An after-tax bonus from shares

The ASX – Russell ‘Long Term Investing Report’ shows shares have performed even better against other asset classes on an after-tax basis.

Summary: Australian shares outperformed returns from residential property and other asset classes over the past 20 years and the last decade, both on a pre-tax and after-tax basis. After-tax, Australian shares averaged 7.9% per annum, compared with 6.8% for residential property. Cash paid the lowest average annual return, at 2%.
Key take-out: Around 19.4% of pre-tax Australian share returns are lost to tax, compared to 28.4% for residential property.
Key beneficiaries: General investors. Category: Asset allocation.

The ASX – Russell ‘Long Term Investing Report’ has been released, with performance data for various asset classes up until the end of the 2012 calendar year. While investors have different philosophies about how they expose their money to investment markets, for most, benefitting from the returns from investment markets over long periods make up an important part of their wealth creation strategy.

Asset Class

20-Year Return to the
End of December 2012 (per annum)

Value of $100,000
Invested 20 Years Ago

Australian Shares

9.8%

$648,700

Residential Property

9.5%

$614,200

Global Shares – Unhedged

5.3%

$280,900

Australian Listed Property

7.1%

$394,300

Cash

3.9%

$214,900

Inflation

2.7%

$170,400

Real Money Returns

We often see returns quoted as a per annum return – and sometimes we might miss what these returns actually mean. The Australian share return (dividends and capital growth, but not including the value of franking credits) averaged 9.8% pa over the past 20 years. It is worth keeping in mind that this period of 20 years includes the Asian Financial Crisis (1997), the ‘Dot Com’ crash and, most significantly, the Global Financial Crisis. This translates into $100,000 invested 20 years ago turning into $648,700 – which most people would agree is a satisfactory return. All that was needed to capture this return was to be exposed to a portfolio of Australian shares for the past 20 years that provided the market average return.

Recent research from the USA financial services firm Dalbar suggested that the average period of time that investors held a managed fund was just over three years. On the Australian sharemarket, the total value of the sharemarket is bought and sold just over every 12 months. With so much trading going on, it is interesting to reflect on what proportion of investors actually managed to capture the Australian sharemarket’s ability to turn $100,000 into $648,700.

There is also a stark difference in results for investors in cash and growth assets like Australian residential property and Australian shares over the past 20 years. The $648,700 (Australian shares) and $614,200 (Australian residential property) ending value of a $100,000 initial sharemarket investment dwarfs the $214,900 return from investing in cash. That is not to say that cash is not a crucial part of a portfolio, providing liquidity for cash needs in the next three to seven years, just that over the long term the returns from cash-like investments lag growth assets significantly.

20-Year Returns to End of January, 2012

Asset Class

Before-tax average annual return
(20 years to end of Jan, 2012)

After-tax (highest tax rate)
annual average return

Asset Class
‘Tax Leakage'

Australian Shares

9.8%

7.9%

19.4%

Residential Property

9.5%

6.8%

28.4%

Global Shares (Unhedged)

5.3%

3.8%

28.3%

Cash

3.9%

2.0%

48.7%

The Tax Story

One of the great disgraces of the financial services industry in Australia is the lack of ‘after-tax returns’ data – most significantly lacking is the performance data provided for most managed funds. However, this ASX Russell report has calculated after-tax returns for the different asset classes – providing some insight into the tax impact.

I have compared the pre-tax and after-tax returns for an investor at the highest tax rate, and calculated a ‘tax leakage’ – the percentage of pre-tax returns lost to tax.

Not surprisingly, the asset class hit hardest is a cash investment as all of the returns are taxable as income. Over the past 20 years 48.7% of cash returns for an investor on the highest tax rate have been lost to tax. As we move to the growth asset class (Australian and international shares and residential property), there are a number of potential tax benefits, not least of which is that the return that comes from the growth in value of a property/shares is not taxed until it is sold. This means that potentially more than half the return from growth assets (the capital growth) is not taxed until the asset is sold – and then at a discount rate if it is held for 12 months.

The ‘tax leakage’ for residential property for an investor on the highest tax rate is 28.3%, almost identical to an investor in international shares. Australian shares have a ‘tax leakage’ of 19.4% for an investor on the highest tax rate - the benefit of franking credits along with unrealised capital gains make both the income and capital growth tax effective.

The 10-Year Story

Asset Class

10-Year Average
Annual Returns
– To End Dec, 2012

Ending Value
of $100,000
Invested 10 years ago

After-tax returns
over 10 years
(after highest
marginal tax rate)

‘Tax Leakage’

Australian Shares

8.90%

$234,573

6.90%

22%

Residential Property

6.50%

$187,714

4.60%

29%

Cash

3.80%

$145,202

2%

47%

Global Shares (Unhedged)

1.40%

$114,916

0.70%

50%

Global Shares (Hedged)

8.20%

$219,924

5.90%

28%

Inflation

2.8%

$131,805

NA

NA

10-year returns to the end of December 2012 show a similar story to the 20-year returns. Even over a period that will be remembered for the Global Financial Crisis, a naïve ‘buy and hold’ strategy of the Australian sharemarket turned $100,000 into about $234,500 – a pretty acceptable return. Tax leakage is also similar, with Australian shares proving the most tax-effective and cash the least tax-effective. The very low returns from global shares means that almost all the return received was from taxable income – decreasing their tax effectiveness over the 10-year period.

Conclusion

I always find it interesting to look at historical data, and think about what that means for my portfolio. This ASX Russell report seems to support the value of exposing money to investment markets for extended periods, while also providing some interesting data on the tax implications of various asset classes.


Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.

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