Protect yourself and your family. Have you ever really thought about how you or your family would cope in the event of a major accident, long term illness
or even death.

Life insurance is serious business. Having enough is very important as it provides you and your family with financial security should something unexpected happen. Furthermore, you can more than halve the cost, in most cases, by taking out insurance within your superannuation fund. This is because the premiums are paid from pre tax dollars. If you are part of an employer group plan you will also benefit from group rate discounts. But best of all the premiums don’t have to come out of your pocket. They are paid out of your employer super contributions.

The following case study shows the level of cover needed to fund a reasonable, not extravagant, life style in the event of a catastrophe.

Steve and Alison, are both 42 years old with three children aged 10, 7 and 5. Alison has stopped working to look after the children full time. Steve currently has $330,000 life insurance in his superannuation account. Alison has no insurance. With a mortgage of $250,000 and three children they are concerned about their level of cover. Steve and Alison’s other assets are a combined superannuation benefit of $42,000 and an investment property with a net value of $150,000.

They consult Sean, a financial adviser. Sean explains that the best way to determine the right amount of insurance is to identify how much income is needed, then estimate the capital that would be required to generate the income and then adjust the capital amount to take into account any debts or other assets that exist. In this article we look at two scenarios:

Steve passes away
Alison estimates that she would need an average income of $40,000 per year, indexed for the rest of her life. Sean estimates that capital of $1,150,000 would be needed to meet the income requirement to age 84, (her life expectancy at age 42) using an earnings rate of 8% pa.

Sean recommends that, if Steve were to pass away, the mortgage should be paid off. Therefore an additional $250,000 life insurance will be required. The sum insured is then reduced taking into account Steve and Alison’s existing superannuation benefits and the investment property. Sean recommends that Steve takes out $958,000 life insurance within his superannuation fund. As a guide, with the Colonial First State First Choice Employer Superannuation Fund, this amount of insurance would cost approximately $700 pa. This information is summarised in the table below:

Alison is totally and permanently disabled
If Alison were to become totally and permanently disabled Steve and Alison estimate that they would need an additional $55,000 pa on top of Steve’s salary to hire a housekeeper/nanny/home carer. Using an earnings rate of 8% pa and assuming the family needs additional income of $55,000 pa until Steve retires at 65, Sean estimates that capital of $1,010,000 is required. After taking into account Steve and Alison’s existing superannuation and investment property, Sean recommends that Alison takes out $818,000 TPD insurance within her superannuation fund. $818,000 TPD insurance for Alison will cost approximately $500 pa as shown in the table below:

If you would like your life and TPD insurance requirements reviewed please call or email your Financial Keys adviser or phegarty@financialkeys.com.au and we will send you out a short one page questionnaire.

Patrick Hegarty

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There is an age old argument in the investment industry about the value of active verses passive portfolio management. Active managers work hard for your money while passive managers take things pretty easy. Yet both will argue that their’s is the best method and will deliver the best long term outcome to you.

We consider the debate is often clouded by misstatements and inappropriate comparisons. In this article we explain the two different methods and draw out some of the key issues that investors should consider when making decisions.

Active management is based on the belief that investment markets provide sufficient inefficiencies to be exploited by the astute investor. It includes the art of stock selection where investments are included in a portfolio following a process of research and investigation. Active management can also refer to market timing strategies. For example utilising a contrarian approach, to counter the herd mentality of investors. By selling out of market segments that become popular and overvalued and buying into less popular undervalued segments investors can outperform the broader market.

Passive management is based on the “Efficient Market Theory” premise. It is a buy and hold approach where the portfolio replicates a wider investment index. “Efficient market theory” postulates that market prices reflect the knowledge and expectations of all investors. It asserts that any new development is instantaneously priced into a security. Therefore, as the share price at any given time is the correct price, based on everything known about the company, it is considered impossible to consistently beat the market. Passive management is offered to investors in the form of Index Funds.

What to Compare? - It is not uncommon for passive managers to compare their investment performance with the average of all active manager’s over a period of time. We consider this to be a flawed comparison. It is no surprise that if you take an average of the worst, medium and best active fund managers you will come up with the average market performance. This is tantamount to replicating the index, as the index is merely a reflection of all the active positions that investors take.

The success of different active managers varies considerably. Managers are usually rated over 4 segments comparing return and risk outcomes. The top 25% of active managers is referred to as top quartile. We consider that most investors who choose an active manager will be targeting the top quartile and it is against this group that a comparison should be made. It is our role as advisers to utilise our expertise and industry research to identify those managers most likely to sit in the top quartile consistently over time.

The following graph from Mercer shows how the top quartile of fund managers have performed against the Vanguard Australian Shares ASX 300 Index over time.

Costs - Passive managers cost less. This is expected as they do less and are able to operate more cheaply. This is a known saving which contributes to overall performance.

Risk - Passive management is often said to contain less risk. This is where risk is measured as the likelihood to underperform the market or index. Clearly, while the risk of underperformance is negligible, some investors are not interested in the market or index performance and are only interested in the absolute performance of their portfolio. i.e. did I make money or did I loose money? For these investors remaining in an index fund when a market reaches record highs is a much greater risk. Active managers are more likely to adjust their portfolios to avoid obvious peaks and troughs in market prices.

Small Caps and Bond Funds - There are certain asset classes that pose particular problems for passive index managers. In particular are the small companies sector and the bond sector.

By their very nature small companies are those companies that receive less market attention, are higher risk and have shorter track records. Management is often less experienced and reporting often less reliable.

