What if there was a royal commission into accounting?

Posted by Matt Connor on 12 July 2018
What if there was a royal commission into accounting?

The banking royal commission has all but been and gone, but it's left us wondering what would happen if there was a royal commission into accountants?

Great accountants operate 100% in their clients' best interests, through a pure fee-for-service model, meaning they only charge and get paid for services that their clients actually need.

As with any industry, however, not all accountants are created equal, so If there was to be a an accounting royal commission, one of the major issues I believe would be in the spotlight is unnecessary complexity.

Complexity for complexity's sake

Where accountants would potentially come unstuck in a royal commission is for advising and servicing complex and unnecessary business and investment structures. Generally speaking, the more complexity involved, the more money that can be charged to manage it, so it makes sense that this is an area that's open to manipulation.

If you're dealing with an accountant that's not on the up and up, and are out to increase their bottom line at any cost, you could be the victim of being sold over-complicated and unnecessarily involved setups that you don't need.

Less is more

The starting point for any accountant should be to act in their clients' best interests at all times, however, further to this, it should ultimately be a focus to steer clients towards the simplest option available to them.

This isn't always easy.

The psychology of complexity is interesting - some people are sceptical of solutions that are too simple, often demanding the solution with all the bells and whistles, even when a simpler (and cheaper) solution will achieve the same result.

Trust is everything

It's critical that you can rely on your accountant to give you honest, impartial advice when it comes to your finances, and not put you into arrangements that are costly to administer and provide no added value.

Bottom line is, if your accountant is telling you you don't need to spend more money on a more complicated solution, you should listen!

Look before you leap

Before you get yourself locked in to a large, complex accounting structure, it's important to make sure you're working with an accountant that understands the value of simplicity and is most interested in offering you the least complicated proposal there is, with the best return.

Take the time to make sure you're comfortable with any proposed course of action before you get started. It can take a number of years and cost significant sums in tax to undo overly complex arrangements, and, often, structures that hold a large asset or business can cost more to unravel than it would cost to simply keep going until you're ready to exit, accountants fees and all.

So, if you find yourself in a complex setup and you're not sure of the benefits, ask your accountant why they've advised the strategy detailed in their proposal.

Better to take your time to scope out your requirements before you set up than race into a new structure that might hurt you in the long run.

Get in touch to learn more and find out how we can help you with your accounting needs.

Posted in: Tax   0 Comments

The Royal Commission...

Posted by Neal Durling on 3 May 2018
The Royal Commission...

Like many I have been saddened to hear the Royal Commission have, again, uncovered a number of systemic "cloudy" advice practices where an advisers "best interests duty" requires something a little purer. 

This simple truth reminds me of why we chose to engage with clients the way we do 10 years ago, with annual opt in and flat dollar fees invoiced directly to clients.

As I set about writing a blog on a subject that many advisers find difficult, a valued client reminded me of why we do what we do. I think these words are more insightful than anything I can write and, I hope, demonstrates what a pure advice relationship should look like.

"I'm confirming I'd like to continue with your ongoing services. In the current context of the Royal Commission into banking highlighting the dangers of hidden percentage based fees for investments and self-managed super, your open, fixed fee service shines as an example of how it should be done!" Ben -  Cardiologist

Posted in: News Wealth Creation Financial planning   0 Comments

Administration is killing me! There's an app for that...

Posted by Matt Connor on 12 April 2018
Administration is killing me! There's an app for that...
Practice administration costs are a bit like taxes - we (mostly) accept they're unavoidable, but we still want them to be as small as possible.

And just like taxes, deep down we know that administration is essential for keeping things running properly. Having said that, there are lots of good reasons for driving down admin costs as much as possible. And with the modern boom in apps and add-ons, there are plenty of tools to help you achieve that.

 

Spoilt for choice

Many accounting software companies are having their annual roadshows at the moment, showing off the features of the new versions of their software, and add-ons that connect to existing programs.

These events can be a bit like religious gatherings, and the mantra is that using their product will increase productivity and efficiency, and therefore make everyone's life better.

But despite all the new functionality this software offers, one thing has remained the same: if you input junk information, you'll get back junk insights.

One way to improve the accuracy of the information going into your accounting software is to automate as many of the inputs as possible.

