Welcome to the November, 2011 edition of Investor Insights.
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Index

1. Yield to be More Significant
2. Are Emerging Countries Vulnerable to a US/European Downturn?
3. Got a Tax Refund or Extra Money?
4. Investing for Children

The major driver of returns for Australian equities is likely to come from dividend streams in the immediate future, according to the head of equities at Tyndall Investments.

"Now that's not unusual. During the '90s we had earnings growth that saw dividend yields taking a secondary place, but for long periods of time the major part of equity returns have been dividend yields," Tyndall Investments head of equities Bob Van Munster said.

And in this environment the biggest winners would be superannuants and retirees as they were likely to be paying 15 per cent tax or no tax at all, making fully-franked dividends all the more attractive, Van Munster said.

"They also become safer because of the lack of leverage most corporations have on their balance sheets," he said.

The increased influence of short-term factors on the valuation process of Australian equities is the phenomenon identified as the cause of this change.

"If you look at why valuation of the market expanded in the '90s and 2000s, it really was because investors could take a longer time horizon. The back was broken on inflation, the Cold War had ended, we had globalisation, and people felt comfortable about taking longer-term projections," Van Munster said.

"But we're now in a scenario where we're moving from crisis to crisis and it's hard to get a handle on things like where the developed economies are going, whether we're going to see protectionism rather than globalism as a result of these types of issues, and therefore shorter horizons and probably shorter cycles in valuations of markets are going to be more prevalent than what we would traditionally see."

Are Emerging Countries Vulnerable to a US/European Downturn? With fears Europe and the US are on the brink of a return to recession and the European debt crisis still out of control and threatening to trigger a re-run of the 2008-09 global financial crisis, it’s natural to wonder how the emerging world, particularly Asia, would fare in the event of another recession in advanced countries.

This is particularly important because the emerging world is now more than 50% of world economic activity. It’s also critically important for Australia given our key export markets in Asia.

During the first half 2008 there was much talk that the emerging world could decouple from the deteriorating economic environment in advanced countries. But the experience of the global financial crisis warns that the stronger structural fundamentals of Asian and emerging countries won’t necessarily protect them from a downturn in advanced countries.

But emerging countries did do much better than advanced countries through the downturn and in the subsequent recovery. And their share markets rebounded by much more – up 118% from their low during the global financial crisis to this year’s highs versus a gain of 82% in developed country global shares. The key lesson seems to be that emerging countries remain coupled to the global economic cycle, but can continue to outperform over time.

Furthermore, a number of considerations are different this time around, or at least suggest the emerging world will continue to perform much better than advanced countries.

• Emerging countries are structurally sounder.
• Inflation is likely to subside as weaker economic activity takes the pressure off food and oil prices and underlying inflation.
• Leverage and credit growth in Asia and other emerging countries has been much more subdued.
• Asian and emerging markets shares are trading at similar valuations to global shares compared to a premium in 2007.

While emerging market shares are vulnerable in the event of a return to recession in advanced countries, the longer-term trend is likely to remain up on much stronger growth potential, driven by rapid industrialisation and urbanisation. At the same time, emerging countries generally lack the macroeconomic risks that come with the excessive levels of debt in advanced countries.

Sensible things to do with your extra money
If you get extra money or a windfall such as a tax refund, a bonus, or an inheritance, you might be tempted to splurge on things you don't need.

Here are some smart ways to spend this money that will give you long-term benefits.

Pay off debt
It's best to pay off your higher interest debts like credit cards first. If you put your extra money towards paying off your debts you'll pay less interest and save money. You could use it to pay your credit card bill, your mortgage or a personal loan.

Put it in a high interest savings account
If you put the money in a high interest savings account it will grow with the power of compound interest. For example, if you put a $2,000 tax refund into a high interest savings account that earns 6% interest, in 5 years time you'll have $2,676

Contribute extra to your super
Making extra contributions to your super can really boost the amount of money you have to retire on. If you earn less than $61,920, the government will match your after-tax super contributions. For more information on this contact Portfolio Managers.

Consider investing
Investing your windfall will really make your money go further. If you would prefer to rely on professionals who are skilled in making investment decisions, a managed fund could be right for you. For more information see speak with Portfolio Managers

Get financial advice
For large amounts of money, such as from an inheritance or a redundancy payment, you should get financial advice. Portfolio Managers will be able to help you work out a strategy to make the most of your money. While it's always nice to spend extra money on luxuries, think through your options and see if your windfall can give your finances a real boost.

Finding the best way to put money aside for your children or grandchildren needs careful thought. The bottom line is the basics of good investment should always apply.

Providing a good start in life for your family is essential to many people. Whether you're interested in starting a nest egg for a newborn or helping a grandchild save for a house, it's important to understand what investments are suitable.

"When it comes to investing for children, people sometimes are too overly focused on tax issues and forget the general investment principles," says Colonial First State's Head of Technical Services Deborah Wixted.

That's why she recommends thinking about the investment time frame – how long before the funds will be needed – and then looking at the types of products and assets that will suit.

Short-term vs. long-term
So what are the options? For short-term savings goals, say three to five years, lower risk investments such as cash and term deposits may be more suitable. A first home saver account is one option that provides a tax-effective way for people to save for their first home.

But if your sights are set on the longer term, such as an education fund for a very young child, then higher growth investments could be considered. Your financial adviser can help you to assess the child's needs and recommend the options that suit, including shares and property. These could be held directly or in managed funds, an investment bond or family trusts.

Buying shares or property is a popular way of providing for a child's future although it may mean that the portfolio is heavily weighted in one area and managing these investments may require some extra work.

Managed funds can be a good way of providing diversity with a single account because funds typically invest across a range of assets. However be aware that most managed funds don't accept investments in the name of a minor (under 18 years of age) but will generally have processes to allow the investment to be set up by an adult on behalf of the child. There's also an opportunity to set up a regular investment plan to take advantage of compounding investment returns. See the effect of making regular investments by using our online calculator at colonialfirststate.com.au.

Thinking about tax
After you have established the goals for your investment, tax is the next consideration. Tax rules will also play a part in the decision to place the investment in your name or the child's.

"Passive investments held directly by children are taxed at very high rates," says Wixted. "There's a reason for that. It's so that parents don't try to effectively split their income by holding investments in their children's name."

Various tax rules apply to different investments so you should check with your adviser for information about your own circumstances.

Establishing and maintaining a family trust can be complicated but a trust may suit some circumstances. Tax must be paid on any distributions made and any income remaining in the trust. But the trust is able to distribute income in a way that takes advantage of the marginal tax rates of beneficiaries.

Special tax rates* apply to children under 18 who receive passive or unearned income. In general, children do not need to lodge a tax return if their only source of income is less than $416.

If the investment is in the child's name and the child has the benefit of the investment income and any sale proceeds, then the child pays the tax. If you use the income or benefit from any sales, you are liable for any tax. This may include capital gains tax when you want to transfer the investment into the child's name.

"Deciding whether or not to place the investment in the child's name or your own essentially comes down to three factors," says Wixted. "Firstly you may want to have control over it while they're young and not able to manage their money," she says. "Secondly, the type of investment may determine the ownership. For example super or first home saver accounts must be held in the individual's name but children may not be able to hold other investments, such as managed funds, in their own name. And thirdly, the various tax issues will also play a part in your decision.

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This newsletter contains general information only and does not take into account the investment objectives, personal circumstances or financial needs of any particular investor. You should therefore obtain professional financial advice before making any investment decision based on the information provided in this document. In the event that this newsletter contains information about a particular financial product, you should also obtain a Product Disclosure Statement in respect of that product prior to making any decision to acquire that product.