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For many years, you’ve been pushing the benefit of compounding, but to be frank, I can’t see the point. I gather you mean letting interest on a bank deposit accrue. Given that the return may be reduced by nearly 50 per cent in tax, I think there must be better strategies. Have I missed something?
For many years, I’ve been talking about the miracle of compounding, and the essence of it is that you leave the earnings on an investment attached to it and do not withdraw them and spend them.
There’s a lot to love about the compounding effect of investing in shares.Credit: Simon Letch
You can certainly do this with any sort of interest-bearing deposit, but as you point out, you are only investing in cash, which I regard as one of the riskiest investments – because there’s no tax benefits (like franking credits) attached to the income, and the value is destroyed by inflation.
You can’t really do it with property because you cannot plough the rental income back into that property. All you can do is hope that the property value will grow as time passes.
This is why shares are the perfect asset, because often you can have the dividends reinvested automatically. But even if you can’t, you can use the cash from those dividends to buy more of the same share, or other ones if that would suit you better. Over time, an enhanced rate of return has a massive difference on the outcome.
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Let’s assume that the Australian All Ordinaries Index produced a long-term yield of 5 per cent growth and 4 per cent income. Suppose two people started investing $1,000 a month into a product such as an index fund.
One relied purely on the growth and spent the income, and the other reinvested all the dividends. The result of this is that the first investor would be getting a return of 5 per cent, and the second investor 9 per cent.
By the end of 40 years, the first investor would have a portfolio worth $1.5 million, and the second investor would have a portfolio worth $4 million. This is the value of compounding.
I have an investment with Vanguard, and I wonder what will happen if I choose fortnightly Auto Invest and decide to withdraw my funds after ten years. I will have created 260 cost bases for capital gains. Does Vanguard help me with this on my final statement? I asked this question of Vanguard and so far, have not got an answer. What is your take?
Vanguard says if you set up an Auto Invest plan using your Vanguard Personal Investor Account, your cost base is tracked automatically.
Each year, Vanguard will issue you an annual tax statement that pulls together all the relevant details for the ATO – interest, dividends, distributions, capital gains or losses, and any cost base adjustments. The statement includes tax guide references and is available after 30 June under the Statements tab in your account.
Regarding the age pension and the assets test: I’m thinking of buying a new motorhome for around $200,000. How does Centrelink value it – both immediately and over time? I’ve been told not to overvalue assets, but at the same time, I don’t want to undervalue it and get into strife with Centrelink. Your guidance would be appreciated.
Centrelink requires pensioners to value their assets at market value, which is defined as the amount you could reasonably expect to receive if you sold the asset on the open market. You’re not required to obtain a professional valuation, and Centrelink will generally accept a reasonable estimate.
It’s important to regularly update the estimated value of depreciating assets such as home contents, motor vehicles, boats, and caravans. Notifying Centrelink of reductions in value over time can help increase your age pension entitlement.
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In the case of a $200,000 motorhome, around $20,000 of the purchase price will be GST. So, a reasonable starting estimate for Centrelink purposes might be in the ballpark of $180,000.
I recommend revisiting the valuation every six to twelve months to ensure it remains in line with market value. Failing to notify Centrelink of depreciation may result in you being underpaid.
My father died several years ago, and my mother has recently entered aged care. I understand we have two years to sell her house before it affects her pension. However, I couldn’t find anything about the CGT implications for me and my siblings if Mum dies before the house is sold – specifically, the difference between the estate selling the house versus us inheriting the property. The plan is to sell the house and inherit the proceeds, not shares in the property itself – which I believe avoids CGT.
Julia Hartman of Bantacs tells me that if the house is being rented out, you can continue to cover it with her main residence exemption for up to six years.
If it is not earning income, the period is infinite – assuming she was fully covering it with her main residence exemption before moving to aged care, and it was not producing income while she lived there.
Then, when she dies, if it has not been used to produce income (or only for six years), it is treated the same as if she died while still living there, and you still get the two years to sell.
Noel Whittaker is the author of Retirement Made Simple and other books on personal finance. Questions to: [email protected]
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
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