Simple Steps to Financial Success in the Current Climate Tuesday 1 st December 2008

1. Simple Steps to Financial Success in the Current ClimateTuesday 1st December 2008 Scott Francis & Scott Keefer

2. Who are we? • Principals and owners of a ‘fee – only’ financial planning practice • Scott Francis • MBA, M Com and M Fin Plan degrees • Regular Contributor to Alan Kohler’s Eureka Report • Author of the Book ‘A Clear Direction – Being a Successful CEO of Your Life’ • Scott Keefer • M Fin Plan, B Com, Grad Dip Ed • Candidate in the Chartered Financial Analyst (CFA) program • Authorised Representatives of FYG Planners Pty Ltd • Australian Financial Services License Number 224 543

3. Overview of the Presentation Tonight we plan to cover the following topics: • The habits of building wealth • Building an investment portfolio • 3 key decisions • Asset allocation • Active v Passive investment approach • A brief synopsis of the current market situation and the impact on building portfolios

4. Our Website www.acleardirection.com.au You can sign up for our free fortnightly email newsletter: www.acleardirection.com.au/sign_up_for_email_newsletter A copy of this presentation will be available at: www.acleardirection.com.au/ieee

5. General Advice Warning ‘The information in this presentation is general in nature – and has not taken into account the personal circumstances of anyone attending the seminar. You should check the information with a professional prior to taking any action.’

6. The Habits of Building Wealth • Spending less than you earn (manage your cash flow). ‘The Millionaire Next Door’ (Stanley and Danko) (Most common millionaires car – Ford Ute; don’t spend more than $200 for a watch; and ‘Affluenza’ (Hamilton and Denniss) • affluenza, n. a painful, contagious, socially transmitted condition of overload, debt, anxiety and waste resulting from the dogged pursuit of more. (de Graaf, 2002) • affluenza, n. 1. The bloated, sluggish and unfulfilled feeling that results from efforts to keep up with the Joneses. 2. An epidemic of stress, overwork, waste and indebtedness caused by dogged pursuit of the American Dream. 3. An unsustainable addiction to economic growth. (PBS) • Investing regularly over time (build passive investment earnings)

7. The Habits of Building Wealth • Invest in growth ‘ownership’ assets (choose to invest part of your money in ‘higher risk’ ‘higher reward’ opportunities) • Minimising fees and taxes • Thoughtfully selecting investment opportunities • Allowing investment earnings to compound over time (fees and taxes directly reduce compounding) – not chopping and changing • THIS IS WHERE STARTING EARLY CAPTURES THE UNIQUE OPPORTUNITY OF COMPOUNDING

8. ‘In the world of capital markets there are four key inputs required by business to create wealth. These inputs are: • Resources (the material inputs involved in business) • Intellectual Capital (the ideas and innovation behind business) • Human Capital (the people who work in the business) • Investment Capital (the money provided for use in business) As an investor, you are providing a key input into this process, the investment capital, and as such you are entitled to a successful investment experience.’ (Investment Philosophy – A Clear Direction Financial Planning)

9. Dilbert’s 9 Steps to Managing Money

10. Dilbert’s 9 Steps to Managing Money 1. Make a will. 2. Pay off your credit cards. 3. Get term life insurance if you have a family to support. 4. Fund your 401(k) to the maximum. (Superannuation) 5. Fund your IRA to the maximum. (Superannuation) 6. Buy a house if you want to live in a house and can afford it. 7. Put six months expenses in a money market account. 8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement. 9. If any of this confuses you, or you have something special going on (retirement, college planning, a tax issue), hire a fee-based financial planner. Scott Adams – “Dilbert and the Way of the Weasel”

11. Cash • Traditionally bank accounts/cash management trusts • Now ‘e accounts’ • No Risk of Capital • Income based on interest rate in the economy – income in the form of interest payments • Current cash rate 4.75% to 6.25% • Long term average return since 30 June 1970 9.6% BUT now in a lower interest rate environment

12. Fixed Interest/Bonds • You ‘loan’ your capital to a bank, Government or company in return for a series of interest payments and the return of your capital at a future point in time • My opinion: You should not take risks with this portion of your capital – do this with your ‘growth’ or ‘ownership’ investments • Well regarded ratings system in place: Standards and Poors – rates fixed interest securities from AAA AA A BBB (last of the investment grade ratings) • Average long term return since 30 June 1970 9.7% • In some ways the most difficult asset class to navigate because there is such a variety of opportunities

13. Australian Shares • You become part owner of a company/portfolio of companies • You benefit from the payment of ‘dividends’ and the growth in value of the underlying company • The average return since 30 June 1970 has been 13% a year • Some 1,400 companies listed on the Australian Stock Exchange

14. International Shares • You become part owner of a company/portfolio of companies outside of Australia • You benefit from the payment of ‘dividends’ and the growth in value of the underlying company • The average return since 30 June 1970 has been 13.6% a year • The Australian share market makes up less than 2% of the value of listed companies worldwide

15. Listed Property Trusts • Listed on Australian Stock Exchange • Underlying Assets are Commercial Style Property (shopping complexes, office trusts, industrial property, entertainment) • Generally pay strong income (7% plus); growth at or slightly above inflation • Average return 14% a year since 1980 • The sector is changing – greater use of debt; greater ‘construction’ risk

16. Direct Residential and ‘Other’ Asset Classes • Other includes: ‘Art’, ‘Taxi Plates’, ‘Wine’, ‘Agricultural’, ‘Hedge Funds’ • Keep in mind diversification: Easy to be overly exposed to residential property • ASX and Russell Survey of 20 year investment performance shows direct residential property returning 12.1% a year to end December 2005 (survey available on the ASX Website under the title ‘Long Term Investing Report 2005’) • For the purposes of this presentation – which is limited by time we will not consider these areas of investing further.

