M4 Investing for life (Stream 1: The Working Client) John King King Indices Creator and Owner ajk.com.au

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1 M4 Investing for life (Stream 1: The Working Client) John King King Indices Creator and Owner ajk.com.au

2 2 Extending the client story Will & Monica are both non-smokers They plan to retire when Monica turns 60 [17 years from now (2033)] They want a low risk of not achieving their financial goals Want living standards to at least grow with rest of society (Preferably more)

3 3 Major Risks Risk is the possibility of not achieving your goal Risk is a concept, not a number Major risks are: 1. Outliving your investments 2. Inflation 3. Investment performance Most safe or low risk investments are high risk in relation to first two risks

4 Will & Monica s Life Expectancy (from 2016) % 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Retirement Couple Will Monica At Least One Alive # of Years Couple 4 At least One Alive Expect (50%) Year Years retired % Probability Year Years retired 30 39

5 Planning Period $1,000,000 Initial Portfolio Annuities assuming 10% p.a. return and various periods Annuity for years in retirement: 10% p.a. (Nominal) 25 Years (88% probability of outliving) $110, Years (72% probability of outliving) $106, Years (20% probability of outliving) $102,259 Perpetuity ( 0% probability of outliving) $100,000 Perpetuity is just 2.2% p.a. less than a 40 year annuity 20% risk of being needed (Premium of 2.2% p.a. protects against this risk) 5

6 Risk of Outliving Investments - Conclusions Don t use life expectancy 50% chance of living longer Take into account life as couple & life of surviving partner What probability of failure is acceptable risk? e.g. Look at 20% probability of life span (or 10%, or ) Life expectancy difficult to control Except for smoking (take 10 years off the non-smoker numbers) Plan for 20+ years of retirement (Maybe use perpetual) 6

7 7 Inflation Silent Destroyer of Wealth and Income Total inflation over previous 20 years (1948 to 2014) 600% 500% 9.3% p.a. ( ) 400% 300% 200% 2.9% p.a. ( ) 100% 0%

8 8 0% Inflation loss over the previous 20 years (1948 to 2014) (10%) (20%) (30%) (40%) (50%) (60%) (70%) (80%) (90%)

9 Risk of Inflation - Conclusions Inflation hurts a lot (Even low inflation) 3% p.a. produces 45% destruction in 20 years; 59% in 30 years; 70% in 40 years 9% p.a. destroys 82% in 20 years Future inflation is uncertain Best 20 year period ended in 1972 (2.9% p.a. average) Next 20 years was worst 20 year period (9.3% p.a. average) Need investments which keep up with inflation (at least) That only maintains living standards at current level Need investments which growth with the economy (at least) Living standards will growth at the average of the economy Living standards will be maintained, relative to rest of society 9

10 Portfolio Creation First Residence (debt-free before retirement) Lifestyle asset, not a financial asset Second Liquidity outside super Regular cash flow needs & Emergency cash flow contingency 6 to 12 months spending (depending on cash inflows and risk tolerance) Long-Term Investments, including Super & Outside Super Super is a taxation vehicle, not an investment Inside super & outside super follow same investment philosophy Our focus for rest of session 10

11 Investment Assets Only Two Types Debt Upper limit on benefit (interest or similar) Lower risk on NOMINAL capital than equivalent equity (Inflation risk) No long-term capital gains Bonds, loans & deposits Equity Owner gets all profits, and losses Value of asset can rise or fall Owner get benefit/loss of asset price change Businesses & real estate (investment, not residence) Shares are not an asset; a legal document showing ownership of business 11

12 12 Diversification So don t lose all assets at once Risk Reduction from Diversification (40% Correlation which is Australian average) Companies % Reduction in Diversifiable Risk 87.6% 91.6% 93.7% 99.4% 100% Get good diversification with as few as 10 assets (87% risk reduction) 15 to 20 assets provides more diversification for risk averse investors Only 4% to 6% extra risk reduction Will & Monica will invest 2/3 rds of their Super Fund in one investment Is this good diversification? [ Yes or No ]

