Investing is a broad subject with lots of different things to learn.

To help simplify tricky questions and clear away confusion, we’re running an ongoing Q&A series. Hopefully these little discussions provide you with helpful insights to further your thinking as you progress towards your goals :)

Just so you know, in many cases there’s often not a ‘right’ answer, so be sure to think carefully how to adapt any information to your own circumstances. None of the below is tax advice, or fund suggestions, or anything else but an open dialogue and general thoughts.

If you have a burning question you’d like answered, feel free to leave it in the comments below, or post it on the Pearler Exchange.

In this Q&A session, we’re tackling:

• Could the US or China cause economic collapse?
• How tax cuts impact franking credits
• Ways to use $50,000
• Global shares and retirement income
• Overseas domiciled funds and ‘tax drag’

Let’s get stuck into it.

Could the US or China cause a broad economic collapse?

I get this question in various flavours every few months or so.

The details change, but the general theme is always the same: could what’s happening overseas derail the local economy? Short answer: yes.

Those asking are typically feeling nervous and anxious about the future prospects of their investments. This is totally natural. Things are always uncertain, whether it appears that way or not.

Risks are everywhere, and we can never be sure which risks will eventuate, and which won’t. Regardless of what’s going on, there are always stories about why global issues will cause major problems for the economy and markets.

Sometimes that’s true, and sometimes it’s not. I listen to these stories too. The difference is, it doesn’t affect how I invest. Why? Because the risks are endless and the outcomes are unknowable. If I let news stories and world events dictate whether I invest or not, I would’ve been in cash for the last 15 years.

At the end of the day, I'm a long-term accumulator of assets. That doesn’t change. The only thing that changes are the prices. If prices fall because of global problems, I'll buy more if I can. My simple equation is more shares = more dividend income. The more I buy, the higher my investment income grows.

Others may wish to take a more cautious approach. Over the long run, regularly buying is typically the most effective strategy, despite all the meltdowns, wars, etc, that have happened in the past.

Investing is uncertain because life is uncertain. There’s no escaping it. Once we accept that, we’re better able to deal with the inevitable hiccups and crises along the way.

Remember, our long-term goals don’t rely on a smooth drama-free scenario. We’re reliant on the world continuing to become more productive, find ways to innovate, and become more prosperous as a species over time. That’s the real bet we’re making – the stock market is just an outcome of that.

How do tax cuts impact franking credits?

I recently got this email from a reader, and I imagine there’s a few people wondering the same thing:

“With the new tax rates due to the Stage 3 tax cuts from 1st July 2024, the main tax bracket for something like 90% of income earners will be 30c in the dollar. Seeing as this is the same as the corporate tax rate, the tax paid on dividend income by the individual would be the same as the tax paid by the company providing the dividend. Would this then make the franking % irrelevant?”

Interesting question.

Firstly, let’s remember that franking credits are based on company taxes. The incoming tax cuts are for our personal tax rates only.

What essentially happens under all circumstances (and all franking percentages) is you'll pay less tax overall.

Currently, anyone paying more than 30% in tax has to pay some out-of-pocket tax to cover the difference between franking and their personal tax rate (assuming a fully franked dividend). But on a 30% personal tax rate, franking credits will cover the entirety of the tax owing.

It also means a much higher level of dividend income can be earned in retirement before any out of pocket tax will be payable. The franking credits received will essentially stretch further. It may also result in greater franking credit refunds in certain cases because there’ll be more franking ‘leftover’ depending on one’s income.

I’ve got $50k and am overwhelmed by the options of what to do with it…

Firstly, excellent job coming into the possession of such a nice chunk of money!

It’s understandable that you’d be a bit flummoxed by the options, since there are quite a few things you could put it towards:

– House deposit
– Investment property deposit
– Share portfolio
– Paying down a mortgage
– Paying down HECS or other debt
– Super
– High-interest savings account
– Taking a year off
– Starting a business
– Car upgrade, holidays, etc
That’s certainly a bigger list than I thought it would be! In fact, this topic could be an entire article in itself.

Now, most of us will automatically cross off a bunch of those since they might not be applicable, but it’s a hefty list nonetheless.

The answer comes down to your priorities. Is it owning a property? Is it building a share portfolio? What’s your risk tolerance? Are you looking to get rid of some debt, or would you rather own more assets? Do you want to keep access to the money, or do you want to optimise for tax and long-term wealth? Are you craving a long break from work while you recalibrate your life and then rejoin the workforce or start a business?

