Ask Paul: My investment is losing money, should I cut my losses?
Two years ago, I set up an investment bond with Generation Life for my children.
This is my first experience with investing, and it hasn't gone very well. There haven't been any gains in that time, only losses.
The 12-month anniversary is coming up, so I need to decide whether I deposit more into the bond or cut my losses and let it sit for the next eight years, when I can cash it in.
My husband thinks I'm mad to add more to it and better off putting it in a term deposit. Love to hear your thoughts. - Rebecca
Some parts of investing are very technical, Rebecca, while other parts are personal.
Generation Life offers an insurance bond with a wide range of investment options and in 2022 was Money magazine's Investment Bond Provider of the Year. That is a solid achievement, clearly showing it offers a competitive insurance bond.
A big plus of insurance bonds is simplicity, but they do pay 30% tax on income earned. So, except for individuals earning more than $120,000, who pay a 37% marginal tax rate plus Medicare, and those earning more than $180,000 (45% plus Medicare), an insurance bond could make a lot of sense.
But I don't see them as a good option for those paying less than 30% tax.
Then there are fees. Every manager will have some form of fee, that is fair enough. Generation Life, to its credit, offers a wide range of options.
The costs to the investor depend on the investment option chosen, but range from 1.95% for the Magellan Global Fund to as low as 0.45% on cash and deposits.
As you know, at each 12-month anniversary you can add up to 125% of what you put in last year, if you wish. It sounds as if you are getting close to decision time.
The returns you are earning will depend on the investment option you chose but, to be fair, it has been a difficult two years for pretty much all fund managers. Rising interest rates, the war in Ukraine, energy supply and cost issues and political uncertainty have made investment a complex process.
But you need to ask yourself whether it is necessary to pay 30% tax as well as the underlying manager's fees and then the insurance bond company's fees.
As an example, let's look at one of the world's biggest managers, Vanguard. It has many options, but let's take its managed funds, where you can start with $500 and add a minimum of $200 on a regular basis
I am certainly not suggesting Vanguard would outperform other excellent managers. One thing I do know is that investment performance is uncertain in the short term but more predictable in the longer term. But fees are certain. Here, with Vanguard and other similar low-cost managers, you would pay around 0.29%pa.
Children are heavily taxed on unearned income above $416, so generally a parent would invest "as trustee for" their child. These investments are generally focused on capital growth, so income may not be high and may be fully franked.
If the adult acting as trustee paid no tax, there would be no tax liability on the income from the investment held for the child. But if the parent acting as trustee paid maximum tax, the trustee could pay 45% plus Medicare levy.
Here you can see the simplicity of an insurance bond. It just pays 30% tax on investment income. This simplicity will appeal to many, which is fine.
But with our kids, we preferred to invest in shares and low-cost managed funds as trustee for them. At age 18, the investment can be transferred to them with no capital gains tax as they were always the "beneficial owner". Again, an insurance bond saves all this complexity.
As you can see, it is a fairly technical argument based on the tax the child would pay on an investment, along with fees charged by an insurance bond.
Where I would disagree with your husband is investing in a term deposit. The income is fully taxable and your invested amount, while highly secure, does not keep pace with inflation. Frankly, with a long-term view, history shows this is likely to be your worst investment.
The long-term history of investment markets is important. It says your kids' money should be invested in growth assets. An insurance bond can certainly do this for you and keep things simple.
But if one of you was a low-income earner, or you chose a high potential capital growth investment with low income, logic says to me that if 30% tax is not being paid and management fees were much lower, then there is a solid argument to invest directly for your kids.
Where history says you are right is to hold growth assets. An insurance bond can do this for you, but if you can invest to keep tax below 30% and pay lower fees, it seems to me the best option may be to own investments directly for your kids.
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