And most recently, this small tropic paradise is gaining a new reputation as a “tax haven.” But does this island chain deserve that title?

we review the laws, political stability, economic climate, available legal entities, the tax situation, financial privacy rules, and the overall financial reputation of a jurisdiction. (Our top favorites remain Switzerland, Panama, Liechtenstein, and Hong Kong.)

For almost 40 years, Vanuatu certainly has been known to some as a tax haven. That explains why so many accountants, bankers, and lawyers are clustered in this small island nation.

But the archipelago’s reputation as an offshore financial center has been highly questionable, to say the least.

In 2000, the Asia-Pacific Group on Money-Laundering claimed the Russian mafia was laundering billions of dollars through offshore banking systems in the Pacific, including Vanuatu. There are about 2,000 registered institutions offering a wide range of offshore banking, investment, legal, accounting, and insurance and trust company services. Vanuatu also maintains an international shipping register in New York City.

In an unprecedented action in December 1999, a group of leading international bankers, pressured by the U.S., placed a ban on U.S. dollar denominated transactions involving three Pacific island nations - Nauru, Palau, and Vanuatu. The bankers accused them of laundering money for the Russian mafia and the South American drug cartels. At the time Vanuatu had 63 licensed offshore banks.

These bankers put a banking ban on these three countries because they were concerned about a report issued by the OECD’s Financial Action Task Force. The report called Vanuatu a “jurisdiction of prime concern” for money laundering because of these same mafia and drug cartel concerns.

Perhaps this small country is eager to distance itself from this past history, because the Vanuatu Government now welcomes outside investment to help develop their country.

The lack of income tax, capital gains tax, death and estate tax is an obvious attraction for outside investors. Plus, the country has no exchange controls. In 2002, following increasing international concern over money laundering, Vanuatu increased oversight and reporting requirements for its offshore sector.

But it was not until 2008 that Vanuatu agreed to release account information to other governments or law enforcement agencies. International pressure, mainly from Australian tax collectors, influenced the Vanuatu government to move to increased transparency.

Tax police raids in Australia this year have spurred a debate on whether Vanuatu will remain a tax-free haven.

Bottom line: We don’t recommended Vanuatu as an appropriate offshore financial haven, because of the history and other reasons stated above. But we also steer clear of this haven because it has a less developed offshore professional sector than other havens. Also, the government is not stable at all.

We wish the Vanuatu islanders well, and we remain open to change our current opinion. But in the meantime, there are too many other well-established offshore financial centers to choose from that deserve more serious consideration.

“Tax havens” are defined as financially attractive jurisdictions that impose low or no taxes. They also typically roll out the welcome mat for foreigners willing to invest, bank or do business there.

With all the pressure put on European tax havens such as Liechtenstein in recent years, , some folks seem to be looking for alternative havens - especially the ones you might call the “far-out tax havens.” Perhaps these adventuresome folks think they can run and hide, but my advice is to be very careful where you go.

For instance, in the last few months I’ve received several inquiries about the Republic of Vanuatu. My readers want to know if it could be a good place for their offshore banking, asset protection plans and estate planning.

I can hear you now — where in the world is Vanuatu? — assuming it is in this world.

Vanuatu is a tropical archipelago group of 80 islands (about 65 of them inhabited). These islands cover 12,200 sq km (slightly larger than Connecticut) in the South Pacific Ocean, about three-quarters of the way between Hawaii and Australia.

The capital city is Port-Vila (on the island of Efate). Some 215,446 people live there, split between English and French speakers.

The different languages reflect Vanuatu’s colonial heritage when it was known as The New Hebrides. Multiple waves of colonists migrated to the New Hebrides in the millennia preceding European exploration in the 18th century. The British and French, who settled there in the 19th century, agreed in 1906 to an Anglo-French Condominium, which administered the islands until independence in 1980. At that time, the new Republic of Vanuatu was born.

At its height, about 12,000 expatriates lived in the islands. But after Vanuatu declared its independence, only people of Vanuatu could own land there. Therefore the mainly French and British expat community shrank to less than 3000.