13 Australian Investment Returns $1,000 Original Investment Shares Property Bonds Bank Bills Inflation 31/12/2014 Value (Nominal) $47,572 $34,681 $23,781 $18,158 $4,286 31/12/2014 Value (Real) $11,099 $ 8,091 $ 5,548 $ 4,236 $1,000 Annual Nominal Return 11.67% 10.66% 9.48% 8.64% 4.25% Annual Real Return 7.12% 6.16% 5.02% 4.21% 0.00%

14 Australian Portfolio Growth (Total Return) 14 $50,000 $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 Shares Property Bonds Bank Bills Inflation

15 Australian Investment Returns Long Term 20 Years Year Returns Shares Property Bonds Bank Bills Inflation Average 788.1% 651.4% 555.4% 363.7% 99.9% Std Devn 38.8% 78.5% 42.9% 47.3% 19.4% Average/Std Devn Worst 20 Years 465.6% 235.9% 272.9% 183.1% 177.7% Best 20 Years 1,363.0% 1,347.3% 1,029.2% 768.7% 64.4% 31/12/2014 Value ($1,000 invested on 31/12/1979) $47,572 $34,681 $23,781 $18,158 $4,286

16 Australian Investment Returns Long Term Real 20 Years 20 Year Real Returns Shares Property Bonds Bank Bills Inflation Average 344.3% 275.9% 227.9% 132.0% 99.9% Std Devn 23.3% 54.9% 23.1% 24.3% 19.4% Average/Std Devn Probability < 220% (6.00% p.a.) 0.00% 15.4% 36.6% 99.99% Worst 20 Years 218.5% 100.7% 117.7% 66.6% 177.7% Best 20 Years 491.3% 533.3% 353.1% 212.8% 64.4% 16 31/12/2014 Real Value $1,000 invested on 31/12/1979 $11,099 $ 8,091 $ 5,548 $ 4,236 $1,000

17 17 Bonds Reality Check Bonds only perform well when interest rates are falling Capital gain is only bringing forward future earnings; not really a capital gain 10 year $1,000 bond with interest rate of 2.5% p.a. Locked in for 10 years. Market rate falls to 2.0%. Value rises to $1,045. Capital gain of $45 (4.5%) Capital gain 4.5% + interest 2.5% = 7.0% total return. Report 7.0% return for current year. Future returns lower by same amount as the capital gain (4.5%) Future returns 2.0% p.a. for next 9 years. Locked in. Total return over 10 years = 2.5% p.a. (Unchanged, just timing changed) If sell (realise the capital gain) and buy a different bond, yield still reduced to 2.0% on new bond Last 30 years of falling interest rates are best bond period ever in Aust. (Still lost to shares) Cannot be repeated, as current interest rates are extremely low and have little room for falling Next 10 Years to 2026 locked in at current low interest rates

18 18 Real Estate (Property) Reality Check Property performance is listed ASX200 property (REITs & developers) 18 entities in ASX200 most by segment (9% by number) About 5% of ASX200 by value Dominated by Westfield & Scentre (former Westfield Retail Trust) Lower return & higher risk than ASX200 (shares), while part of shares Residential property investment is worse Most own 1 property Property risk is based on many properties in many different cities Average risk is highly correlated with shares (no diversification benefit) Risk from 1 property is very high no diversification Return is lower than listed property and shares Price increases represent more investment (larger homes), not like-for-like Long-term prices rise 2% p.a. less than inflation (on like-for-like basis) Rent yield is 2% to 3% p.a. lower than commercial yield

19 Conclusions: 20 Year Performance (Nominal & Real) 1. Shares Highest return & Lowest risk (Value 37% better than 2 nd best) Only one 20 year period less than 6.0% p.a. real (220% in 20 years + inflation) Best worst 20 years. Worst 20 years much better than all alternatives. 2. Cash & Bonds More variation than shares over 20 years Lower return & higher risk (Cash Best < Shares Worst ) 3. Property Highest risk (More than double that of shares), 2 nd best return (it is equity) Worst 20 years only beats bank bills (cash) Will this be the same in the future? 19

