When markets fall, it’s natural to want to take action to prevent further losses. Doing so however can do more harm than good. Here’s why timing the market to buy low and sell high is not as easy as it sounds.

If you’re invested in the financial markets and also keeping up with the news, you’re probably wondering if you should do anything to insulate your portfolio from incurring further losses alongside rising interest rates and inflation.

In times like these, reminding investors to “maintain discipline” and “stay the course” – in other words, stay invested and here’s why:

Reacting to the here and now

Most market commentary are about the events of the day, with a focus on the here and now. However, the ‘today’ is not as significant to financial markets as they’re generally forward looking and more concerned about what will happen in the future. Thus, using daily developments to make constant adjustments to your portfolio is unlikely to help you accumulate wealth over the long term as the market will have already priced it in.

Additionally, to successfully time the market, investors need to get all five of these investment factors right including precisely timing exit and re-entry – a near impossible feat for even the most experienced of investors.

Locking in your losses

When markets fall, it’s natural to want to sell riskier assets (i.e. equities) and move to cash or safer assets like government securities. But exiting the share market now means locking in your losses permanently and not giving your portfolio the opportunity to benefit when markets recover. Research found that 80 per cent of investors who panicked and moved to cash during the 2020 sell off would have been better off if they had stayed invested¹.

Investing at the peak

While we all want to “buy low and sell high” so our portfolios can outperform the market average, in reality, it is extremely hard to execute perfectly every single time. Analysis of the last 5 decades reveals that even in the worst-case scenarios – where investors bought into the market at its peak, just before a dip – as long as investors stayed invested instead of moving to cash, they still benefited from positive annual returns of almost 11%.

If the recent market volatility is keeping you up at night, take a moment to reflect on whether your emotions are short-term reactions to the current conditions, or something you really need to act on. If you feel like you cannot stomach temporary losses, consider if your asset allocation is right for your overall investment goals and risk appetite.

A well-diversified core portfolio, aligned to your risk appetite will help spread your risk and afford you a margin of safety over the long term. Get this right and you will probably sleep better at night.

Contact us if you would like to discuss this further.

Source: Vanguard

1 https://corporate.vanguard.com/content/dam/corp/research/pdf/Cash-panickers-Coronavirus-market-volatility-US-CVMV_072020_online.pdf

Reproduced with permission of Vanguard Investments Australia Ltd

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.

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With the double whammy of cost of living and mortgage interest rate rises, it’s no wonder many mortgage holders, and those saving to buy their first property, are feeling anxious about meeting their repayments or savings goals.

The best way to check, is to stress test your household budget and mortgage repayment capacity. Your reality may not be as dire as the media leads you to believe.

The first thing to remember is that when mortgage brokers and lenders evaluate how much they could loan you, they assess your borrowing capacity and ability to service your loan assuming mortgage rate increases. This was tightened by APRA in 2021, requiring all new home loan applications to be assessed at an interest rate at least 3 per cent above the loan product rate.

So, if your income and expenses haven’t dramatically changed since then, you should have a buffer built in. If you have had your mortgage for some years and are ahead on your repayments, or have savings in an offset account, you can also draw on these funds to lower your repayments.

Stress test your budget

Both our incomes and expenses change over our lives, so whether you took out your mortgage 12 years or 12 months ago, or are saving to buy in the near future, it’s always a good idea to re-visit your budget every couple of years or at a major life event.

This includes checking your home loan interest rate and repayment structure and defining your property goals. This enables you to see if you’re still on the best loan for your circumstances or on track to buy in your chosen area.

A common measure of mortgage stress is when a household spends 30 per cent or more of its pre-tax income on mortgage repayments. However, every household is different, so it’s important to do your own calculations and work out what mortgage stress is for you and how changing mortgage rates will impact this.