Today, the expat population is about 8000 and growing, with heavily taxed Australians and New Zealanders in particular finding the island’s lifestyle — and lack of taxes — to their liking.

The vast majority of consumers see “inflation” as what we’re paying for groceries, gas, a Starbucks coffee, and electricity.

Yes, it’s true that rising prices for these necessities has been the poster child for inflation lately. But there’s much more to inflation than just forking over more at the gas station or coffeehouse.

When it comes to Europe, wage push inflation plays a crucial role.

Producers Pass the Inflation Buck

the Consumer

Producer prices are simply the costs required to produce goods and services. Naturally, when producers have to pay higher costs to produce goods, they’ll demand higher prices for the goods they’re selling. In other words, they pass their higher costs to you, the buyer.

Rising commodity prices tend to be a big reason why producers’ costs rise. More money spent in production means smaller profit margins at current prices. If a producer wants to make up for shrinking profit margins but can’t control his input costs, then he must pass on these costs in the form of higher prices. Excess money creation is what drives this type of inflation, affording higher prices.

No doubt, this is exactly why rising energy costs have been such a huge driver of the inflationary environment we’ve trudged through over the last several months.

The debate is heating up among whether this global inflationary period is coming to an end. I tend to believe it is. But, more importantly, economic growth and available credit across the globe is rolling over at the same time surging commodities have left inflation concerns on everyone’s mind.

For this reason central bank policy makers are struggling.

The cost of energy has buoyed the cost for producers, consumers, and everyone in between. But what happens when this pressure eases for a considerable stretch of time?

Inflation Is a Little Bit Different on the Other Side of the Pond

They don’t serve ice cubes in their drinks. They can drive on the left-hand side of the road. And inflation is also a little bit different in Europe. Despite this fact, inflation analysis in these respective regions often focuses on generalities and overlooks one particular difference. Let me explain…

Let’s focus only on two countries and two central banks: The Federal Reserve and the European Central Bank. If you haven’t been hiding under a rock for the last year, then you probably have some kind of idea how their respective policies vary.

The Federal Reserve has knocked off more than 3% from its benchmark interest rate in the last year. In that same time, the European Central Bank has mostly stood its ground, mixing in one rate hike of 25 basis points that brought its benchmark up to 4.25%.

And if you’ve been following my currency articles lately, you also probably know that this monetary policy discrepancy has been a boon to the euro, and a detriment to the buck. For many months, even years now, the relative performance of each currency has been primarily based upon expectations for this rate differential to change.

As you might imagine, inflation expectations play an enormous role in monetary policy expectations. Even though inflation has received plenty of attention over the last several months, many analysts have neglected an important difference between European inflation and U.S. inflation.

Now’s the time to pay closer attention.

What All the Analysts Have Missed Over the Last Few Months

In the last few weeks, commodity prices (particularly crude oil) have cracked. With that abrupt downturn also came a reprieve in inflation expectations. And that’s got many accepting the potential for a lasting shift towards even lower prices and less inflation pressure.

With that in mind, the dollar has managed to rally on two simple facts:

1. The U.S. Federal Reserve has already lopped off a considerable portion of its benchmark interest rate. So they’re now ahead of the rate-cut curve, which has helped maintain some growth in the U.S. relative to Europe.

2. The European Central Bank will be forced to bailout their deteriorating economy by cutting their benchmark interest rate.

Up until this point, the European Central Bank had a good reason to keep fighting inflation. But with commodity prices easing up, now may be the time for ECB policy makers to take action. Here’s why they’ve struggled…

Why Hasn’t the ECB Joined the Worldwide Rate Cutting Party Yet?

With many threats to global growth and concerns over several Eurozone member countries, many have been surprised the ECB has gone so long without letting up on the interest rate front. After all…

• The Federal Reserve has made several moves to lower rates
• The Bank of Canada has followed suit
• The Bank of England has gotten the ball rolling
• So has the Reserve Bank of New Zealand
• The Reserve Bank of Australia is likely next

If you’re wondering why the ECB hasn’t budged, look no further than labor unions. Simply put: Wage contracts put in place via labor unions have employees’ wages moving higher in lock-step with inflation.

