Assessment Task 2: Case study report 2020 PDF

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ACCT 2285 Wealth Creation and EstatePlanningAssessment Task 2: Case study reportSemester 2, 2020ContentsGoals Discussions ...........................................................................................................................Copper’s current financial position is highlighted in t...

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ACCT 2285 Wealth Creation and Estate Planning Assessment Task 2: Case study report Semester 2, 2020

Contents Goals Discussions...........................................................................................................................5 Page 1 of 13

Assessment of Achievable Goals and Recommend Adjustments to Goals................................6 $200,000 invested in 10 years’ time & Pay for children’s university degrees.....................................6 Pay off Mortgage in 5 years...........................................................................................................7 Reduce Taxation, New Car Every 3 years & Donations of $5,000.........................................8 Donations.........................................................................................................................................8 Reduce Taxation.........................................................................................................................8 Client’s Risk Profile..........................................................................................................................9 Asset allocation................................................................................................................................9 Managed Fund.................................................................................................................................10 Managed Fund Analyse.................................................................................................................11 Gearing..............................................................................................................................................13 Benefits & Risks of Gearing.....................................................................................................13 Benefits.....................................................................................................................................13

Copper’s current financial position is highlighted in the tables below: ASSETS & LIABILITIES ASSETS

Malcolm

Amanda Page 2 of 13

Principal Residence Holiday Home Cash and Bank Deposits Motor Vehicles Home Contents Superannuation TOTAL ASSETS LIABILITIES Principal Residence Holiday Home Motor Vehicles Personal Loans/ Overdrafts Credit Cards TOTAL LIABILITIES

$950,000 $400,000 $40,000 $110,000

$45,000 $80,000

$300,000

$50,000 $1,975,000

$250,000 $200,000 $65,000 $20,000

$15,000 $3,000 $553,000 $1,422,000

NET ASSETS Table 1: ASSETS & LIABILITIES Income Tax 30/06/2020 Malcolm Taxable Income $180,000 Income tax payable $54,097 Medicare levy payable $3,600 Net Payable $54,097 Income after tax & Medicare levy $122,303 Table 2: Income after tax

Amanda $30,000 $2,242 $600 $2,242 $27,158

CASHFLOW Cashflow Position of Coppers 30/06/2020 Income $122,303 $27,158 $149,461

Net Income Malcolm Net Income Amanda Total Income EXPENDITURE Rent/Mortgage Household expenses Medical/Education Motor Vehicle Expenses Clothing/Entertainment Super/Life Contributions Holidays Private Health Insurance Other Expenses TOTAL EXPENDITURE Surplus Table 3: Cashflow of Coppers

$25,000 $22,000 $8,000 $32,000 $18,000 $2,000 $8,000 $6,340 $4,000 $125,340 $24,121

Goals Discussions Using the above information, we can identify that your total family income per annum is $149,461 and total expenditure is $125,340. This results in a surplus income of $24,116 this Page 3 of 13

year to invest in order to create wealth for your family. And as your partner in expecting her salary to increase in the future, this will significantly increase your family’s surplus income helping to achieve your desired goals. Therefore, with your current financial position, we can discuss and assess your goals to see if they are feasible. From the client data form, you have stated that you would like to achieve the following: • To pay off house and holiday home in 5 years. • To build wealth with a goal of $200,000 invested in 10 years’ time (today’s dollars terms) • To reduce taxation • To acquire a new car every 3 years • To make charitable donations of $5,000 per annum • To save to pay for children’s university degrees (estimated at $50,000 each) in 10 years’ time (today’s dollars terms) In order to see if your goals above are achievable, we will need to look at future projection of cashflow. Here we will be taking into account your partner Amanda’s future salary increase to $60,000 p.a. from the end of next year. Assumptions: - Salary for the couple will be increased by 2% per year - Expenses are inflated at 2% per year - Amanda’s salary increase to $60,00 from the end of next year (2022)

