Identifying your investment risk & return profile.
A diversified investment portfolio consists of defensive and growth assets that can be classified into cash, fixed interest, shares, property and alternative assets (hedged funds, futures).
It is important to assess our client’s tolerance to fluctuations in investment returns. We look at:
● A client’s tolerance to their risk and return trade off.
● A client’s risk capacity – short term capital loss that they can sustain.
The key to our investment advice is that we are seeking risk adjusted returns. There are various methods available to determine an investor’s risk and return profile.
Lancewood Investment advisers use a detailed psychometric testing programme. It is a comprehensive financial risk tolerance test that gives a reliable in-depth insight into a client’s financial attitudes, values, motivations, preferences and experiences. This is a scientifically validated approach and helps to remove any bias an investment adviser may have.
What are the CR and FDR taxation methods?
In constructing a diversified portfolio, approximately 60% of your investments may be held offshore. Investments held outside of New Zealand and direct Australian share investments fall under the Foreign Investment Fund or FIF regime.
There are advantages and disadvantages based on how your portfolio is constructed.
PIE Funds
Foreign investments in Portfolio Investment Entities (PIE) funds are taxed under FDR (Fair Dividend Rate) method. Examples of PIE investments are Kiwisaver funds, superannuation schemes.
The investor declares their taxation rate 0% (only applicable to Family Trusts), 10.5%, 17.5%, 28%. This is the PIR (Portfolio Entity Rate). The rate is based on your highest income in the previous two years. For income earners that fall in the 30% or higher marginal tax range there is an advantage to investing via a PIE fund. However, this is not straight forward and should be discussed with your accountant.
Since the 2021 taxation year the IRD is now refunding any overpaid PIE tax. Previously this was not refunded. They will also request a payment if the rate is under declared.
The major advantages for PIE funds is when your marginal tax rate is 30% or higher and taxation is managed by the fund manager.
FDR Method
Effectively the part of your portfolio that falls under the FIF regime can be taxed under FDR or CV. For PIE funds its compulsory that investments are taxed under the FDR method.
Effectively (simplifying) with the Fair Dividend Rate (FDR) method the taxable income for funds that fall under FIF rules is calculated as 5% of the opening balance on the 1st April.
For example, lets assume your portfolio balance on the 1st April was $100,000 and at the end of the tax year 31 March the balance was $110,000 (a 10% growth). The tax is effectively calculated based on 5% of the opening value, $100,000 which is $5,000. This is treated as taxable income and you pay tax at your marginal tax rate on this amount.
If the funds that fall under FIF grow by more than 5% you are winning, if less than 5% you are disadvantaged.
CV Method
With the CV (Comparative Valuation) method your taxable income for the part of the portfolio that falls under FIF rules is calculated as the closing value on 31 March minus the opening value on 1 April the previous year.
For example. If the opening value was $100,000 on 1 April and the closing value on 31 March the following year was $110,000 (a 10% gain). The taxable income would be $10,000. Your tax liability is based on this as being your taxable income for investments that fall under the FIF regime.
If your balance on 1 April was $100,000 and on 31 March it was $90,000 (a 10% fall) then your taxable income would be negative $10,000. Unlike investment properties the IRD deem this as $0 and losses cannot be carried forward.
In the 10% gain scenario the investor would be better off calculating their tax on FIF investments under FDR. In the 10% loss scenario the investor is better off under CV calculations.
The advantage of non PIE investments
With investments that are not held in PIE funds and that fall under FIF rules you can change each year between the FDR and CV calculations based on which one gives you the lower taxable income.
MyFidicuary in their taxation paper May 2023, showed the ability to switch FIF calculation methods can reduce the expected annual tax rate paid over a period of years by an average of approximately 0.60% (compared with choosing or having to stick with the Fair Dividend Rate method every year as occurs with PIE funds).
For clients with portfolios held in non-PIE investments and held on a custodial wrap platform each year in May we email a paint-by-numbers guide to completing your tax return.
By using your myIRD many of the input numbers are automatically included and for the FIF calculations we provide a simple fill in the numbers guide with examples.
Where you have a more complex tax structure like owning rental properties or a business then we do recommend using an accountant.
Managing your Inheritance
Receiving an inheritance can bring both opportunities and challenges. Whether it’s cash, property, or investments, managing it wisely can significantly impact your financial future. From paying off debts to strategic investing, we help guide you in making the right decisions for your inheritance.
Inheritance
Receiving an inheritance can pose several challenges. It may entail a substantial influx of cash, investments, real estate, and valuable assets all at once. While these inherited assets are fundamentally similar to any other financial resources, the way you treat them may differ. Effectively managing your inheritance is crucial, as it has the potential to significantly enhance your financial wellbeing.
Optimal strategies for handling your inheritance typically include using it to pay off high interest debts, establishing an emergency fund, and making strategic investments.
Why you should seek financial advice
When you receive an inheritance what are the first things you might think of doing? Buying a new car, doing that house renovation you have been putting off, going on holiday, gifting to your children so that they can purchase their first home. You have many choices and it is prudent to seek help form an experienced financial adviser if the inheritance is substantial.
Property relationship issues
It is important to note an inheritance is separate property as it’s considered to be a gift. If those inherited items or cash assets are mixed with relationship property, then they are likely to then become relationship property. For example if a cash inheritance is paid into a joint account or is used to purchase an asset that is jointly used then it falls under the Property Relationships Act.
You can separate your inheritance from your relationship. For example setting up an investment portfolio in your own name. Provided no additional investments are made to the portfolio from joint assets.
Another way to separate your inheritance could be to enter into a contracting out agreement with your partner under the Property Relationships Act. This is often referred to as “pre-nuptial agreement”. This agreement would specify how the inheritance, regardless of its use, is treated upon separation. A contracting out agreement can be entered into at any point before, or during, the relationship, however always seek legal advice during this process.
What to do with inherited investments?
You could be inheriting shares, bonds or an established investment portfolio. It can be overwhelming to receive all these investments, especially if you are not an experienced investor.
An important aspect of investing is identifying your risk-return profile and seeing how your inheritance fits in or whether a restructure is required.
Disclaimer: This information is general in nature and does not constitute financial or tax advice. We recommend consulting a qualified accountant or financial advisor to discuss your individual circumstances.