There’s really no thought to profitability (the point when workers typically consider demanding higher wages). In other words, rising headline inflation fuels this wage-spiral. And this wage-spiral spurs greater headline inflation. And it continues on like this. That’s something Ben Bernanke hasn’t had to deal with.

You see, the Fed has been able to react to weakening growth by cutting interest rates. The plan: As growth moderates, or rolls over, inflation is likely to follow. But that assumption is more difficult to make when you’ve got rising wages keeping prices unnaturally high. The ECB hasn’t yet been able to make that assumption. Its interest rates remain high.
But here’s what you should expect…

When the ECB finally decides to cut rates, they will do so substantially and they will do so quickly. It will be their way of reloading. Because we know, with the labor unions continually eroding profit margins and forcing prices higher, the ECB will need some fire power for their next inflation shoot-out.

If they cut back rates now, they’ll be able to hike rates and combat inflation when the time comes again. All you need to do is be prepared to act accordingly.

Professional gamblers have long claimed that there are two basic position-sizing strategies - martingale and anti-martingale. Martingale strategies increase one’s bet size when equity decreases (during a losing streak). Anti-martingale strategies, on the other hand, increase one’s bet size during winning streaks or when one’s equity increases.

If you’ve ever played roulette or craps, the purest form of martingale strategy might have occurred to you. It simply amounts to doubling your bet size when you lose. For example, if you lose $1, you bet $2. If you lose $2 then you bet $4. If you lose $4, you bet $8. When you finally win, which you will eventually do, you will be ahead by your original bet size.

Casinos love people who play such martingale strategies. First, any game of chance will have losing streaks. And when the probability of winning is less than 50 percent, the losing streaks could be quite significant. Let’s assume that you have a streak of 10 consecutive losses. If you had started betting $1, then you will have lost $2,047 over the streak. You will now be betting $2048 to get your original dollar back. Thus, your win-loss ratio at this point - for less than a 50:50 bet - is 1 to 4,095. You will be risking over $4,000 to get $1 in profits. And to make matters worst, since some people might have unlimited bankrolls, the casinos have betting limits. At a table that allows a minimum bet of $1, you probably couldn’t risk more than $100. As a result, martingale betting strategies generally do not work - in the casinos or in the market.

If your risk continues to increase during a losing streak, you will eventually have abig enough streak to cause you to go bankrupt. And even if your bankroll was unlimited, you would be commiting yourself to risk-to-reward strategies that no human being could tolerate psychologically.

Anti-martingale strategies, which call for larger risk during a winning streak, do work - both in gambling arena and in the investment arena. Smart gamblers know to increase their bets, within certain limits, when they are winning. And the same is true for trading or investing. Position-sizing systems that work call for you to increase your position size when you make money. That holds for gambling, for trading, and for investing.

The purpose of postion-sizing is to tell you how many units (shares or contracts) you going to put on, given the size of your account. For example, a position-sizing decision might be that you don’t have enough money to put on any positions because the risk is too big. It allows you to determine your reward and risk characteristics by determining how many units you will risk on a given trade and in each trade in a portfolio. It also helps you equalize you trade exposure in the elements in your portfolio.

Some people believe they are “doing an adequate job of position sizing” by having a “money management stop.” Such a stop would be one in which you get out of your position when you lose a predetermined amount of money - say $1,000. However, this kind of stop does not tell you “how much” or “how many,” so it really as nothing to do with position sizing. Controlling risk by determining the amount of loss if you are stopped out is not the same as controlling risk through a position-sizing model that determines “how many” or if you can even afford to hold one position at all.

1. Develop Consistency - You can create a mindset of consistency by developing beliefs that support you in obtaining this result. In order to develop consistency, there are a number of things, which you must do, including identifying your edges, defining the risk in each trade in advance, and accepting the risk to be able to exit a position when a defined loss level is realized. These and key mindsets help traders work through the issues they face in taking a trade, making the trade and executing their exit from the trade

2. Trading is a Probability Game - You can’t be a perfectionist and expect to be a great trader. Your losses (that you hope will return to breakeven) will kill you

3. Jumping In Too Soon or Getting In Too Late - These mistakes come from traders not having a well-defined plan of how they will enter the market. This positions the trader as a reactive trader instead of a proactive trader, which increase the level of emotion the trader will feel in reacting to market movements. A written plan helps make a trader more systematic and objective, and reduces the risk that emotions will cause the trader to deviate from his plan.