There are endless variables at play here. Sit down this weekend and think about what’s most important to you. You could always split up the money and allocate it to multiple goals – it doesn’t have to be one or the other.

So make that decision, then get to work on your next $50k ;)

Global shares pay low dividends. How can I make it work for retirement?

It’s true, global shares tend to have lower dividend yields than Aussie shares. The return profile is more skewed towards capital growth. In real terms, the difference is 2-3% per year vs 5-6% per year (including franking), so it’s quite significant.

Does this mean global shares are a bad fit for a retiree's portfolio? Well, no. Most Aussies will typically invest in local shares too, so it’s not as if the whole portfolio will only pay 2% per year in dividends.

In fact, when you blend global and Aussie shares together (for example, 50/50), it results in a portfolio dividend yield of 4% (with franking). So that’s pretty good already. If the preference is for a more global portfolio, then there’s the option of harvesting some of the growth by selling a few shares each year.

This also helps keep the portfolio to its desired split, whether 50/50 or something else entirely. Because if left alone, global shares would keep growing faster than the Aussie shares (given their likely growth profiles described above). So over time it would grow to an outsized position in the portfolio.

So you can also see capital growth as another form of return you can tap into. Of course, you want the portfolio to keep up with inflation. But if you have a higher growth asset, harvesting some capital growth can be done while still keeping the portfolio ahead of inflation.

Selling a few shares not only provides an extra source of cash, but it keeps the portfolio in balance. And remember, share prices will grow over time, meaning fewer shares to be sold to get the same number of dollars. I’ll explore retirement income more in a future article. In the meantime, I wrote about finding your ideal Aussie/Global split in the following article: What’s the right amount to invest in Aussie shares?

I also talk about how I got over my hangup about selling shares for income here: My Latest Thoughts on Dividends and Diversification.

Do ETFs which are domiciled in Australia but hold non-Australian assets have tax drag?

“For example, since IVV holds US assets, does that result in tax drag for us Australians?”

This is a complex topic that is nuanced and multi-layered. I’ll do my best to summarise some of the key points you should be aware of.

Tax drag refers to a loss in returns due to taxes being taken out of an investor’s return. This sounds scary and can happen under certain circumstances, but for Aussie investors, it only affects a handful of funds.

So what’s it all about? Basically, an ETF which is not domiciled in Australia, or an ETF which is domiciled in Australia that invests in funds which are domiciled in the US (like DHHF for example), can experience slightly different tax outcomes.

In simple terms for Aussie investors, that typically means US domiciled funds which own non-US shares. To the original question, the short answer is no, IVV should not experience tax drag. In practice, a fund which is affected is VEU. Some tax is withheld from the dividends of European + Emerging +Market companies before it’s passed onto the US fund owning those shares. In turn, that reduces the return for investors of those US domiciled funds.

If a fund operates from here and invests directly in overseas shares (VGS, BGBL, VGE are other examples), that’ll mean no tax drag.

The secondary tax issue with overseas domiciled funds is the possible exposure to US estate taxes. Take a fund like VTS, which we can invest in from Australia, even though it is domiciled in the US. Because the fund is domiciled in the US, it can create estate tax issues for individuals outside the US who hold this fund (an Aussie domiciled alternative would be IVV as the questioner mentioned).

If you want to dive deeper into this topic I highly recommend you read this article , which delves into the nuances of how this all works and why.

The more I look into things like this, the more I’d like to avoid any sort of complications and overanalysis. It’s all pretty confusing to be honest, but at least there are options to choose from which avoid these issues.

By the way, when trying to figure this out, it’s best to go to the specific ETF provider’s website and look at the ETF info page and it should say on there somewhere whether the fund is domiciled in Australia. And if the fund owns ETFs, you can Google those separately to find out more.

Final thoughts

I hope you enjoyed this Q&A session, and these answers gave you food for thought.

Remember, if you have a question on a topic you’d like some more information on, feel free to post it on the Pearler Exchange. They’ll be answered by fellow investors in the community – like myself, someone more knowledgeable, or one of the Pearler team.

You can also post a question down in the comments selection and we’ll cover it in a future Q&A article.

Until next time, happy long-term investing!

Dave