One household, for example, may be able to cope with interest rates at 6 per cent while another may find that impossible. Knowing your numbers means you can recognise when you might need to look for help or make changes to your lifestyle as rates increase. The government’s MoneySmart website has a general budget calculator which can help you with accurate budget planning.

Making room for rate increases

You may want to start cutting back on non-essentials before you really have to; streaming subscriptions, cheaper utility and phone deals, and reducing your credit card debt all make a difference and can help you feel more in control.

It’s also important to consider the type of mortgage you have and if it still offers you the best outcome for your circumstances. If you have a flexible mortgage rate, it might be a good idea to look into fixing it, so you know exactly how much to budget for each month. You could also have a split loan that’s part fixed and part flexible. We can help you work out what type of mortgage structure could be best, moving forward.

The other thing to consider is increasing your income by negotiating a wage rise, evaluating a move in your job or starting that side gig you put on the back burner. Even a small increase in income may reduce the need to cut back on non-essentials and stop you eating into savings or any extra mortgage payments you’ve made.

How interest rates effect what you can borrow

If you’re saving for your first home or interested in an investment property, higher interest rates may reduce your overall borrowing capacity. Most lenders are honouring existing agreed-in-principal amounts, but please get in touch to discuss your current pre-approved amount or what you are likely to be able to borrow moving forward. More than ever, you need to keep up to date with your current buying limit – and stick to it when looking.

What to do if you are concerned about mortgage stress

The first thing is to contact us. We can speak to your lender and provide advice about your options moving forward. You can also access the government’s free financial counselling service via the National Debt Helpline on 1800 007 007.

Please get in touch if you’d like to discuss your current mortgage in light of recent rate increases so we can work with you to ensure you are able to withstand the changing environment – no matter what the news is telling you.

i https://www.abs.gov.au/statistics/people/housing/housing-occupancy-and-costs/latest-release

Tax compliance, higher fines in spotlight

Business taxes remained largely unchanged in the second Federal Budget of 2022, but employees working from home can expect less generous deduction rules for the 2022-23 financial year. Here’s some of the latest tax developments.

All quiet on the small business tax front

There were no significant tax changes affecting small business in the October 2022 Federal Budget, although there was a big focus on tax compliance.

The ATO will receive $685 million over four years to help it raise $2.1 billion from a crackdown on shadow economy activities. This may be of concern to some small and mid-size enterprises (SMEs), as the ATO believes the bulk of these activities occur among smaller business taxpayers. The Budget also included a $15.1 million boost for the existing small business debt helpline and programs focused on the financial and mental wellbeing of small business owners. Help with rising energy costs included $63 million to improve SME energy efficiency and energy use.

It’s unknown whether measures of the popular instant asset write-off and carry back of losses will be extended past 30 June 2023. We may need to wait for the May 2023 Budget for the answer.

STP Phase 2 deadline soon

With Single Touch Payroll (STP) Phase 2 reporting now well underway, small business employers need to remember their next reporting deadline is 1 January 2023.

Common STP reporting mistakes seen by the ATO this year include incorrect re-mapping of pay codes and not separately itemising bonuses, overtime and commissions; failure to correctly input existing year-to-date amounts; and incorrectly categorising allowances. The ATO has a range of factsheets and resources available to help employers get their STP reporting right.

Draft guidance on work from home deductions

Taxpayers working from home are likely to face significant rule changes when claiming tax deductions this financial year following release of the ATO’s draft guidance on the issue.

Under the new guidelines, employees will only be permitted to claim a deduction of 67 cents for every hour they genuinely work from home, instead of the 80 cents under the short-cut method available prior to 1 July 2022.

Asset depreciation on items used for work purposes will require a separate depreciation calculation. Employees will not require a separate home office or dedicated work area to claim the deduction, but normal substantiation rules apply.

Alternatively, employees working from home can claim a deduction for their expenses using the traditional actual cost method.