4. Not taking profits on winners and Letting winners turn to losers - Again this is a function of not having a properly thought-out plan. Entries are easy but exits are hard. You must have a plan for how you will exit the market, both on your winners and your losers. Then your job as a trader becomes to execute your plan precisely.

5. Great traders don’t place their own expectations on to the market’s behaviour, whereas poor traders expect the market to give them something. The market does not know who you are and owes you nothing. Period. When conditions change, a smart trader will recognize that, and take what the market gives.

6. Emotional pain comes from expectations not being realized - When you expect something, and it doesn’t deliver as expected, what occurs? Disappointment. By not having expectations of the market, you are not setting yourself up for this inner turmoil. The market doesn’t generate pain or pleasure inherently; the market only generates upticks and downticks. It is how you perceive and respond to these upticks and downticks that determine how you feel. This perception and feeling is a function of your beliefs. If you’re still feeling pain when taking a loss according to your plan, you are still experiencing a belief that your loss is somehow a negative reflection on you personally.

7. The Four Major Fears

• Fear of Losing Money
• Being Wrong
• Missing Out
• Leaving Money on the Table

All of these fears result from thinking you know what will happen next. Your trading plan must approach trading as a probabilities game, where you know in advance you will win some and lose some, but that the odds will be in your favor over time. If you approach trading thinking that you can’t take a loss, then take three losses in a row (which is to be expected in most trading methods), you will be emotionally devastated and will give up on your plan.

The government’s heroic plan this year has been to bailout the banks, brokers, speculators and sub-prime lenders with your money.

But who will save the savers? In other words, who will save you? They say the FDIC will be there to insure you in case the worst should happen. But what if your account balance is over the $100,000 FDIC insurance limit?

What do you do then? Answer: We’ve discovered a masterful solution to protect your savings, even if your personal or business account is worth up to US$50 million (yes, million).

I’ll explain how in just moment, but first: Do you know what you’re up against?

An Even Bigger Crisis Than the S&L

So far this year, eight banks have collapsed. At first blush, eight banks failing doesn’t sound quite as bad if you consider 834 banks went under during the S&L crisis from 1990 to 1992.

But if you want to know the real extent of this crisis, you need to look at the bottom line. Worldwide, the credit crisis has already cost US$476 billion in losses, write-downs etc.

Seventeen years ago, the Savings and Loan Crisis cost the global economy US$190 billion (or US$350 billion in inflation-adjusted dollars).

The Federal government already bailed out Bear Stearns Cos, Fannie Mae, and Freddie Mac this year to stop a systemic risk, but at a massive cost to taxpayers.

On top of that, the government’s actions did nothing to fix the credit crisis, which is still the big looming threat to all the other smaller banks and mortgage lenders that aren’t getting bailed out.

The Federal Reserve won’t dirty its hands or spend the money to bailout smaller lenders.
That means it’s going to be a long, painful recovery for the banks going forward. And a few banks won’t make it.

Take IndyMac for example…

When IndyMac’s clients got word that the bank was in trouble in early July, thousands of concerned depositors pulled their cash out of the bank to salvage as much as they could.
All totaled, depositors walked away with US$1.3 billion in 11 days.

That’s when the FDIC stepped in and shut IndyMac’s doors for good.

And the remaining IndyMac clients had to depend on the FDIC to recover their deposits - assuming their accounts were fully insured.

What Good Is FDIC Insurance in the 21st Century?

As I said, when a bank fails, the FDIC accountants swoop in to tally the books.

The FDIC agents officially close the bank. They freeze the accounts at the bank. Then they begin the long painful process to determine exactly which funds are insured or not.

In the meantime, if the FDIC is dismantling your bank, you’re stuck waiting to recoup what you lost. You can’t write checks. You can’t pay bills. You can’t use your debit card. You can’t even go to the grocery store to buy food unless you have cash lying around.