20 20 S&P 500 (1971 to 2011) [US] S&P500 grew 17 times (7.3% p.a.) Dividend paying shares up 29.5 times (8.8% p.a.) Non-dividend paying shares up 2.0 times (1.7% p.a.) 22% of companies in S&P500 no dividends: Apple, Amazon, Dell, ebay, Google, Symantec, Yahoo Berkshire Hathaway Apple started a dividend in 2012 US has low dividend payouts (32%) & low yield (2.0%)

21 21 James Montier (2010) [US & Europe] 90% of long-term return from dividends Dividend growth: 0.94 correlation with long-term inflation (10 years) Total return (share price change + dividends): zero correlation with long-term inflation (10 years) Dividends are good long-term inflation hedge

22 Robert Arnott (2003) [US] Dividends provided most of the return 1802 to 2002 $100 became $459 million (7.97% p.a.) Without dividends $100 became $5,556 (2.03% p.a.) Inflation has a big impact: $100 became $1,804 (1.46% p.a.) Without inflation (Real returns): Total real return = 6.42% p.a. Total real dividend return = 5.82% p.a. Real dividend return = 90% of total real return 22

23 John King (2014) Australian Evidence 23 Dividends provided most of the return 1987 to 2014 (98% of return: 61% cash, 37% franking credits) [Dividend Imputation started July 1, 1987] Cash dividends are 96.6% of return if franking credits ignored Return ($) Balance Return % (p.a.) Initial Investment (30/6/1987) $ 1,000 Share price change $ 285 $ 1, % Cash dividends $ 8,067 $ 9, % Franking credits $ 4,853 $ 14, % Total (to 30/6/2014) $ 13,205 $ 14, %

24 Aust: Dividends-Payers vs No Dividend Companies ( ) 24 Dividend portfolio worth 206% more than portfolio of no dividend companies

25 In setting investment strategy: Ignore big winning outliers with low chance of repeating Risk of using averages Do not ignore bad outliers, even with low chance of repeating Outliers: What to Do? One bad outlier in a long-term strategy (10-30 years) can produce disastrous results, so must be considered Risk first always consider bad results in setting strategy Need to survive these to succeed Reward second never consider exceptionally good results in setting strategy Do not need these to succeed 25

26 Dividends are Lowest Risk Investment (1980 to 2014) Real Annual Returns Cash Dividends Bond Interest Bank Bills Inflation Average 4.54% 4.02% 4.21% 4.25% Std Devn 0.87% 2.47% 2.66% 3.03% Worst Year 2.55% 0.48% 0.15% 11.30% Best Year 6.66% 10.90% 9.84% (0.20)% Real growth (p.a.) 3.17% (4.25)% (4.25)% 0.00% 26 Dividend yields have low variation Dividends grow in real terms (i.e. Faster than inflation) Real Interest goes backwards at the rate of inflation

27 Dividends Summary Total return = Dividends + share price changes Dividends = 90% to 101% of long-term return Dividends good long-term hedge against inflation Long-term share prices move with dividends Dividend paying companies better Dividend paying companies grow more High dividend payout companies grow more Dividends are lowest risk investment It s All About The Dividends 27

28 28 King Indices (a Dividend-Based Strategy) Dividend-Based Indices (31 March 2000 to 30 June 2016) Indices which: Benchmark the performance of Australian dividend-paying companies Have consistently produced excellent performance Outperformed all fund managers over 3 years & longer Beat almost all fund managers in 2015/16

29 29 King Indices Top Performance Only King Indices performed consistently well over the past 1, 3 and 5 years King Indices beat all fund managers for past 3 and 5 years Last 5 years: King10 up 261% (29.3% p.a.), King20 up 229% (26.9% p.a.) King10 index was up 26.1% in 2015/16 Only 2 fund managers did better (out of 265) King20 index was up 23.5% in 2015/16 Only 3 fund managers did better (out of 265) ASX200 was up 0.6% in 2015/16 (Last 5 years up 43% [7.4% p.a.]) Based on Mercer Investment Surveys of 265 Australian fund managers [139 invested in Australia, 126 invested overseas]