 

Making admin automatic

In the bad old days (not so long ago), you had to manually enter every bank transaction into your accounting software. Not only was it enormously time consuming, it was also prone to human error.

Often what we would find is people would only enter the most basic data into the system the date and amount of each transaction for example. This meant when you tried to analyse the data for tax reporting and business decision making, you had no idea who was paid or whether GST was processed correctly or a host of other important facts. Junk in junk out.

This all changed with the introduction of bank data feeds into accounting software. Not only would all your bank data magically appear in your accounting ledger, you could program the software to automatically categorise recurring transactions. This new technology was as ground-breaking as the mobile phone (for accountants at least)

 

Join the automation revolution!

Bank data feeds are now almost universally available, but there are still many practices that aren't making the most of this incredible business hack. It really is a no-brainer. Once the data link is made and the recurrent transactions set you'll be amazed how much easier your monthly accounts are to manage.

In our next blog we'll dive into the detail of just how powerful automating your financial records can be.

Posted in: News Budget Owning a medical surgery Staffing Planning Risk management   0 Comments

Investment Philosophy & Portfolio Construction

Posted by Sean O'Kane & Neal Durling on 15 February 2018

 

About Medical Financial Group

Our role is to maximise the probability of you achieving your financial objectives.

We take this responsibility very seriously and value the trust our clients (and their families) put in us.

This document outlines our investment philosophy and how we manage money. It's important, however, to first put this step in context.

Discovery

Money means different things to different people and truly understanding what's important to you and your loved ones forms the basis of our advice relationship with you.

In maximising the probability of you achieving your financial objectives it's important we don't make any assumptions about what we need to do to perform this role.

The purpose of our discovery meeting is for us to understand your financial objectives at a deeper level. Our resources and those of our deliverables team can then be harnessed to give you the highest probability of success. We use this information to produce an Advice Road Map, which is your financial life on a page and Terms of Engagement offer which we present at the Engagement meeting.

Engagement

Based on research, we believe clients are looking for value outcomes rather than products and the following in particular:

  1. Long term advice relationship built upon trust
  2. Understanding and transparency at all levels and throughout the end to end engagement process
  3. To understand and feel in control of their financial situation

At the Engagement meeting we will present your draft Advice Road Map and our proposed scope of advice together with the fees to engage us. We believe this process builds trust, delivers clear expectations with a transparent fee structure and allows you to understand the engagement process and the outcomes we are working toward.

Strategy

Whilst there are many strategies we use for clients this document is specifically focused on investment.

Effective strategy has the largest impact on your eventual financial outcome. How much to invest, when to start and which structure(s) to use are all important considerations. How to achieve a strong after tax outcome and how leverage could be used will also be considered.

Our Investment Philosophy:

  • Educating clients improves investment returns
  • Time in the market not timing the market
  • A disciplined approach underpins successful investing
  • It's less about beating the market than harnessing it
  • Asset allocation and diversification are key
  • After tax returns are what matter
  • Minimising costs can improve returns

These beliefs form the core of our approach and are important for you to understand.

Belief 1: Educating clients improves investment returns

We believe a big part of investing is simply avoiding the mistakes that the large majority of investors make. There have been many behavioural finance studies showing that without advice investors will consistently make mistakes which cause them to perform poorly. According to the 23rd Annual Quantitative Analysis of Investor Behaviour by Dalbar:

  • In 2016, the average equity mutual fund investor underperformed the S&P 500 by a margin of -4.70%. While the broader market made gains of 11.96%, the average equity investor earned only 7.26%.
  • Equity fund retention rates decreased materially in 2016 from 4.10 years to 3.80 years. (This is directly related to psychology and behaviour.)
  • In 2016, the 20-year annualized S&P return was 7.68% while the 20-year annualized return for the Average Equity Fund Investor was only 4.79%, a gap of -2.89% annualised.

Some of the reasons that Dalbar has identified for this happening and indeed we see with clients are shown in the diagram below:

 

 

Belief 2: - Time in the market not timing the market.

Warren Buffet, arguably the most successful investor of all time, has a great quote that sums this up nicely "Our favourite holding period is forever." The diagram below is taken from the JP Morgan Guide to Markets and in simple terms shows the difference between the low point during each calendar year and the ultimate year end return.