Technically the FDIC insures every account up to US$100,000, and every retirement account up to US$250,000. But the devil is in the details. It’s generally US$100,000 per holder of account.

So for example, if you and your spouse have a joint savings account, you could hold up to US$200,000 in a single account. Then in theory, if your bank failed, you would recoup your entire account.

But these limits get dicey when you’re talking about trusts, annuities and other accounts - depending on how the account is titled. (Get the full rules here.)

In IndyMac’s case, a whopping US$1 billion of the US$19 billion deposits was uninsured. According to FDIC, US$2.6 TRILLION is currently uninsured in the United States.

So the question is: What do you do if your accounts are simply too big for the FDIC to insure?

A Masterful Solution to This FDIC Insurance Problem

For years, we’ve recommended you seek refuge from possible bank failures by diversifying your holdings.

For example, you can hold up to US$100,000 at several U.S. banks, or invest your long-term safe funds in a bank account overseas where liquidity is much higher. And in our recommended jurisdictions, there hasn’t been a bank failure in over 125 years.

But now, we’ve discovered another unique solution.

Our friends at EverBank have devised a new “Insured Advantage Certificate of Deposit,” that protects your capital up to US$50 MILLION. You can literally park your funds in this CD and the FDIC will insure you up to US$50 million no matter what happens.
You can open this CD for yourself, your business, your non-for-profit organization, etc.

Also, you don’t have to hold this CD for years (unless you want to) for it to mature. You can hold this CD for as little as three months.

Plus, your funds receive high yields at the same time. EverBank is able to do this by spreading the risk out among many banks, to ensure your money is fully protected.

Please take a moment to review the balances and the title on your U.S. bank accounts. Make sure that you don’t exceed the FDIC limits in a climate like this. And, if you discover you do, find the time to find the right solution for you and your family.

The best time to do it is now before the next bank goes bust and takes your savings along with it.

Are You an Investor, a Speculator or a Gambler?

What exactly is an Investor, a Speculator or a Gambler in the context of the Stock Exchange Market or for that matter, any markets?

The Public as well as the Media have often loosely and interchangeably used these three terms. Comparisons are often made between their activities, but the terms are never explicitly defined.

You might ask if there is a need to be distinct on these terms. Well, there is definitely such a need simply because, if you want to profit from the market consistently, it is crucial to first, know who you are and how you are going to participate in the market. In fact, the mindset and methods employed by an investor, speculator or gambler differs extensively and greatly affect the profitability of participating in the market. How perilous it is to venture into the markets blindly!

The Public often called themselves Investors, perhaps, influenced by the Media. But how many of them are really Investors or even Speculators. Think about it, many of the self- acclaim Investors are actually habitual Gamblers, betting on the market on the slightest rumours, insider news, company news or fluctuations, hoping to get rich quick by chance. This is not a debate on whether gambling is good or bad, but if you’re going to gamble; don’t you think you have a better chance at the Casino, which is there for this purpose?

So, what are the differences between an Investor, Speculator and Gambler? In order to differentiate between them, we should start by defining them. If you’re sufficiently motivated, I encourage you to try to define the terms ’speculating’, ‘gambling’ and ‘investing’ before you continue reading this article… you may surprise yourself.

Consider the following.

Investor

An investor is an individual whose primary concerns in the purchase of a security are regular dividend income, safety of the original investment, and if possible, capital appreciation.

A person whose principal concern in the purchase of a security is the minimizing of risk, compared to the speculator who is prepared to accept calculated risk in the hope of making better-than-average profits, or the “gambler” who is prepared to take even greater risks.

In 1934, Graham and David Dodd addressed the issue and offered a definition of “investment” in their classic text book Security Analysis

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return.
Operations not meeting these requirements are speculative.”
- Graham and Dodd’s Security Analysis (original 1934 edition)

Speculator

Speculation is the buying, holding, and selling of stocks, commodities, futures, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income - dividends, rent etc.

A speculator is one who is prepared to accept calculated risks in the marketplace for attractive potential returns.