17. Decision 1 Defensive Assets vs Growth (Equity) Assets Decision Criteria: • Timeframe (how long is the portfolio for) • Liquidity (how easily do I need to access money and how much money MIGHT I need) • Risk Tolerance • Experience (understanding of risk)

18. Growth Assets • Australian Shares • Listed Property Trusts • International Shares

19. What is an Index? • Collection of all of the assets in an investment universe. For example, the ASX200 measures the investment performance of the biggest 200 investments on the Australian Stock Exchange. • Usually weighted by size. For example, BHP has a much higher index weight than Flight Centre; The movement in price of BHP are more important to the overall index that the movements in price of Flight Centre.

20. Investment Fees • Commissions and Structural Corruption in the Financial Planning Industry • Think in % to see how fees erode your investment returns: Think in $ to see if you are receiving the service that you deserve • Fees are a risk free investment cash flow (away from the investor)

21. Active Versus Passive Management • Active Management – ‘normal’ for the investment industry: Assumes some level of skill or knowledge that nobody else has that will allow a person to ‘beat’ the market. • Stockbrokers • Managed Funds • Traders • Passive Management – Investing in index funds or passive funds that replicate some portion of the investment universe passively (i.e. without research or assuming skill). E.g. small companies fund

22. Active Appears Intuitively Smarter • Why shouldn’t people have the skill and ability to ‘beat’ the market? • The market return is good, a better than average market return is better…. • BUT: There are costs involved in active management that reduce the expected market return (trading costs and research costs). This reduces the average return of the market. • If everybody expects to beat the average return on the market, then more than half (because of trading and research costs) are going to be disappointed. Is there overconfidence at work here?

23. Passive (eg Index Funds) Does Have Some Advantages • There is very little trading, so trading costs are low. (this includes the ‘market impact’ cost of trading) • Passive funds tend to be low cost (less than half the price of an active fund) because there is no money spent on research • Passive funds are extremely well diversified because they hold all the investments in an index

24. Evidence Active vs Passive • Dr Rich Fortin and Dr Stuart Michelson, both finance professors, authored a paper in the September 2002 Journal of Financial Planning entitled ‘Indexing Versus Active Mutual Fund Management’. (A mutual fund is another term for a managed fund). They found that, in both before tax and after tax terms: • Index funds outperformed managed funds for most share based categories and all fixed interest categories. • Active management did not add value

25. David Gallagher and Elvis Jarnecic, from the University of New South Wales, have authored two papers that look at the performance of Australian managed funds that invest in international assets and fixed interest assets. • In the article ‘The Performance of Active Australian Bond Funds’, published in the December 2002 Australian Journal of Management, they found that there was ‘significant underperformance for retail bond funds after fees’. • In the article ‘International Equity Funds, Performance and Investor Flows: Australian Evidence’, published in 2003 in the Journal of Multinational Financial Management it was found that ‘active management (ie in managed funds) does not provide investors with superior returns to passive indices’. • In reviewing the literature concerning managed funds Gallagher and Jarnecic found that ‘…the empirical evidence widely documents the inability of active fund managers to outperform market indices’, with ‘Australian research also supporting this international evidence’.

26. Two economics professors from the University of Queensland, Michael Drew and Jon Stanford, examined the returns from superannuation investments. • In a paper published in the September 2003 edition of the Service Industry Journal, entitled ‘Returns from Investing in Australian Equity Superannuation Funds, 1991 – 1999’, they found that ‘the average superannuation fund, specialising in the management of domestic share portfolios, underperforms passive market indices by about 2.8 to 4% per annum. • Their overall conclusion was ‘Australian superannuation investors would achieve their retirement income objectives more rapidly by engaging a low cost fund manager employing a passive technique (ie indexing)….’. • It is interesting to note that most of our superannuation assets are managed in active managed funds.

27. Dr Ross Miller, a finance professor from the United States, in his paper ‘Measuring the True Cost of Active Management by Mutual Funds’, considers the returns from 152 managed funds from January 2002 to December 2004. On an overall basis the 152 mutual funds underperformed the index by an average of 1.5%.