 

 

You can quite clearly see that in almost all years there is a big difference between the low point for that year and the ultimate return at the end of year. Taken from the same report, the following shows the impact on not having your money fully invested in the market and missing the best days for investment returns. It's quite staggering to think that by missing the best 10 days over 21 years the reduction in performance is 212% per annum or almost 40%.

Belief 3: - A disciplined approach underpins successful investing.

Truly successful investing is not about chasing the highest return in any one year, but taking a strategic and disciplined approach.

At the heart of this is not reacting to short-term performance but, rather, understanding that different market conditions will favour different asset classes, investment styles and strategies resulting in a tail wind for some of your investments and a head wind for others.

Because of this, within a diversified portfolio is quite usual for some investments to be underperforming others and at times even go down.

This in itself is not a reason to change your portfolio and indeed holding these investments is often important so you can benefit from the time when market conditions favour these investment types.

The diagram below shows asset class returns for each of the last 15 years and lists them in order from highest to lowest. You will see there are a number of years where the top performing asset class becomes the bottom performer the following year.

 

Belief 4: It's less about beating the market than harnessing it

In Vanguard Investments Research Report, "The case for low cost index investing" the xero-sum game theory is explained:

The theory states that, at any given time, the market consists of the cumulative holdings of all investors, and that the aggregate market return is equal to the asset- weighted return of all market participants. Since the market return represents the average return of all investors, for each position that outperforms the market, there must be a position that underperforms the market by the same amount, such that, in aggregate, the excess return of all invested assets equals zero.


Figure 1 illustrates the concept of the zero-sum game. The returns of the holdings in a market form a bell curve, with a distribution of returns around the mean, which is the market return.

 

Figure 2 shows two different investments compared to the market. The first investment is an investment with low costs, represented by the red line. The second investment is a high-cost investment, represented by the blue line. As the figure shows, although both investments move the return curve to the leftmeaning fewer assets outperformthe high-cost investment moves the return curve much farther to the left, making outperformance relative to both the market and the low-cost investment much less likely. In other words, after accounting for costs, the aggregate performance of investors is less than zero sum, and as costs increase, the performance deficit becomes larger.

 

And this is borne out in the returns of actively managed funds compared to the index, shown below:

 

So if it's not about beating the market index, what is it about? We will explain this in our following beliefs:

Belief 5: Asset allocation and diversification are key

We believe a sound investment strategy starts with an asset allocation suitable for the portfolio's objective, built on reasonable expectations for risk and return, and using diversified investments to avoid exposure to unnecessary risks.

There have been a number of studies that show asset allocation is by far the biggest determinant of return, as shown below:
 

Diversification is a genuine way of reducing uncertainty in your portfolio by spreading your investments across multiple asset classes and multiple securities. We employ a core and satellite investment approach that uses a low cost diversified index fund as a core and then select active managers as the satellites.

It's important to point out that the aim of this approach is not to try and beat the market. The purpose is to improve diversification, reduce volatility and provide some protection in falling markets.

Our asset allocation guidance is taken from Jana who have 30 years of experience in the field. Our fund selection is done using 360 Research, Morningstar and Lonsec research houses.

For all of our portfolios we run a correlation matrix from Morningstar, using historical returns, to see how each investment correlates with the others. Clients often think they have some diversification by holding two different funds, when in fact the historical correlation between the two can show quite the opposite.

All of our portfolios are reviewed quarterly, unless we are provided with advice during the quarter from one of our consultants that a change is required.

As a large number of our clients are starting their investment journey, we usually implement the portfolio in stages, over a period of time, to reduce complexity and implementation cost.

 

Belief 6: After tax returns are what matter

Who owns an investment and their tax rate will have a big impact on the after tax returns received. In the US publication of after tax returns for all investments is mandatory. Unfortunately in Australia this is not the case, although the more tax aware funds will provide this information.