Speculation: The activity of forecasting the psychology of the market.
Speculative motive: The object of securing profit from knowing better than the market what the future will bring forth.
John Maynard Keynes in The General Theory of Employment, Interest, and Money

Gambler

Gambling (or betting) is any behaviour involving the risk of money or valuables on the outcome of a game, contest, or other event in which the outcome of that activity is partially or totally dependent upon chance or on one’s ability to do something.

“A gamble is the assumption of risk for no purpose but enjoyment of the risk itself, whereas speculation is undertaken in spite of the risk involved because one perceives a favorable risk-return trade-off. To turn a gamble into a speculative prospect requires an adequate risk premium for compensation to risk-averse investors for the risks that they bear.”
- Investments by Zvi Bodie, Alex Kane, and Alan J. Marcus

Regardless of how you define the terms, it is likely to be a worthwhile activity to estimate your expected returns on both an absolute basis as well as relative to an appropriate benchmark. And if you find yourself enjoying the activity of investing or if you find yourself addicted to the speed and excitement of the trading game, perhaps you should seriously consider whether you’ve crossed the line between investing and speculation, or worse yet, maybe you are really gambling with your money.

I meet many newbie currency traders who want to become day traders. But just like many people would love to race cars or model professionally, you need certain prerequisites to be a day trader.

Day traders are also strictly technical traders. They love charts. That’s because there’s really nothing fundamentally that moves currencies over 30 minutes to an hour or so periods. It takes time for fundamentals to affect currencies. And time is exactly what day traders DON’T have. So they’re all about the indicators, short-term timeframe charts like the five minute and 15 minute timeframes.

Day traders may trade fundamental news announcements but they’re only looking for the short-term pops that react to the news. They’re not looking for news items that will affect the long-term fundamentals of a currency.

You have to know that when you enter into the day trading arena. That takes incredible skill, and not everyone can learn to do it. In fact, most people can’t. However, if that’s your long-term ambitions, it doesn’t mean you can’t go for it. But I compare it to becoming a pro athlete, rock star or professional actor. People jump into those amazing careers everyday, even if it’s not a huge amount of the population.

If you want to hop into the arena with the day traders, please take my advice — only use capital that you can afford to lose.

Otherwise, follow the intermediate to long-term trends in the foreign-exchange market. Leave the day trading to the professionals…who don’t have another day job.

CFD’s - one of the most publicised and talked about trading instruments to hit the Australian retail investment scene in quite some time. We have put together this little introductory page to ensure that you understand the basics of these highly leveraged, highly risky products.

What are CFD’s?
A contract for difference (CFD) is fundamentally an agreement between two parties, where one of those parties pays to the other, an amount of money based on the price movement in a security. However neither party has any obligation to acquire or deliver the actual underlying security. This transaction simply comprises the parties settling the difference between the purchase price and the sale price.

People trade in CFDs for various reasons, such as speculation. For example, share CFD traders may be investors wanting to profit from intra-day or overnight, or longer-term market movements in the underlying shares.

Some people trade share CFDs to hedge their exposures to the underlying shares. In this way CFDs become a risk management tool, allowing holders of underlying shares to lock in an effective sale price for those he shares by taking a “short” CFD position. If the price of the underlying shares held by the investor falls, the “short CFD positions” will wholly or partly offset the losses incurred on the actual shares held.

How It Works
You can take a “long” or “short” leveraged position – all you do is simply provide a cash deposit (known as the initial margin) as collateral. Each business day, the position is marked-to-market, with the consequential payments being made between the parties. Although a CFD replicates the price movement of the underlying instrument or security, you have no right or obligation to acquire or deliver the instrument or security itself and do not entitle you to any voting rights.

You can take both “long” (buy) and “short” (sell) CFD positions to open positions. If you take a long position, you profit from a rise in the underlying instrument or securities price, and you lose if the underlying instrument or securities price falls. Conversely, if you take a short position, you profit from a fall in the underlying instrument or securities price, and lose if the underlying instrument or securities price rises.

The volume of CFDs you can short in a single day may be limited due to limited borrowing availability in the underlying market.  And when short selling CFDs, you may experience forced closure of a position if your CFD gets recalled.