Table 4: Future cashflow projection

Page 4 of 13

Assessment of Achievable Goals and Recommend Adjustments to Goals $200,000 invested in 10 years’ time & Pay for children’s university degrees You would like to have invested $200,000 in today’s dollars and your kid’s university degrees of $100,000, this will be converted into the future value to reflect its true value. This is an achievable goal if invested strategically. We recommend that you combine the two goals as both are aiming to have an amount of money invested in 10 years. 200,000 (1.03) ^10 = $268,783 100,000 (1.03) ^10 = $134,391 Assumption of 3% inflation

You would like to have $403,175 in 10 years in todays dollars. In order to achieve this, we will be using margin lending gearing strategy. We will discuss what gearing means for you later on in the report. You have stated that you have $40,000 in savings and with this year of surplus of $24,121 to use for investment. If you were to retain $10,00 for emergency funds and the remaining funds of $30,000 to invest. Your initial capital investment would be made of $30,000 and $22,000 taken out of your surplus this year. Which means you would have $52,000 initial capital to invest and if we were to combine this with a 60% LVR gearing strategy, borrowings of $78,000. This allows an initial investment of $130,000 adding $13,000 contribution annually in a managed fund. We can see what the result would be with the assumption of investment earnings of 7% and total management fees of 1%.

Figure 1: Managed funds result As you can see from figure 2 that the result is $404,842, meaning this goal is achievable. Page 5 of 13

Pay off Mortgage in 5 years

Figure 2: Mortgage repayments

As you can see from table 4, you will need $8,200 monthly repayments in order to pay off the mortgage in 5 years. Which comes to $98,520 annually (8,200*12+10*12), you are currently paying $25,000. You will need an extra $73,520 annually ($98,520 - $25,00 = $73,520) to pay off the mortgage in 5 years. With your current financial position and with the increasing annual surplus it will still not be possible to pay off the outstanding loans within 5years.

As you will be taking out $13,000 contribution annually to place in the managed fund, we recommend that you keep paying the $25,000 plus the left over surplus and change your goal to a realistic one. When your partner’s salary has increased to $60,000, it would significantly increase your annual surplus as seen from table 4 to help pay off the mortgage.

Table 5: Mortgage repayments

An achievable goal would be to pay off the mortgage in 10 years. You can increase your monthly repayments from the left over surplus after taking out the $13,000 managed fund contribution. As you can see from figure 2, your repayments increase over the years which results in your mortgage being paid off within 10 years. Page 6 of 13

Reduce Taxation, New Car Every 3 years & Donations of $5,000 Donations - You have stated that you are especially keen on donating $5,000 p. a., however with your current financial commitments and circumstances such as paying off the mortgage and building wealth for particular goals. This will be unlikely to be achievable as your other goals are taking all of your left over surplus to fulfil your other important goals. If you really want to donate to charity, I advise that you increase the length of your investment’s goals such as, investing $200,000, paying off the mortgage and your kids university fees. This will allow more money to be left over to pay for the donations. Other way you would potentially achieve this goal is by using HECS HELP loan. This will allow your kids to get loan from the government to help with the fees. Which will result in you decreasing the amount of investment needed to finance for your children’s university degrees. This will enable you to have a smaller investment goal due to the use of HECS loan, which will reduce the amount of money needed annually as your investment goal has decreased, meaning you have some surplus of money left over to donate.

Reduce Taxation – You would reduce your taxation several ways, such as donations and salary sacrificing. Your goal of Donations allows you to achieve tax deduction to reduce tax liability. This will largely depend on the above goal where you would have to increase the lengths of your investment goals to accommodate for the donation. As previously talked about, depending on how much surplus you have left over, the amount of donation will reduce your total taxable income meaning a reduction in taxation. Salary sacrificing is another way that you can use to reduce tax, most people tend to use this to contribute to their super. Where you place some of your pre-tax income into super which will be taxed at 15% rather than at your higher marginal tax rate. Though this reduces your taxable income and taxation, this also reduces the amount of money you have left over after tax to use for your goals. As you have used it to decrease your taxation and placed it into super. This may not be a good strategy since if you were to do this, you would have to also increase the time of length of your goals due to having less surplus of money to contribute towards your goals.