Increase in ATO penalty units

Taxpayers running afoul of the taxman will find themselves facing bigger bills this year after the Federal Budget included measures to increase the fines for regulatory penalty units. From 1 January 2023, fines will jump from $222 to $275 per penalty unit, a 19.3 per cent increase.

This is on top of regular indexation by the CPI, which is every three years, and this will remain in place, with the next one due to take effect on 1 July 2023.

Enhancing tax transparency

Large private business entities will face more scrutiny of their tax affairs after new legislation passed through Parliament to require greater transparency of the tax affairs of private companies.

The reform reduces the tax information reporting threshold for private corporate tax entities to companies with a total income of $100 million or more (previously $200 million or more). This lower threshold applies to reporting for 2022-23 and subsequent financial years.

The previous grandfathering of the exemption applying to certain large proprietary companies from the normal obligation to lodge their annual reports with ASIC was also removed.

Super for holiday season employees

Employers planning to hire staff on a short-term basis for the holiday season need to remember changes to the Superannuation Guarantee (SG) rules mean temporary staff may be eligible for super contributions.

From 1 July 2022, employers must make SG contributions at 10.5% for eligible employees regardless of how much they earn after removal of the $450 per month eligibility threshold.

For new employees who are offered choice of super fund but fail to choose, you must request their stapled super fund details from the ATO to meet your super obligations.

Higher interest rates are a worry for people with home loans and borrowers generally. But they are good news for older Australians who depend on income from bank deposits and young people trying to save for a deposit on their first home.

Rising interest rates are also a sign of a growing economy, which creates jobs and provides the income people need to pay the mortgage and other bills. By lifting interest rates, the Reserve Bank hopes to keep a lid on inflation and rising prices. Yes, it’s complicated.

How high will rates go?

In early May, the Reserve Bank lifted the official cash rate for the first time since November 2010, from its historic low of 0.1 per cent. The reason the cash rate is watched so closely is that it flows through to mortgages and other lending rates in the economy.

To tackle the rising cost of living, the Reserve Bank expects to lift the cash rate further, to around 2.5 per cent.ⁱ Inflation is currently running at 5.1 per cent, which means annual wages growth of 2.4 per cent is not keeping pace with rising prices.ⁱⁱ

So what does this mean for household budgets?

Mortgage rates on the rise

The people most affected by rising rates are likely those who recently bought their first home. In a double whammy, after several years of booming house prices the size of the average mortgage has also increased.

According to CoreLogic, even though price growth is slowing, the median home value rose 16.7 per cent nationally in the year to April to $748,635. Prices are higher in Sydney, Canberra and Melbourne.

CoreLogic estimates a 1 per cent rise would add $486 a month to repayments on the median new home loan in Sydney, and an additional $1,006 a month for a 2 per cent rise.

While the big four banks are not obliged to pass on the cash rate changes, in May they passed on the Reserve Bank’s 0.25 per cent increase in the cash rate in full to their standard variable mortgage rates which range from 4.6 to 4.8 per cent. The lowest standard variable rates from smaller lenders are below 2 per cent.

Still, it’s believed most homeowners should be able to absorb a 2 per cent rise in their repayments.ⁱⁱⁱ

The financial regulator, APRA now insists all lenders apply three percentage points on top of their headline borrowing rate, as a stress test on the amount you can borrow (up from 2.5 per cent prior to October 2021).^iv

Rate rise action plan

Whatever your circumstances, the shift from a low interest rate, low inflation economic environment to rising rates and inflation is a signal that it’s time to revisit some of your financial assumptions.

The first thing you need to do is update your budget to factor in higher loan repayments and the rising cost of essential items such as food, fuel, power, childcare, health and insurances. You could then look for easy cuts from your non-essential spending on things like regular takeaways, eating out and streaming services.

If you have a home loan, then potentially the biggest saving involves absolutely no sacrifice to your lifestyle. Simply pick up the phone and ask your lender to give you a better deal. Banks all offer lower rates to new customers than they do to existing customers, but you can often negotiate a lower rate simply by asking.