The “Efficient Market Theory” argument is less convincing in the small cap sector where index weighting may contain greater risk. Active managers will argue, that it is in this arena they can add the most value.

The bond market is made up of debt. The problem with this is that the companies with the largest loans comprise the largest part of the bond index. Therefore an index fund will reward companies that borrow heavily by increasing their exposure to that company’s debt book. Active managers will argue that, when it comes to a company’s debts levels, biggest is not necessary best and analysis and research are essential to reduce the risk of default.

Large Cap and Large Market Bias
Index funds will always have more investments in the large companies that make up the majority of the market. However it is in smaller companies where often the potential for greater growth lies. Index funds will also be weighted more to the largest markets. For example, in the international arena more than 50% will be weighted to the US market even if that market becomes heated and reaches cyclic peaks.

This a brief consideration of the key issues related to this topic. There are many aspects of this topic that cannot be covered here. At Financial Keys we have a preference for active portfolio management but acknowledge there is a place for index managers in portfolio construction.

Andrew Condell


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Australian economic growth has slowed in the last quarter while the share market continued to do well after a sharp fall in April. In contrast, global economies have provided mixed signals. Global expansion has been sluggish with oil prices as high as $US64 a barrel being a main contributor. The uncertainty in the global economy can be largely attributed to mixed signals coming from China and the US.

Despite tightening measures, China’s economy continued to grow at a reasonable rate. Exports expanded by approximately 35% over the year to June fuelling the continued demand for oil, coal and other natural resources.

In the US, high oil prices were absorbed by the economy through higher than expected increases in employment and wages. The US Federal Reserve continues to maintain an interest rate tightening bias.

Japan experienced weaker exports during the June quarter but surveys showed signs of an increase in business and consumer confidence during the period. This may be attributed to the reduction in bad debts and signs that banks are starting to loosen tight lending restrictions.

In Australia, miners have benefited from increased oil prices, yet the impact on inflation has been offset by cheaper manufactured goods coming in from China. This has increased competition in the domestic economy and has subdued inflationary pressures.

More competition and higher resource costs have resulted in corporate profit warnings. Consumers have reduced spending as they reorganise their finances in response to the housing slowdown and interest rate rises. On a brighter note, healthy unemployment figures, real wage rises and potential for further government spending provide a promising outlook for the Australian economy.

With these opposing factors in play, the Reserve Bank has taken short-term rate rise discussions off the agenda. The CPI is sitting at exactly 2.5%. This falls in line with the RBA’s 2-3% target. It is expected that the cash rate will remain at 5.5% for at least another two quarters.

The increasing spread in interest rates between Australia and the US may put further downward pressure on the Australian dollar. This would enhance returns on international investments and would also be positive for our Current Account Deficit, making our exports more competitive and slowing imports.

Winnie Butt

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New legislation allowing over 55’s to access their super benefit before retirement provides some interesting tax planning opportunities. With the introduction of non-commutable pensions from 1 July 2005 over 55’s can now start a retirement income stream while continuing to top up their superannuation benefit through salary sacrifice.

This strategy can potentially deliver tax savings by converting fully taxable salary income into rebateable pension income. The tax saving can be as high as $7,143 per annum which can translate to an annual super balance increase of the same amount.

Up until now if your were 55 or over you had to retire to access your super benefit between age 55 and 60. From age 60 to 65 you had to cease a gainful employment. Now you can start a retirement income stream from your super benefit without leaving your current job or retiring. This means you can access your super benefit much earlier.

This can help if you want to wind down your employment activities and supplement your declining income with an allocated pension or other income stream, drawn from your super benefit. The purpose of the legislation is to give you the flexibility to remain in the workforce longer albeit at a reduced level.

The potential tax saving opportunity is greatest if you wish to continue full time employment and are in the highest marginal tax bracket. The saving can be taken in the form of a higher net salary or can be directed to your super account thereby accelerating the growth of your super benefit over time.

The example below shows the optimum benefit where an employee on $200,000 makes the maximum salary sacrifice super contribution of $100,587 and takes a reduced salary of $99,413. The example is based on tax rates for the 2005-6 financial year.

As with any strategies where the purpose is principally tax driven, there is a risk that the ATO may apply the Part IVA anti-avoidance provisions of the Income Tax Assessment Act. The ATO has indicated they are looking into this strategy following the publication of the article titled “Magic Pudding for Over 55’s” in the Financial Review on 10 August.

It is very important if considering this strategy to get tax advice and to ensure that the salary sacrifice arrangement with your employer has dealt with prospective income entitlements and is not done retrospectively.

The strategy has other variations which enhance the benefit and also make it potentially less likely to attract the interest of the ATO. From 1 July 2006, legislation is proposed that will allow couples to split their super contributions. It is proposed that fund members can have 60% of the previous year’s deductible super contributions go to their spouse’s super account. The combination of this element with the above mentioned strategy would provide a strong “non tax” purpose thereby reducing the potential tax problems.

There is also the potential for fund members to benefit from the government’s co-contribution if they can salary sacrifice to a salary below $28,000. This means the government will contribute a further $1,500 on top of $1,000 contributed providing a 150% gain. It is also possible to make a spouse contribution of up to $3,000 and receive the $540 spouse contribution tax offset.

Non-commutable pensions do provide a new planning opportunity for over 55’s, but we recommend patience and caution before embarking on the more aggressive tax ideas being bandied about in the market place. We would prefer some indication from the ATO or further industry commentary before recommending clients proceed further.

Andrew Condell

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