New Car Every 3 years – As you can see from table 4 Future cashflow projection, this goal is achievable as we have included the cost of replacing the cars every three years by the expenditure of $32,00 p.a. Although it is recommended that you increase the want to acquire new cars to double the current goal of 3 years. This will allow for better use of the money to help pay the mortgage, your investment goal and your donations.

Page 7 of 13

Client’s Risk Profile From analysing your answers to the risk profile questionnaire concerning your capital and tolerance to risk, it is determined that you are a growth investor. The following was found from the questionnaire:       



You are a long-term investor (5 to 7 years), which can be seen from your goal of wanting to have invested $200,000 in today’s dollar in 10 years’ time Comfortable with trying to beat inflation Enough experience to comprehend the significance of having a diversified portfolio Have experience with managed funds, indicating previous knowledge Can be concerned from a loss of investment, but can hold and wait for recovery, which shows that you understand that markets may fluctuate and know there is risk Are focused on capital growth and reinvestment to accumulate wealth Have no need for fast access to funds from your investments, which shows low liquidity needs, in your goal it can be seen that you are investing large amount of your surplus money from your high paying job Are comfortable with your investment having higher volatility and risk for a prospective of higher capital return, which can be seen from having a big goal, so you are willing to take the risk to get higher return to achieve the said goals

Asset allocation You are a growth investor, meaning you are earning a sufficient and stable income and are prepared to take higher volatility and risk for higher returns. Which indicates your goal of wanting to accumulate assets over the long term. Your asset allocation is to hold 20% assets that are defensive, which tend to have lower risk, therefore offer lower return since defensive assets are assets such as cash and fixed interest, which generally can provide returns in the way of income rather than growth of investment. The other 80% of your asset allocation is in growth assets, which focuses on growing your investment rather than trying to provide returns in the form of income. These growth assets carry much higher level of risk in order to potentially provide higher returns. It is recommended that you acquire funds that are diversified in order to reduce portfolio risk whilst maintaining the required return. Based on the initial investment of $130,000 from your goal on page 7, your investment will likely be allocated in a managed fund like so: Risk Profiles Growth/Defensive Asset Classes Shares Property Fixed interest Cash Total Table 6: Risk Profile Allocation

Growth 80/20 % 70 10 18 2 100

Value $130,000 $ $91,000 $13,000 $23,400 $2,600 $130,000

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Managed Fund Managed funds are investments scheme where organisation receives funds from its investors and then invests those funds into a diversified portfolio. Managed funds offer diversification as unit-holder benefit from holding funds that are invested in a wide range of companies and industries, hence can reduce the risk from any one or few investments. They also have professional fund management team that relieves the investors from day to day management and record keeping.

Legg Mason offers lots of product one can chose from, one that may suit you is the Diversified Growth Fund. Which invests in multiple asset classes, with about 70% in growth assets and 30% in defensive assets.

Vanguard also offers lots of product from ETFs to wholesale funds to diversified funds. There are two that may suit you. One is Vanguard Life Strategy Growth Fund and the other a High Growth Fund. -

-

The Growth fund targets a 30% allocation to income asset classes and 70% to growth assets classes. This is for investors pursuing long term capital growth like yourself with need for diversification and a bit of fixed income to reduce volatility. The High Growth Fund invests mainly in growth funds, this fund targets a 10% allocation to income asset classes and a 90% allocation to growth assets classes. This is for investors pursuing long term capital growth and who have a higher tolerance for risk with share market volatility.

As you are a growth investor, your asset allocation is 80% in growth assets and 20% in defensive assets. So, the Growth fund is suitable for you with a 70% and 30% asset allocation. The high growth fund has a 90% allocation to growth and 10% in defensive assets, which has higher risk than what you are looking for.

