There are many challenges that face advisers, not least of which are those presented when clients have preconceived ideas about investing and producing an income in retirement.

In some cases, the focus and bias of these clients can border on an addiction. Three of the most common catalysts of investment addiction are residential property, listed equities and guaranteed bank deposits.

Addiction to shares

Clients who have invested in the Australian sharemarket for many years, whether successfully or unsuccessfully, often want to retain their shares after they have retired and also allocate a high percentage of their superannuation to Australian shares.

When clients have a large investment in listed shares, the adviser’s task is to educate them about the risks presented by not selling down their shareholdings to maximise the value of their superannuation.

One of the sobering tax facts for clients with share portfolios that have large unrealised capital gains is that if they don’t deal with those gains in a tax-effective manner now, they will be passing on a large CGT headache to the beneficiaries of their estate.

In addition, if the Labor Party’s policy to eliminate tax refunds from imputation credits becomes law, clients with an over-allocation to Australian shares might find their after-tax cash flow severely reduced. This is something I’ve written about in the past.

Addiction to property

The problem with clients who have built an investment portfolio of rental properties is trying to convince them that their portfolio should not be regarded as a pseudo-superannuation fund. This idea that a rental property portfolio is better than superannuation is often falsely reinforced by how much the properties’ values have increased since they were purchased, and the amount of income they produce annually.

When faced with clients who have a rental property addiction, it is important to establish the market value of each property and compare this to the net rental income. It can be a shock to clients to realise that properties that have more than doubled in value during their ownership have, in fact, increased at an annual rate of less than 6 per cent.

What property-focused clients often fail to appreciate is that, although they may be receiving a reasonable amount of rental income in cash terms, when the value of that income is compared with the value of the properties, the percentage return is lower than for other investments that don’t have the risks associated with property.

In broad terms, the net rental yield for residential properties is, on average, less than 3 per cent. The main benefit of investing in residential property comes from capital gains and the tax benefits while people are accumulating assets for retirement.

As with Australian shares, when clients regard rental properties as an alternative form of superannuation and don’t deal with accumulated capital gains in a tax-effective manner, they not only limit the amount of income they produce in retirement but also pass on a massive capital gains tax headache to their children.

Addiction to guaranteed deposits

The final investment type of addiction – in which clients invest only in deposits with federal government-guaranteed banks – is by far the hardest to break, especially in older clients. The guarantee might have made sense during the GFC, but since then it has led to the big four banks having an even more unfair advantage from which they profit.

With the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in its final stages, and even more examples emerging of how the big four banks have put the pursuit of profits ahead of fairness and equity, I can only hope that one of the recommendations will be scrapping the federal government guarantee of deposits up to $250,000, thus creating an opportunity to break clients of this addiction.

Max Newnham has worked in public accounting for almost 40 years. He is a financial planning specialist with the Institute of Chartered Accountants and a specialist adviser with the SMSF Association of Australia.
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