Sent: 01-07-2008 14:48:01
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The Safe Income Level for Income Streams
The Kitces Report is a document written by Michael Kitces. The May 2008 edition deals with the level of safe withdrawal rates from income streams.
Kitches has taken some original research first done in 1994 and expanded it significantly and therefore done a great service to the financial planning industry.
From his research Kitches concludes what a safe withdrawal rate one a range of different of equity holding whilst still allowing for annual inflation to income payments. For example for 60% equities the initial safe withdrawal level appears to be 5%.
He found a fascinating strong inverse correlation between the average P/E ratio of the S&P 500 index and the safe withdrawal rate over the next 30 years. From here he concluded that the higher the P/E, the lower the initial withdrawals have to be.
I can see at least four potential problems with taking this research and applying it without any adjustment in Australia.
Firstly, the report is based upon the S&P US equity index and doesn't seem to take into account any dividend payments. Largely for tax reasons dividends are much more important in Australia than the US.
Secondly our retirement system is different to the one used in the US. The new Account-based income stream given to us by the Better Super reforms has an automatic inflation adjustment built into its payment factors just like the factors used for Allocated Pensions and Term Allocated Pensions. We will leave to another time how effective the inflation adjustment in the new Account-based income stream actually is.
Thirdly checking some issues across past broad market performance is fundamentally important. However there are two obvious flaws with this approach - the market is always correct and it never repeats itself. Just because something has worked in the past does not necessarily mean it will work in the future. Additionally broad market performance is not meant to be strictly replicated by active managers. Most people purchase their services to provide a return higher than the total return of the broad market.
Is it okay to argue that past successes will guarantee future success? Kitches argues that future long-term sharemarket performance is not entirely random because it depends upon dividends paid, future underlying earnings and changes in the price/earnings ratio. In this respect he is correct however given it is almost impossible to predict these great unknowns with any accuracy perhaps it is better to assess the suitability of a strategy by using a large range of appropriate randomly generated numbers?
Fourthly we might want to argue about Kitches' asset allocation. His analysis allows for US domestic fixed interest and equity investments. Most Australian financial planners seem to recommend to their clients that they should invest some of their funds into International equities and fixed interest investments. This then raises the whole issue of currency fluctuations impacting real underlying values and hence a safe withdrawal rate.
Despite these comments, Mr Kitches has conducted some extremely valuable research which is well worth reading.
On another topic the Joint Parliamentary Committee of Public Accounts and Audit produced a very good report on Tax Administration after a fairly lengthy inquiry. Tax is a key ingredient in how many financial plans are structured and it is therefore a little surprising that no financial services organization made a submission to this inquiry.
Finally what should or should not be in your client's SMSF investment strategy? What does the regulator expect to see? What other sources of information may be relevant? Do you have trouble talking to your centres of influence about SMSF Investment Strategies and how you might be able to help? We hope you find the following guide of assistance in your endeavours: https://www.atcbiz.com.au/smsf_investment_strategy_paper.php
One purchaser had the following to say about this document, "It's a very useful document, the best I've come across in my search far and wide for practical assistance with putting together a SMSF."
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