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Vanguard Growth Fund

Legg Mason Growth Fund

Management Style

Passive

Active

Investment Objective

Seeks to track the weighted average return of the various indices of the underlying funds

Portfolio Mix

Management Fee Establishment Fee Minimum Initial investment Minimum additional investment Risk Level Minimum suggested timeframe Buy/Sell Spread

Fund targets a 30% allocation to income asset classes and a 70% allocation to growth asset classes. First $50,000 - 0.90% p.a. Next $50,000 - 0.60% p.a. Balance over $100,000 - 0.29% p.a. First $50,000 you have in the fund, you will be charged $145 each year

Investment across multiple asset classes, the Fund aims to earn an after-fee return in excess of the Benchmark over rolling three-year periods. Invests across multiple asset classes, with approximately 70% in growth assets and 30% in defensive assets 0.85% p.a. For Every $50,000 you will be charged $425 each year

Nil

Nil

$5,000

$30,000

$1,000

$5,000

High

High

Long term

Short to long term

0.09% / 0.12%

0.2% / 0.2%

Managed Fund Analyse Table: 7: Managed Funds comparison From the analyse of table 7 reveals numerous characteristics among the managed funds: As you can see Legg Mason has a lager minimum initial investment, though this is not an issue as your investment will be $130,000. Vanguard fund has a lower buy and sell spread when compared to Legg Mason’s fund, this is important as the buy-sell spread represents the transaction costs which occurs when buying or selling investment assets. In this aspect Vanguard takes the lead by having lower transaction costs. Vanguard fund has lower management fees overall when compared to Legg Mason, this can be seen from table 7. This is very important as over the long term, it can affect how much fees you get charged and how much balance you have at the end of 10 years. The lower the fees the better, so Vanguard with the lower fees takes the lead in this aspect. It can be said after the evaluation of the two managed funds, Vanguard life strategy growth fund is the most suitable with your needs. Therefore, it is recommended that you use Vanguard to accumulate your wealth.

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If we were to asset allocate your $130,00 funds, it would look like below:

Vanguard Life Strategy Growth Fund Asset Allocation Fund Australian Shares Index Fund (Wholesale) 28.00% Global Aggregate Bond Index Fund (Hedged) 21.20% International Shares Index Fund (Wholesale) 20.40% International Shares Index Fund (Hedged) 12.60% AUD Class (Wholesale) Australian Fixed Interest Index Fund 9.00% (Wholesale) International Small Companies Index Fund 4.90% (Wholesale) Emerging Markets Shares Index Fund 3.90% (Wholesale) Total 100.00% Table 8: Allocation to underlying Vanguard funds

Value $36,400 $27,560 $26,520 $16,380 $11,700 $6,370 $5,070 $130,000

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Gearing Gearing is when money is borrowed for investment purposes. Gearing can be used to accelerate the development of wealth creation, as it allows you to make a lager investment than you would otherwise be possible to achieve.

Benefits & Risks of Gearing Benefits Your wealth accumulation: you can accelerate your capital creation by investing a larger amount by borrowing than you could have otherwise by investing using your own money. Could in theory pay less income tax: the interest you get changed and other fees from gearing are tax deductible, which could possibly reduce your taxable income. As these costs are tax deductible if you borrow money to invest in a managed fund to build wealth. Acquiring assets soon than later: from the additional capital, you can investment in assets now rather than wait unit you accumulate enough savings. Using this, your investment timeframe could dramatically decrease. This is the same as your goal of wanting to have invested $200K in 10 years, as you did not have enough capital so it was recommended that you borrow in order to have enough investment invested to accumulate $200,000 in today’s dollars in 10 years. Should you have waited until you accrued sufficient savings, your goal would not be possible due to you other goals requiring your savings such your mortgage. Greater diversification: with a larger portfolio, you get better diversification which can spread your investable funds to various assets. So, if some of them performed poorly, this reduces the overall risk of your portfolio.

Risks Gearing gains and losses: gearing magnifies your gains, but it can also magnify your losses. If the investment returns are less than the cost of gearing, you might not be able to service this loan. Meaning you will have to sell some of your assets to avoid default. Income risk: you have to be sure can afford to service the loan, as you need sufficient cash flow to meet repayments ...