30 30 Scoring system to be included in a King Index: Dividend growth for at least the three most recent years Low risk from: Dividend reduction Be in ASX200 Index (Largest 200), or All Ordinaries (Largest 500) Two Indices: King10 10 highest scoring companies King20 20 highest scoring companies King Indices - Scoring System Consistently beat ASX200 since inception in 2000 in all market conditions

31 31 King Indices Outperform the ASX200 (Total Return) King Indices have outperformed the market for the past 16 years (to 30 June 2016) $100,000 invested on 31 March 2000 (dividends reinvested) would have grown to: Accumulation Mode Value on 30/6/2016 Total Return Annual Return King10 Index $3,020,297 2,920% 23.3% King20 Index $2,603,984 2,504% 22.2% ASX200 Index $ 332, % 7.7% Will & Monica have 17 years to retirement ($1.5M now)

32 Portfolio Values ($100,000 invested on 31/03/2000 Cash Dividends Reinvested) $3,200, $800,000 Logarithmic scale $200,000 $50,000 King10 Index King20 Index ASX200 Index

33 King Indices Risk is 30% Less than Market Average What is the risk that the King Indices will not continue to outperform the ASX200 Index? Beta is a common measure of investment risk Average risk [or Market risk for ASX200 Index] beta = 1.00 King10 s beta is 0.70, which indicates 30% lower risk King20 s beta is 0.69, which indicates 31% lower risk 33 89% of companies had positive return 78% of companies beat market average (ASX200) King Indices are not dependent on a small number of big winners

34 Largest Stock Market Meltdown in Austn History ( ) Largest Bear Markets Mths Total Fall (Incl Divs) Price Fall Annual Total Fall (p.a.) 2007 (Nov 1) to 2009 (Mar 6) 16 (50.4)% (53.93)% (40.7)% 1973 (Jan 31) to 1974 (Sep 30) 20 (49.8)% (53.92)% (33.9)% 1987 (Sep 21) to 1987 (Nov 11) 2 (49.7)% (50.1)% (99.3)% 1929 (Feb 28) to 1931 (Aug 31) 30 (37.8)% (46.3)% (17.3)% King Indices: Fell less (33.2%), back to 25 Sept 2006 [13 mths before peak] (2 yrs 5 mths ago), and Recovered faster (15 Oct 2009: 23.5 mths since peak & 7 mths from bottom) ASX200 (11 Sept 2013: 5 yrs 10 mths since peak & 4 yrs 6 mths from bottom) ASX200 back to 3 Nov 2004 [3 yrs before peak] (4 yrs 4 mths ago) 34

35 35 GFC & Recovery ($100,000 invested on 31/10/2007 Total Return) $400,000 Logarithmic scale $200,000 King Index Recovered ASX200 Recovered $100,000 $50,000 30/06/ /06/ /06/ /06/ /06/ /06/ /06/ /06/ /06/2016 King10 Index King20 Index ASX200 Index

36 36 King10 Consistently Beat the Market (ASX200) King10 has beaten the ASX200 for every period of 2 years & longer, and for 90% of the 12 month periods Usually by more than 5.0% p.a. Probability of King10 Beating the ASX200 Index (based on history) 1 Yr 2 Yrs 3 Yrs 4 Yrs 5 Yrs Number of Periods Better than ASX % 100.0% 100.0% 100.0% 100.0% More than 2.00% p.a. better 85.3% 97.1% 100.0% 100.0% 100.0% More than 5.00% p.a. better 77.7% 86.0% 98.1% 98.6% 100.0%

