Everyone benefits when you take a hard-headed and objective approach to advice, instead of trying to be the client’s best friend, as Mark Story discovers.
On paper, Dick and Jane Gillespie (not their real names) look like classic cashed-up baby-boomers enjoying the trappings of everything that a boom-town like Perth has to offer. With six-figure incomes, two rental properties, a franchise cleaning business on the side and two grown-up kids off their hands, cash flow was the least of their concerns.
However, they learnt the hard way the danger of mixing business with pleasure. The trouble with their financial adviser also being their friend was that formal reviews all too quickly turned into social occasions. Unsurprisingly, when Cameron Paul inherited them as clients after their former adviser and friend sold his one-man business late in 2004, there were revelations aplenty.
Building the Framework
Following a lengthy review, Paul discovered that while the Gillespies had some money in super and a few direct equities, their investment strategy was skewed towards residential rental property. While the Gillespies’ preoccupation with property, courtesy of WA’s sky-rocketing house prices (notably in Perth) has put them in an enviable position (when they sell), it’s also created some unforeseen tax issues.
Like many successful couples living busy lives, Paul says the Gillespies had only a rudimentary knowledge of investing. During the review, Paul says it became clear that not having a coherent financial planning strategy – effectively linking all their investment, business and estate planning considerations – would cost them dearly over time.
“They enjoyed life a lot, but had no real insight into what strategy was going to lead them successfully into retirement,” says Paul.
“They had no idea of what their capital base could deliver in revenue, so we had to review their property in terms of cash flow and how it fitted into their overall strategy.”
Paul quickly saw to it that Dick Gillespie maximised his salary sacrifice contributions in the lead-up to his imminent retirement.
Capital Gains Tax
| Portfolio Snapshot
(Self managed super fund) Dick and Jane Gillespie |
| Cash: 25 per cent (including 12 per cent in fixed income).
Managed Funds ($430,000) Domestic: Challenger Orion wholesale Australia Share Fund International: Platinum Asia Fund; Morgan Stanley Global Franchise Fund; Colonial First State Global Resource Fund; Macquarie Infrastructure; Morgan Stanley Global Fund; UBS Property Security Fund. Direct equities: 10-15 per cent of overall portfolio – looking for income and growth through fully-franked blue-chip shares: Rio Tinto, Wesfarmers, Woolworths. Property Unlisted property fund: Becton Fund (10 per cent of overall SMSF). Residential property: Rental: Stirling, Perth; Land: Dawesville, WA; Rental: Mandurah (Greater Perth). Overall portfolio performance: 16 per cent to May 2007. The Gillespies’ total net-worth As at June, 2005: $990,000 As at May, 2007: $2.295 million |
But the most pressing issue facing the Gillespies was a hefty capital gains tax bill that needed to be quickly addressed following the sale of a rental property in Broome. Arranging for the Gillespies to pre-pay interest on an investment loan, and investing in a Margaret River winery, reduced their capital gains tax from $60,000 to around $5,000.
“In addition to removing capital gains tax, the winery’s projected income stream coincides well with their retirement plans,” Paul says.
| The Planner:
Cameron Paul Momentum Planning Pty Ltd, Perth, WA Paul holds a Bachelor of Commerce from the University of WA (Finance and Strategic Management), a Graduate Diploma in Financial Planning from the Securities Institute and is completing his Certified Financial Planner (CFP) qualification. A former paraplanner, Paul has been a financial planner for seven years and specialises in the five key areas of cash flow, risk, wealth, estate planning and taxation. History The Gillespies’ portfolio moved to Paul’s care when Momentum Planning acquired the client base of a retiring financial adviser in 2004. As the financial adviser was also a friend, Jane Gillespie admits regretfully that what should have been formal reviews turned quickly into social occasions – much to the detriment of the advice provided. Advice structure Momentum Planning embarked on a fee-for-service model when it opened its doors in 2002, rather than taking the more traditional, transaction-based commission approach. Subject to the complexity of advice required, the company’s charging model is based on funds under advice, and a minimum fee structure. In addition to providing greater transparency, Paul believes a fee-for-service model creates a stronger mandate for the adviser to deliver a holistic and “high touch” service for individual investors. Strategy Dick and Jane Gillespie were aged 65 and 57 respectively with no real sense of their retirement destiny when they were introduced to Paul. Unsurprisingly, his primary strategy centred on plugging structural holes within their existing strategy. Their former adviser had failed to provide any meaningful sense of financial guidance, so the Gillespies’ brief to Paul was a simple one. First, find out what our current financial position is, then provide a clearer picture of where we should be heading and, finally, show us how we go about getting there. There was some rationale to the plan in place, but what they needed, Paul recalls, was an entirely new financial planning strategy encompassing the key areas of cash-flow, salary sacrifice, estate planning and, more notably, capital gains tax issues. |
Business Structure
The next issue was to better separate their business from their private lives, while maximising the deductibility of super contributions. Paul recommended that the partnership structure become a limited liability company. “Under their partnership structure they only had access to the first $5000 and 75 per cent of the remainder,” Paul says.
“But by doing this we were able to maximise the super contributions.”
Becoming incorporated meant that both Dick and Jane could extract as much income as possible from the business in super, as employees of the business. Given their robust cash flow position, Paul also encouraged the Gillespies to incur legitimate expenses against the business, including the purchase of new vehicles and numerous travel arrangements. The Gillespies had contemplated selling the cleaning business, but with cash flows dramatically improving their overall position, Paul recommended they stick with it for now.
SMSF Framework
With around $300,000 split between five super funds (industry and retail), Paul’s advice was to roll over into a diversified combination of international and domestic funds within a self managed super fund (SMSF) structure.
Also operating within the Gillespies’ SMSF structure is a combination of cash, managed funds, direct and unlisted property and direct equities. With rental income failing to keep pace with house price growth, the yield from their residential property wouldn’t adequately support the Gillespies’ income requirement (about $50,000 a year) once they entered retirement.
“The plan is to unlock significant unrealised property gains through eventual sell-down,” Paul says.
“These funds will be used to retire debt, and what’s left will go into super to reduce capital gains.”
Paul also recommended a direct equities strategy. The Gillespies have adopted a dollar cost averaging strategy to acquire a handful of blue-chip, fully franked shares.
“We’re confident that dividends from equities, together with rental income, business cash-flow, plus future annuities will get us to the targeted annual $50,000 net Dick and Jane expect to live on in retirement,” he says.
Performance
Since June 2005 the funds within the Gillespies’ SMSF have delivered annual returns between -6 per cent and 37 per cent. But in the 12 months to May, 2007, these funds delivered an overall 16 per cent return. Since their involvement with Paul, the overall value of the Gillespies’ managed fund portfolio has grown from about $300,000 to about $430,000. Much of this growth is attributed to a combination of double-digit annual returns, plus an aggressive salary sacrifice strategy while Dick was still working full-time.
During the same time, the overall value of their total portfolio has grown from $990,000 to $2.295 million (at May 2007). While managed funds have generally performed well, Paul attributes most of the upside to gains from residential property.
Hindsight
While Perth property has arguably been the Gillespies’ best all-around asset performer, they unashamedly admit that it was more down to “dumb-luck” than clever planning. While residential property was always the asset class they felt most comfortable with, Jane Gillespie says they’ve learnt to diversify into other areas.
The Gillespies still see themselves as conservative investors. But since their time with Paul, they’ve become more disciplined and knowledgeable. It’s also given them the confidence not to panic during the tough times.
“We would have been far better off had we embarked on this years earlier,” Jane Gillespie says.
“We’re also more aware of the value of paying for good advice.”
