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Before you read this post, please read my general advice disclaimer. Also, please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance on the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this post.
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Recently, someone asked me for an opinion on an article written by Stockspot on Investing in Insurance Bonds. The post they were referring to can be found here: https://blog.stockspot.com.au/investment-bonds/. Roughly a day later, I stumbled upon another site run by a FIRE member on how ‘diabolical’ investment bonds are.
So here’s my take…
Investments bonds have their pros and cons. They are great for those on >30% marginal tax rates, business owners and those in high-risk occupations, or those who don’t want to deal with annual tax statements and the effect of portfolio turnover in their yearly tax return. They also may not be the greatest for Investors who are in the lowest tax bracket.
If you look at the premise of Stockspots blog post, it’s that net investment returns are paramount over tax benefits.
You can’t not agree with this statement as it’s quite logical – the best result is the one with the highest after-tax value.
However, doing a little analysis on Stockspots article, there are a few shortcomings with how they have presented the information.
The issues I’ve identified are broken down into two points:
Asset Allocation -which takes into consideration of like for like comparison.
Taxation – how the underlying funds are tax vs an ETF portfolio.
I’ve quickly done a “poor mans” infographic based on the information in the article (see below).
Performance before/after tax
The figures used on Stockspots performance are before tax, while the unit prices used to calculate the rate of return for the Investment Bonds are after applying a 30% tax rate.
Apples to Oranges
When comparing funds, its best practice to compare “like for like” options.
In their scenario, they have compared the stockpot Topaz portfolio to the Generation Life MLC Balanced fund. There were a number of permutations that could have been picked within generation life that results in a Growth portfolio, and MLC Horizons 5 had the lowest track record.
This isn’t the case with all options analyised, for example the KeyInvest and IOOF portfolios used an 80% growth portfolio
Asset Allocation
Based on the data available on the Stockspot website, I recreated and backtested a portfolio made up of the ETFs listed in the Treemap. The portfolio is an interesting one - it’s passive in nature as each option tracks an index, however, they have an active overweight allocation to Emerging Markets (22%) compared to 10% in the iShares Global 100 portfolio.
I’ve rarely seen a portfolio with such a large exposure to gold (14%) - Ray Dalio’s All Wealth Portfolio sits at the highest I’ve seen at 7.5%. I can however appreciate that the returns of government/corporate bonds are pretty poor, and gold does play a great inflationary hedge.
From experience, most fund managers would not have such a large percentage in Emerging markets especially considering that North America (U.S. and Canada) makes up 70% of the World index by market capitalisation. Interestingly the 5-year performance of the Ishares Global 100 outperformed the other options in the portfolio (next chart)
They’re not wrong – MLCs performance sucks
The blue line is my recreation of the ETFs used in the Stockpot Topaz portfolio. The green line is the MLC Horizons 5 Portfolio held within Generation life
The Topaz portfolio smashed the performance of the MLC Fund. Keep in mind the performance reported for Topaz does not include any income tax or capital gain tax events. The MLC fund held within Generation Life however have built in their tax provisions into graph..
Investment Choices matter
If you invested in the MSCI World Index through Generation life (top 1500 companies worldwide ex Australia) which is represented by the Vanguard International Share fund held within an Investment bond you would have outperformed the Topaz portfolio. Keep in mind I have not factored in CGT/income tax into the Topaz portfolio, while the investment bond returns are reported on an after-tax basis.
‘Apples to Apples’ comparison
In this graph, I have modelled a Vanguard 80/20 portfolio vs Stockspots Topaz portfolio. Both portfolios are on an after fee before tax basis. To create the scenario, the Vanguard 80/20 portfolio holds:
50% Vanguard Growth Index Fund (which is a 70/30 fund)
50% Vanguard High Growth Fund (which is a 90/10 fund)
As you can see, based on the headline rate, you would be better off in this Vanguard portfolio over Stockspots Topaz.
As an FYI, I am not recommending either portfolio, I’m simply presenting it for illustrative purposes only.