking any action.

A common perception in finance is that the risk in growth assets, like equities, declines over a longer investment horizon. Recent research by consulting economists, Drew, Walk & Co into the equity risk premium (ERP) shows that even over the long run, equity investing is like a chocolate wheel: there are plenty of winners, but also losers. Retirees should not assume that the volatility of equity returns will be smoothed out over time, not even over 20 years. Retirees need to factor this into their goals for retirement income.

What is the ERP?

The ERP is the additional return that investors require, on average, for taking the extra risk of investing in equities, over and above any risk-free return (the government bond return). If investors do not expect to receive this additional return, they won’t invest in the risky asset.

The ERP has been labelled the most important variable in finance and is used in a number of applications. Just about every decision in finance has a link to the ERP.

Unlike a long-term bond, where an investor can hold to maturity and receive a known term premium, the equity premium is unknown in advance and is far from certain. The challenge for investors and superannuation fund members is the range of actual equity return outcomes, compared to the originally expected ERP.

The (un)predictable equity risk premium

In their paper, Drew, Walk & Co explore whether investing in equities in previous 20-year periods was adequately rewarded for the risk taken. They calculated the historical equity return (out)performance over various periods in a range of jurisdictions. The report concludes, among other things, that the equity return (out)performance:

• is uncertain, and its timing and magnitude are unpredictable
• has shrunk in recent history to below its long term average in Australia
• was only 1% per annum for the last 20 years.

The flaw of averages

Traditionally, the ERP is calculated by averaging the entire period of available historical data, and this average is then used to make an assessment of future returns. In using such an average, people miss the fact that an Australian retiree household is planning for roughly 30 years, which is obviously well short of the 115 years since 1900.

Long-run historical average returns can be flawed because:

• They are not an indicator of future outcomes.
• There are potential survivorship biases, where losses incurred in failed companies are not properly included.
• The early history reflects the benefit of Australia emerging as a financial economy. Since WWII, Australian equities have actually performed lower than prior decades and in line with other major global markets.
• Most people do not get the average outcome. Around 50% will do better and a similar proportion will do worse.

In addition, retirement is different, because most retirees:

• Need to spend their capital and so are impacted by sequencing risk.
• Segment their retirement capital over a range of time horizons within their retirement timeframe, to meet their investing and spending goals.
• Won’t have an unbroken exposure to equities for decades.

Time doesn’t diversify equity risk

Most people assume that 20 years is long enough to get the ‘long-run average’, however the research indicates that there are a wide range of potential outcomes, even when they can stay invested for 20 years.

Only with hindsight, at the end of the 20 years, will a retiree find out their premium (if any) for taking equity risk over that period.

Figure 1 shows the frequency of the 20-year historical equity return (out)performance. The graph shows that Australia performed better in the first half of the 20th century, when it would still have been an emerging economy rather than the fully developed market economy it is today. There have been 14 periods of 20 years in Australia where the equity return outperformance exceeded 10% per annum, but they were mostly before WWII (shown in light green).

Figure 1: Distribution of 20-year Australian outperformance

The typical retiree needs some equity exposure

Even though equity investing is volatile over the long range, most retirees typically have the time horizon and risk tolerance to invest in at least some equities and they are likely to benefit from the premium. This is why the great majority of account-based pensions already have a generous exposure to equities.

A retirement risk management strategy

But what do retirees do about the equity risk? What happens when something goes wrong? Instead of adopting a conventional ‘set and forget’ approach, well-advised retirees work with a risk management strategy for their equity exposure in retirement. The idea of having a safety strategy is common in everyday life, and when it comes to investing in risky assets, retirees should be no different.

Using a long-term bucket for equities in retirement is one strategy that is sometimes used. However, as equity outperformance is uncertain over 20 years, a retiree will not have certainty about how much will be in the bucket after even as long as 20 years.

Portfolio allocation in retirement

Starting with Chhabra (one of the early papers that advocated goals-based investing rather than efficient frontier targeting), there has been a distinctly different approach for making asset allocation decisions in retirement. This approach is to consider the full range of the retiree’s objectives and goals. Instead of trying to meet all targets with one investment decision, a goals-based approach will segment the main objectives. The approach is similar to the asset-liability matching practised by many insurance companies and defined benefit funds around the world.