28. Individual Investors • Two University of California Professors, Brad Barber and Terrance Odean, studied 35,ooo households with discount brokerage accounts from 1991 to 1997. • They found that trading destroyed value for investors: Trading reduced • men’s portfolios by 2.65% a year, and • women’s portfolios by 1.72% a year

29. The Question of Persistence? • Mark Carhart, in his paper ‘On Persistance in Mutual Fund Performance’ published in the Journal of Finance in 1997 found that there was no evidence of persistence in the performance of managed funds. (1962 – 1993: 1,982 equity funds) • Sawicki and Thomson, in their paper ‘An Investigation into the Performance of Recommended Funds: Do Managed Fund ‘Approved’ by Research Companies Outperform the Non Gratea (non approved)? also found that there was no evidence of ‘persistence’ of returns.

30. Every US large cap fund with a 15 year history vs the S&P500 and CRSP 1-10 indexes. 15 Years ending 31 December 2001 (285 Funds)

31. Annual returns of “buy and hold” index vs actual annual returns enjoyed by US mutual fund investors from 1984 to 2002 Source: DALBAR, Inc. Media release of 2003 update of “Quantitative Analysis of Investor Behaviour” study.

32. The Role of Luck • There are more than 9,000 managed funds in the Australian investment universe (less than 2,000 listed entities on the ASX……) • Over time some are bound to outperform

33. Building a Passive Portfolio • Asset Allocation is the Key • Passive Funds available from: • Vanguard • Global State Street (through platforms) • Macquarie • Virgin Superannuation • Colonial

34. The idea of an Efficient Market • An efficient market is one where all stocks are fairly priced according to publicly available information – such an environment would support the use of indexing as the prudent investment approach • Note that no-one is saying that the market is perfect: just that it is efficient

35. The Current Market As at the end of November 2008 (Year on Year % change) • ASX All Ords -44.3% • S&P 500 -39.5% • Dow Jones -34.0% • Nikkei 225 -45.7% • FTSE100 -33.3% • Shanghai Composite -61.6%

36. Four Key Factors • In looking at the current situation and prospects going forward we think there are 4 key factors to consider: • The Credit Crisis • Fears of a Recession • Forced Selling / Fear Selling • USA Home Prices

37. Credit Crisis • Since the fall of Lehman Brothers, financial institutions have been extremely hesitant to loan to each other which has forced up interest rates for inter bank loans • The recent problems for the Citi group has added some more uncertainty • The signs are that borrowing rates are coming down as measured by LIBOR (London Inter Bank Offer Rate) • It has taken some extreme government action but the signs are positive

38. Fears of a Recession • This now seems to be the key issue weighing on investment markets • The National Bureau of Economic Research in the USA have today announced that the downturn commenced in December 2007. This already makes this US recession the 3rd longest since the Great Depression • The good news for Australia is that current indications are that our economy will continue to grow through the end of 2008 and into 2009 (OECD, IMF, Aust government) • Company profits up to the end of September have actually been stronger than expected

39. Fears of a Recession • However, we are not immune from global woes, some economists predict Australia may already be in recession • Wednesday’s GDP figures will provide some clarity to the picture • Governments around the world are lowering interest rates and announcing stimulus plans to counteract these fears • The big unknown are the large amounts of consumer credit and the impact of unemployment on the ability to keep paying off this credit

40. Recessions and Share Markets • One interesting point to note is that on average through history, investors start to factor in an economic recovery about ½ way through a recession which leads to rising share prices. This continues as an economy picks up steam. • With some experts suggesting the recession will continue through to the middle of 2009, this may place the US past the ½ way point.

41. Forced Selling • This is the most difficult factor to judge • There is clearly still fear around (VIX Index at historically high levels) • Margin calls are still being made • Reports are that hedge funds have been selling down to accommodate redemptions • However, some good news came through last week in that we saw net inflows into stock mutual funds in the US compared to net outflows in previous weeks. (www.cnn.com)

42. US House Prices • The US Housing market is where the current problems began and any improvement here will be a boost to the US and global economies • The latest data shows home prices are down 17.5% across the 20 largest US cities to the end of September (S&P/Case-Shiller Home Price Indices) • However, recent moves by the US Treasury and Federal Reserve are likely to lead to significant reductions in mortgage interest rates • This should help to put a floor under home prices and a floor under the securities that have caused so much of the problem

43. What is Priced Into Shares? • There is an obvious desire to sell shares, and put the money into cash at such a difficult time. However, the price of shares at the moment must reflect a great deal of fear. • The value of shares at the moment would likely reflect: • The USA recession • Continued problems in credit markets • A slow down in company earnings

44. Strategic Decisions for Investors • Keep a reasonable level of cash • Diversification is a positive strategy (avoid collapses like MFS, ABC Learning, Macquarie Fortress Notes, Asset Loans, Babcock and Brown, Basis Capital, Absolute Capital, City Pacific, MFS Premium Income Fund, Centro Property………………) • Aggressive Long Term Investors – possibility to buy in a distressed market (but a strategy with risk) • Keep an eye on the ‘income’ from investments – Australian shares are paying a dividend yield of greater than 6%; that is very attractive

45. Double or Nothing – Eureka Report article • Also on our website is an article written by Scott Francis published in Alan Kohler’s Eureka Report online newsletter • A link can be found at the seminar materials page – www.acleardirection.com.au/ieee • The article looks at: • Investing regularly into shares • The mortgage is cheaper • Salary sacrificing • Building a passive income stream

46. Questions?