Let's look at some examples of the impact of tax on a super fund where the top tax rate is 15% and an individual whose tax rate is 47.5%. Both are for a $500,000 investment yielding 6% income and 2% capital growth per annum:

For the super fund:

  • $500,000 x 6% = $30,000
  • $500,000 x 2% = $10,000

Taking off tax on the income portion:

  • $30,000 15% ($4,500) = $25,500

Remember tax on capital gains is not paid until realised so it has been ignored in this example. Therefore, after tax on the income has been taken into account, the year- end return is:

  • $35,500 or 7.1%

And now let's look at the 47.5% tax payer:

  • $500,000 x 6% = $30,000
  • $500,000 x 2% = $10,000

Taking off tax on the income portion:

  • $30,000 47.5% ($14,250) = $15,750

Therefore after tax on the income has been taken into account the year end return is: $25,750 or 5.15%

Thus overall a 1.95% difference!

Tax is only paid on capital gains when the gain is realised and where the asset has been held for more than 12 months the gain is discounted by 50%. Thus a 47.5% tax payer might only pay a tax rate of 23.75% and even be able to choose a year when their income is lower to reduce the liability further.

Fund managers don't always take this into account when buying and selling assets in a fund and Investors are often unaware of the tax impact of high turnover funds.

Fortunately we are aware of this which is why we favour low portfolio turnover funds i.e. buying and holding with a focus on growth and tax effective income for investments where the individual has a top tax rate of 47.5%.

For super funds this is less of a concern as the tax rate is far lower.

Belief 7: Minimising costs can improve returns

When investing there are a lot of things out of our control especially market returns.

Therefore we need to ensure that the things we can control, such as costs and taxes, are managed well.

In respect of costs, high admin and management fees can act as a drag on performance, which is often not represented in better after tax returns for clients.

Morningstar recently studied the fund characteristics which predict future outperformance, a summary of which is shown below:

So does that mean we only use low cost index funds and ETFs? No.

As explained earlier we use an indexed core with selected active fund managers where they are expected to add out performance, diversification or downside protection qualities for our clients. This is, however, only done after carefully considering their relative cost.

Posted in: Financial planning Investment   0 Comments

The missing middle of personal finance

Posted by Sean O'Kane on 29 January 2018
The missing middle of personal finance

There are only really three factors that contribute to achievement of your financial goals: what you earn, what you spend and what you do with the rest.

If you've completed your training your income should be reasonably stable and if you're getting professional financial advice what happens to "the rest" will be determined by a plan that may focus on investment, debt reduction or a combination of both.

That leaves what you spend.

I'm earning more but where is it going?

Having helped doctors with their finances for nearly 15 years, what I too often see is a habit of overspending that starts as incomes increase. This combined with not knowing where all the extra income is going has far reaching consequences.

Firstly, the sooner you start investing, the sooner you get what Albert Einstein called "the most powerful force in the universe" compounding returns on investments. And secondly, if you create a lifestyle that uses all of your income it will be impossible to reach financial independence.

The first step is awareness

Understanding what your fixed expenses are along with what you are spending on discretionary items is a good place to start. Importantly, this also provides a clear view of how much money will be left over each month that can be put to work through investment.

Exporting online bank statements into a spreadsheet provides a starting point for checking where your money goes. The problem with this method is that it's time intensive and doesn't easily track activity moving forward.

Once you have an idea of what you have spent by category, the next step is to have a plan of what you intend to spend going forward.

Run your household like your practice

Most practices use accounting platforms like Xero to track income, expenditure, assets and liabilities. If you have a good practice manager and the right tools they can easily tell you your practice's financial position in heartbeat. It's the only way to know your practice is running the way it should.

There's no reason why you can't run your personal finances the same way. Very soon Medical Financial will begin offering access to a platform that provides the same kind of insights as Xero, but for personal finances.

It will allow you to track your expenditure, understand where it's going and produce regular personal profit and loss statements. It can even track your change in net wealth via a personal balance sheet. And you will be pleased to know, that once set up, the time taken to keep on top of things will be around an hour a month. Armed with timely, relevant information about your finances you can start taking greater control.

Posted in: Wealth Creation Financial planning Planning Investment Financial independence   0 Comments

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The information on this site is of a general nature. It does not take your specific needs or circumstances into consideration, so you should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.

The financial planning services are provided by Medical Financial Pty Ltd trading as Medical Financial Planning (AFSL 506557)