Matching objectives enables a retiree (or their adviser) to consider the risk/reward trade-off that is represented by the ERP and select a suitable allocation of risk for each objective. For example:

• Generating income for life to meet essential spending needs will generally have a limited exposure to risky assets, as the objective is to maintain a minimum standard of living for life.
• Investing for spending on holidays and luxuries later in retirement can have a higher allocation to growth assets.

Under this approach, retirees with differing objectives, but the same wealth, age and risk tolerance will actually have different asset allocations.

Spinning the chocolate wheel in retirement

Retirees should think about investing as being like spinning the chocolate wheel shown. This has been assembled using the global historical numbers, the average of which roughly matches the forward projections for the ERP made by Drew, Walk & Co. in their paper.

Figure 2: Chocolate wheel of global historical average annual equity return outperformance over-20 year periods

This ‘chocolate wheel’ reminds retirees that the average annual outperformance that might be expected over a 20-year investment period is not certain. It will not be a guaranteed rate. Most outcomes are attractive returns, but the risks are broader than what Australian history alone suggests.

Conclusion

For investors and retirees today, care needs to be taken drawing conclusions from long-term averages when planning for the future. In addition, a set and forget approach will not ensure that a retiree’s exposure to equities risk will be appropriately mitigated.

Jeremy Cooper is Chairman of Retirement Incomes at Challenger, and chaired the Super System Review (the ‘Cooper Review’). Drew, Walk and Co.’s full report, is available at www.challenger.com.au/equityriskinretirement

Benjamin Franklin’s statement that nothing in life is certain but death and taxes remains relevant after 200 years. As a result of an ageing population and increasing household wealth for older generations, Australia faces the largest intergenerational wealth transfer in history in the coming decades. This has significant policy implications, but at a personal level, raises many challenges also. How do we prepare for the inevitable, and do the best for our loved ones?

Facing one’s mortality is rarely an enjoyable or engaging experience. Many would prefer to believe they will live forever, or at least long enough to justify putting off consideration of the implications of their death. Others feel uncomfortable discussing or even thinking about wealth and its implications for their estate. The consequences of a head-in-the-sand approach, however, are often dramatically less benign than the deceased may have presumed. Instead of leaving a secure or empowering legacy, they may bequeath angst, conflict and considerable expense. Feuding families and disappointed potential beneficiaries are a lawyer’s best friend; even those who can amicably settle an estate may still struggle with the cost and administrative burden of a non-existent or ineffective will.

Motivation to address the issue

This is not just thinking or talking about money. It is your legacy to the world and the potential contribution to other people (or the community or the planet) in the future. A vision of the future you would like to create can help to frame a positive outcome from a potentially depressing process. Alternatively, consider that you are simply reducing the future burden on loved ones. If you have a spouse who is refusing to engage, you may need to go it alone and hope that your persistence will motivate them to act. Set a deadline to have your affairs in order, not too far in the future, and stick to it. Make an appointment with an estate planning professional if necessary.

In addressing your estate planning needs, consider both your objectives (what you want to achieve) and your strategy (how you plan to achieve it). While the most perfectly-designed estate plan has little value if it has not been documented, similarly, a perfectly drafted but ill-considered will may not support those who will ultimately rely on it. This article provides a framework for determining your estate planning objectives. Part 2 will consider strategy alternatives, including the structures, professionals and documentation required to ensure your wishes are met.

Estate planning checklist

The amount of time and thinking needed for this process is not the same for everyone: a 40-year-old with young children and a mortgage will plan differently from a 65-year-old who owns their own home and has several million dollars in investments. Similarly, those with complex personal lives, particularly blended families, will have more challenging decisions to make than those with simple affairs.

Here’s a useful framework for your estate planning objectives.

1. Consider all potential eventualities. These include your death (sadly this one’s a certainty), and physical or mental incapacity (such as dementia, long term illness or permanent injury). Many people prepare thoroughly for what will happen on their death, but do not consider a lengthy period of declining mental and physical capacity that may erode capital otherwise intended for their estate, or expose them to unscrupulous individuals. For younger people, injury or illness could have devastating financial consequences. Consider a protection plan for ensuring your needs are met if you no longer have capacity to make your own decisions, and insurance to ensure your dependants are financially secure in the event that you are no longer able to earn an income or due to substantial medical costs. Some of these decisions can be made independently (such as preparing Enduring Powers of Attorney so someone you trust will make decisions if you can’t); others should be considered together (life insurance should form part of your overall estate plan).