Large Upside BUT Big Downside!
CFDs can be a very highly leveraged play, enabling users to outlay a relatively small amount (in the form of initial margin) to secure exposure to the underlying share. As always with leverage, it can work against you as well as for you - large losses as well as large gains are always possibilities…

So you can buy 10,000 of shares in a company at $1.00 and pay your broker $10,000 (plus costs), or you can buy the company CFD and use an Initial Margin of $1,000 (plus costs). For the experienced investor, this leverage can provide a cost effective means of profiting from the performance of the underlying shares (if it does actually perform of course) without buying the actual share.

Let’s start at the beginning, by addressing the fundamental question…‘what is a derivative?‘

Derivatives are financial instruments that derive their value from an underlying instrument (such as shares, share price indices, fixed interest securities, commodities, currencies etc). Some examples of derivatives are warrants, futures and exchange- traded options.

The purpose of derivatives is to provide a means of accessing and trading in the value of the underlying financial instrument (on which the derivative is based), without having to put up the capital for the full value of that underlying instrument.

Derivatives are usually only offered on the top 20 to 50 stocks in the equity market, and there are often liquidity (and other) constraints.

‘Derivatives’ is a term that often confuses and as such, many people perceive them to be extremely risky. But then investing in anything is risky for some people because they do not understand the markets, or because they are sometimes foolish, or because they are totally risk averse.

As we have said many times before, life and investing per se are always risky, and risks vary from the minimal to the ridiculous.

Let’s stick to the facts.
Derivative instruments are usually riskier in nature than investing in the underlying instruments themselves, but the quid pro quo is that the returns on money invested may be higher. You do need to know what you are doing in the derivatives market. However, with a clear and defined strategy, derivative trading can be an integral part of a successful portfolio.

Why use Derivatives?
Often perceived as advanced instruments traded only by professionals, derivatives are also traded by retail investors. Equity derivatives such as warrants and options, offer the opportunity to earn extra income from shares, or to protect the value of existing shareholdings. Investors can also use derivative products to hedge their portfolios, gain broader exposure to the market, or even speculate by using the leverage opportunities that some derivatives offer.

As the basic maxim of investing states, the higher the risk, the higher the return - and vice versa.

Derivatives can also be used as a risk management tool in so far as they can expose you to more or less risk depending on how you use them. Options and warrants can be used to help increase your exposure to a particular security, such as a share, or they can help you protect your position from a price fall.

Some key reasons for using derivatives include…

Leverage
Derivatives give an investor the ability to access the movement in the share price for a low investment. It is similar to putting down a deposit on a house; the derivatives market allows you to put down a deposit on a share and access the benefits of the movement in the share price.

Hedging
Hedging allows investors to protect the value of shares they own - effectively like taking out insurance in the share market. As the share price drops in value this particular derivative increases in value.

Income
Investors can generate an income from shares they own - this is in effect like renting out a property. But it is also possible to ‘rent out’ the shares you own using options to generate an income. Warrants cannot be used to do this.

Long or Short
Derivatives can be used to profit even when shares are dropping in value. No longer do you have to sit and wait for the share to turn around and start to climb before you are making money. You can be making money regardless of which direction the share moves in. Using derivatives you could make as much money on the way up as on the way down.

Once again, knowledge is the key!

One of the biggest mistakes people make when using derivatives is not knowing which derivative product to choose. For example, purchasing an ‘out of the money’ call option in the hope of capturing a rise in the share price, only to be left confused when the stock price reaches the target, but the option price has in fact lost money! That is why we only put forward derivative strategies that also identify which product to buy - one of the most important aspects of trading. We use a risk-to-reward ratio to help choose the best product.

DIY Super

In recent years Self-Managed Super Funds (SMSF) or Do It Yourself Funds (DIYF) have become increasingly popular, becoming the fastest growing section within the superannuation industry. There are now some 300,000 such funds in existence (increasing by 2,500 each month) with about 560,000 members who control $135 billion, representing well over 20% of Australia’s superannuation assets.

What is a self managed super fund?
A self managed superannuation fund comprises four or fewer members, where the Trustees and Members are usually the same person or people. A SMSF or DIYF is regulated by the Australian Taxation Office.