37 37 King20 Consistently Beat the Market (ASX200) King20 has beaten the ASX200 for every period of 2 years & longer, and for 94% of the 12 month periods Usually by more than 5.0% p.a. Probability of King20 Beating the ASX200 Index (Based on history) 1 Yr 2 Yrs 3 Yrs 4 Yrs 5 Yrs Number of Periods Better than ASX % 100.0% 100.0% 100.0% 100.0% More than 2.00% p.a. better 88.0% 94.7% 100.0% 100.0% 100.0% More than 5.00% p.a. better 77.1% 82.6% 96.2% 99.3% 100.0%

38 King Indices Dividends are Much Higher & Grew Faster $100,000 invested on 31 March 2000, with dividends reinvested: 38 Dividends in 2000/01 Dividends in 2015/16 Growth Growth (p.a.) King10 Index $ 5,640 $ 79,773 1,314% 19.3% King20 Index $ 4,931 $ 81,843 1,559% 20.6% ASX200 Index $ 3,749 $ 15, % 9.8%

39 Annual Cash Dividends ($100,000 invested on 31/03/2000 Dividends Reinvested) 39 $128,000 $64,000 Logarithmic scale $32,000 $16,000 $8,000 $4,000 $2, / / / / / / / / / / / / / / / /16 King10 Index King20 Index ASX200 Index

40 King Indices Share Prices Grew More (Spend Dividends) 40 King Indices have outperformed the market for the past 16 years (to 30 June 2016) $100,000 invested on 31 March 2000 (dividends spent) would have grown to: Share price growth Value on 30/6/2016 Total Return Annual Return King10 Index $1,533,259 1,433% 18.3% King20 Index $1,338,245 1,238% 17.3% ASX200 Index $ 167,025 67% 3.2%

41 Portfolio Values ($100,000 invested on 31/03/2000 Cash Dividends Spent) 41 $800,000 Logarithmic scale $200,000 $50,000 King10 Index King20 Index ASX200 Index

42 King Indices Dividends are Much Higher & Grew Faster 42 $100,000 invested on 31 March 2000, with dividends spent: Dividends in 2000/01 Dividends in 2015/16 Growth Growth (p.a.) King10 Index $ 5,504 $ 41, % 14.3% King20 Index $ 4,817 $ 42, % 15.7% ASX200 Index $ 3,659 $ 7, % 5.2%

43 Annual Cash Dividends ($100,000 invested on 31/03/2000 Dividends Spent) 43 $64,000 $32,000 Logarithmic scale $16,000 $8,000 $4,000 $2, / / / / / / / / / / / / / / / /16 King10 Index King20 Index ASX200 Index

44 Portfolio Construction - Conclusions Shares only Highest long-term real returns, lowest risk Dividend share focus Provide 100% of long-term returns from shares at lowest risk Only 10 to 20 different shares needed for diversification Bonds, cash and property are highly correlated with shares, higher risk and lower returns than shares Provide no benefits in a portfolio 44

45 45 King Indices Dividend-Based Investing Massively outperforms Stock Market average Growing dividends Growing capital values Lower risk Falls less in bear markets & recovers faster Beats the best fund managers ajk.com.au

46 General Disclaimer 2016 AJK Consulting Pty Ltd (ACN ). All rights reserved. It is not possible to invest directly in an index. The King10 and King20 indices are benchmark indices which measure the performance of the constituents of each index. Past performance of an index is not a guarantee of future results. AJK Consulting Pty Ltd is not an investment advisor and makes no representation regarding the advisability of investing in any investment vehicle that seeks to track any of its indices. Inclusion of a security within an index is not a recommendation by AJK Consulting Pty Ltd to buy, sell, or hold such security, nor is it considered to be investment advice. These materials have been prepared solely for informational purposes based on information generally available to the public from sources believed to be reliable. Whilst every effort has been made to ensure the integrity of the data, AJK Consulting Pty Ltd do not guarantee the accuracy, completeness, timeliness or availability of the content. This disclaimer is subject to any requirement of the law. 46

47 Questions? 47

48 48 Thank You Best Wishes John King FCA King Indices Website: ajk.com.au (08)

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