2. Ensure your needs are met. Many older people care greatly about providing for their children and grandchildren, and yet may not have considered their own needs for retirement and aged care. This can result in tragic circumstances where the elderly are financially dependent on the age pension and receive little recognition from the children (or others) who have benefitted from an early inheritance. Once an asset has been given away, it is generally the property of the recipient and the giver has renounced their rights to compensation, even if their circumstances change and they now require support. In addition, Centrelink and the Department of Veterans Affairs have specific rules for assessing gifts and other forms of ‘deprivation’ which can result in a reduced social security entitlement for the giver. Have a clear view of what you need to live a comfortable lifestyle, and determine what you can give only once these needs have been met. This doesn’t mean you can’t help others, it simply means taking care to do it prudently, as we will discuss in more detail in Part 2.

3. Consider the legacy you would like to leave. This should speak to your personal values most of all. Your beneficiaries will likely to be top of mind, so identify every person you wish to provide for, as well as those causes that are dear to you. Bill and Melinda Gates, for example, have invested their wealth in charitable programmes and innovations in healthcare and education for developing countries, while leaving a (proportionately) small inheritance for their children. Contrast this with the poor outcomes of ‘trust fund babies’, where children inherit vast fortunes which they are often ill-equipped to manage. For some, a legacy will be as simple as ensuring their grandchildren have a private school education while others may have grander objectives, such as preserving land for environmental causes.

4. Prioritise your objectives. Planning for the ideal scenario on your death may require compromises. Can you achieve all of your objectives with the available resources? If you are eroding your capital during your retirement, you may need to adjust your arrangements over time. It can be challenging providing for your dependants equally when they clearly have different needs. Providing for young children or a child with a disability, for example, is very different to providing for financially secure adult children. Blended families can create significant challenges. Adult children from a first marriage may have lesser needs than young children of a second marriage, but desire an equal share of the estate. They can also resent large bequests to very recent new spouses or partners. Similarly, family businesses can create disparities where one or more children or family members have made different contributions to the business without being adequately compensated or with expectations of receiving a disproportionate share of the business on your death. Finally, one or more children may make a disproportionate contribution to your care if you become physically or mentally incapacitated.

Seek professional advice if you are concerned or your scenario is particularly complex. Succession planners and estate planning experts can give you guidance and assist with counselling and conflict resolution once you choose to engage with potential beneficiaries.

5. Review. While your estate plan is ultimately a reflection of your wishes, the most positive outcomes are likely to occur when all beneficiaries are informed and prepared for what’s to come. Your spouse will preferably be assisting with the process; ideally you will reach a mutually beneficial agreement as to how you’ll look after each other and your children or others. If there are areas of contention, however, it is best to discuss these openly and engage a professional if you’re having trouble reaching agreement (if nothing else, to avoid costly litigation at a later date).

While you are under no obligation to change your plans as a result of other’s concerns or wishes, they may raise legitimate concerns and have alternatives or strategies you hadn’t considered. An informed conversation will also help to keep relationships intact in the future.

Once you have considered your objectives and your legacy, the process of preparing and documenting your estate plan becomes easier.

Part 2 will help you understand the various strategies for achieving your goals and avoiding the pitfalls that can create emotional and financial stress for those you care about.

Gemma Dale is the Head of SMSF Solutions at National Australia Bank. This information is general only and does not take into account the personal circumstances or financial objectives of any reader. Readers should consider consulting an estate planning professional before making any decision.

It started out as a news story about cars, not investing:

“When a Google self-driving car edged into the middle of a lane at just a bit over 3km/h on St Valentine’s Day and hit the side of a passing bus, it was a scrape heard around the world.”

Although the incident was big news in the car industry and at Google, it has no apparent connection to investing. But then the story took a delightful twist:

“The accident illustrates that computers and people make an imperfect combination on the roads. Robots are extremely good at following rules … but they are no better at divining how humans will behave than other humans are.”

Starting to sound familiar? Rather like markets and behavioural economics? Here’s the punch line:

“Google’s car calculated that the bus would stop, while the bus driver thought the car would. Google plans to program its vehicles to more deeply understand the behaviour of bus drivers.”

You gotta laugh. Good luck with that one, Mr Google. Will you be programming the bus driver who is texting, or the one who drank too many beers last night, or the one who fought with his wife as he left for the bus depot, or the one onto his fifth coffee?