Trustees/Members are actively involved in running the fund and make their own investment decisions. They may seek external professional advice if they consider it appropriate.

What are the benefits of a self managed super fund?
These are many and varied, and will coem down to your own situation. However here are a few…

* It puts you in control
* Choice of investments, including alternative assets and integration (within limits) with personal investments
* Lower management costs and no entry and exit fees
* Flexible retirement income options
* Tax advantages - SMSF’s only pay 15% tax on the taxable income of the fund
* Estate planning - your family can benefit

How much money do I need?
Most experts recommend that at least $100,000 for a Self Managed Super Fund if you have stopped contributing, and at least $50,000 between the members if you are still contributing regularly.

The annual costs involved in running a DIY Fund will vary from fund to fund depending on the number of transactions and the skills of the Trustees/Members. The fund’s accounts must be independently audited and there is also a $45 regulatory fee to the Tax Office. Most people will also elect to pay a professional for preparing the fund’s accounts and tax return.

Are you tax-wise?

Rules relating to taxation of investments can get very involved, very quickly. So professional taxation advice is prudent. However, you should also try to develop your own informed overview of the main tax issues that apply to investment - it is all part of the investment learning journey - it will help you better understand what the tax professional is doing for you. 

Below are 3 scenarios and the applicable tax deductions for each. These may or may not strike a chord with you. Talk to your taxation professional before making any claims.

Scenario 1 - Norma

A little about Norma:
* Holds a large and diverse investment portfolio, but does not carry on a business of share trading,
* Trades through a stockbroker,
* Investment decisions, although ultimately her own, are generally made in consultation with her broker after monitoring trends to ensure the best return for her investment.
* The majority of her investments yield income in the form of dividends or unit trust distributions, but in the past she has also made capital gains.

Norma subscribes to a share information service, which provides information used to monitor her portfolio.

What is Norma entitled to by way of tax deduction?

Norma may be entitled to a deduction for the cost of sharemarket information subscriptions, as the expenditure is relevant to the management of her investments. Costs incurred are for the purpose of producing assessable dividends and trust distributions, rather than to source capital gains.

Scenario 2 - Mike

Mike’s situation:
* Previously purchased three parcels of shares in listed companies (X, Y & Z) - all of the companies yield assessable total dividends in excess of $2,000,
* Has sold half of his shares in company X, purchased more shares in company Y and made an initial investment into a managed fund; and
* Actively manages his investments by closely monitoring not only his shareholdings, but market activity in general.

Mike purchases a monthly journal and a daily financial publication, which provide him with general information and analysis of market conditions, in order to keep track of his investments. These subscriptions cost $790.

What is Mike entitled to by way of tax deduction?

As the publications are used by Mike to keep track of current investments, and are not used solely for the purpose of generating capital gains, he may be entitled to a deduction for the cost of purchasing both the investment journal and daily financial publication.

Scenario 3 - Jill

Let’s look at Jill’s situation:
* Has held a small parcel of shares in two blue chip companies for a number of years,
* Has a share portfolio with a value of $5,000,
* Receives bi-annual dividends from both companies - approx. $200 in total; and
*Is nearing retirement and is anticipating a lump sum of $50,000, part of which is earmarked for investment in more shares.

Jill has decided to subscribe to an online investment service, which costs her $500 per year.

What is Jill entitled to by way of tax deduction?

On face value, it would be reasonable to conclude that Jill subscribed to the online investment service for the purpose of making investment decisions & purchases after her retirement, thus the expense would be deemed non-deductible.

However… given Jill’s current shareholdings, it’s also reasonable to assume that a portion of the subscription would be used to monitor and make decisions for her current investments. In this case, at least a portion of the expense may be deductible. Jill could claim a nominal amount of the subscription fee; say $50, as a deduction.

Simply put, if Jill didn’t have shareholdings prior to taking up the subscription, she would not be entitled to any deduction.

Disclaimer
The above scenarios do not constitute tax advice and you should not rely on any of the information contained above. wise-owl.com, its advisers, Directors and officers do not accept any responsibility or liability for any taxation consequences. As a result, you should consult a professional tax consultant to consider your specific circumstances.