If your bank won’t budge, then consider switching lenders. Just the mention of switching can often land you a better rate with your existing lender.

The challenge for savers

Older Australians and young savers face a tougher task. Bank savings rates are generally non-negotiable, but it does pay to shop around.

The silver lining is that many people will also see increased interest rates on their savings accounts as the cash rate increases. By mid-May only three of the big four banks had increased rates for savings accounts. Several lenders also announced increased rates for term deposits of up to 0.6 per cent.^v

High interest rates traditionally put a dampener on returns from shares and property, so commentators are warning investors to prepare for lower returns from these investments and superannuation.

That makes it more important than ever to ensure you are getting the best return on your savings and not paying more than necessary on your loans. If you would like to discuss a budgeting and savings plan, give us a call.

i https://www.rba.gov.au/speeches/2022/sp-gov-2022-05-03-q-and-a-transcript.html

ii https://www.abs.gov.au/

iii https://www.canstar.com.au/home-loans/banks-respond-cash-rate-increase/

iv https://www.apra.gov.au/news-and-publications/apra-increases-banks

v https://www.ratecity.com.au/term-deposits/news/banks-increased-term-deposit-interest-rates

Steps to getting your pre-approval organised

Home loan pre-approval is when a lender states in writing how much they are likely to let you borrow. This allows real estate agents and sellers to take your purchase offer seriously. It means the lender has reviewed most of your documentation and is likely to approve your home loan application faster. It also gives you a very realistic maximum price point when researching properties.

Pre-approval time frames usually vary from three to six months. While you may be able to negotiate an extension, in the current volatile market it’s actually in your favour to regularly check that your pre-approval maximum loan amount is still valid.

It’s important to understand that pre-approval isn’t a guarantee. Lenders can still refuse your loan application. Common reasons for this could include the property not meeting their loan requirements – it could be a low valuation or it’s in a development that’s considered high risk. It could also be because you haven’t satisfied other conditions like providing additional documentation if required, or your financial situation has changed due to pregnancy, redundancy or starting a new job (this could mean waiting six months).

Interest rate rises may also affect how much lenders decide you can afford to borrow. First homebuyer grants may change and differ in each state, so you will need to keep an eye on these too.

Get your documentation organised

Application requirements may differ between lenders and depending on your particular circumstances, will determine what they require. So, it’s important to review your information so we can match you with the best potential lenders and understand what documents you might need.

Most lenders will want to see proof of:

1. 1. Identification: your passport, driver’s licence, birth certificate

1. 1. Income: recent payslips, PAYG statement

1. 1. Expenses: a detailed list of your monthly spending from childcare, food delivery, utilities, petrol, streaming services and clothes.

1. 1. Assets: car, savings and shares, and investment property.

1. Liabilities: statements for any existing debts including credit cards and car finance or personal loans.

The sooner this is submitted the sooner your pre-approval is organised to start your property search.

How to reach unconditional approval

Once you apply for a loan and have found a property you would like to buy, it will remain ‘conditional’ while the lender checks additional documentation and waits for the valuation and completed sale contract to be submitted. Your loan only becomes ‘unconditional’ (guaranteed to go through) when the lender formally approves the loan. While pre-approvals don’t register on your credit score, being refused a specific loan does, so it’s important that you regularly check in with us about any changes lenders may make before putting in an offer on a property.

Self-employed considerations

If you are self-employed or a company, pre-approval can be more complex. Most lenders ask for at least two years’ worth of tax returns, financial and BAS statements. Some may consider you with one year of financial documentation, depending on your financial history and accountant’s statement. While most lenders will consider home loans for companies and family trusts, the loan documents can be more complicated. This means you may need more time to organise your paperwork and look at your loan options.

And with your pre-approval ready, you can feel confident when putting in your offer. Let’s have a chat about your situation sooner rather than later to get your pre-approval underway and get you into your new home in 2023.