Welcome to the world of investing and human behaviour which is anything but rational.

Behavioural finance and the struggle for explanations

Every human emotion plays out when investing, making financial markets unpredictable and struggling for a theory based on scientific evidence. We have covered the subject of behavioural finance many times in Cuffelinks, such as here and here. Often, investment decisions are driven by emotions rather than facts, with common behaviours such as:

• Loss aversion – the desire to avoid the pain of loss
• Anchoring – holding fast to past prices or decisions
• Herding – the tendency to follow the crowd in bursts of optimism or pessimism
• Availability bias – the most recent statistic or trend is the most relevant
• Mental accounting – the value of money varies with the circumstance.

A new book to be published soon, written by Meir Statman, called Finance for Normal People, argues that the four foundation blocks of standard finance theory need rewriting, as follows:

The unfortunate truth is that if an investor went to ten different financial advisers, it’s likely they would end up with ten different investment portfolios. Investors have their own views on issues such as diversification, risk, active versus passive, efficiency, short run versus long run, etc, and often settle for ‘rules of thumb’ as a guide to investing. The bestselling book, Nudge, by distinguished professors, Richard Thaler and Cass Sunstein, quotes the father of modern portfolio theory and Nobel Laureate, Harry Markowitz, confessing about his personal retirement account,

“I should have computed the historic covariance of the asset classes and drawn an efficient frontier. Instead, I split my contributions fifty-fifty between bonds and equities.” (page 133)

That’s it! One of the greatest investment minds of the twentieth century simply goes 50/50. This is all the industry has achieved despite decades of research, complicated theories and multi-million dollar salaries paid to the sharpest minds from the best universities.

Economics as a ‘social science’

Why is investing so imprecise, replete with emotions and strategies with little supporting evidence, when other ‘sciences’ have unified theories? Why does a physicist know how gravity works, an arborist knows how a tree grows and a doctor can treat a patient with cancer, while fund managers around the world have different view on markets, stocks and bonds?

Consider Newton’s third law of motion:

“When one body exerts a force on a second body, the second body simultaneously exerts a force equal in magnitude and opposite in direction on the first body.”

There is no equivalent of this certainty in economics. For example, we do not know how the market will react when a central bank reduces interest rates. Maybe it happened because the economy is slowing, which is bad for the markets, and the hoped-for stimulus does not occur. And so the central bank plunges into unproven QE and even negative interest rates as it runs out of ideas.

Although economics pretends to be a ‘science’, it is a social science of politics, society, culture and human emotions.

It is often said that economics suffers from ‘physics envy’. Economists cannot test a theory in a controlled laboratory-style experiment in the way a physicist or chemist can. Ironically, economists usually earn a lot more than physicists, and are called upon as the experts in almost everything. Economists don’t even need empirical validation of their theories.

Which leaves markets prone to irrational bursts of optimism and pessimism, as we have seen in the last month. January and February 2016 started off with dire predictions on oil, other commodities and China and the market fell heavily, and then in early March, it staged a strong rally as the banks and resource companies recovered some of their losses. Prices were higher despite no apparent improvement in underlying fundamentals. Morgan Stanley analyst Adam Parker advised clients:

“If the consensus is right that we will chop up and down, then by the time we feel a little better, we should take off risk, not add some. Maybe you should do the opposite of what you think you should do. That’s the new risk management.”

Do the opposite of what you think you should do

That’s the advice! Maybe it’s not as crazy as it sounds.

Consider the above chart, courtesy of Ashley Owen. It compares the Westpac Consumer Sentiment Index with the All Ordinaries Index. It shows that bearish sentiment (the blue line for economic conditions in the next 12 months) is usually followed a rising share market. Bullish consumer sentiment is followed by a falling market. It’s why people tend to buy high and sell low, and empirical evidence is that investors usually underperform the index by poorly timing the market.

Let’s leave the final words to Jack Bogle, Founder of the Vanguard Group:

“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in the business, I do not know of anyone who has done it successfully and consistently.”

Good luck with that, Google

I can imagine the scientists and engineers doing what we all do to start a new project, and Googling about human behaviour as they attempt to model how bus drivers might behave. They could do worse than study a good book on behavioural finance.

Graham Hand is Editor of Cuffelinks and confesses his own SMSF has a growth/defensive allocation of about 50/50. If it’s good enough for a Nobel prize winner …