How to Choose – Are AFIC Shares Right Investment for You?

AFIC is a listed investment company with a long track record.  It is a type of actively managed fund with very low management fees (currently 0.13%).  A common question among investors trying to choose a fund for their Australian equity allocation is whether to choose a LIC or ETF.

ETFs are a more recent creation, and are also extremely low cost investments. ETFs in contrast to LICs are passive investment models.   VAS is an index ETF that passively tracks the ASX 300, the top 300 shares in Australia with a management fee of 0.1%.

I have a more detailed explanation of the differences between LICs, ETFS and index funds. Here we will mainly consider Australian foundation investment country in comparison with VAS.

The first thing to point out is that these two investments are very similar.  Australian foundation investment company is actively managed but tends to hug the index anyway.  After reading this article, if you are still unsure stop procrastinating, choose one or alternate

Are Australian Foundation Investment Company shares a good investment?

This fund has a long track record, and is a trusted investment.  Over the past 10 years, performance has been almost identical to VAS.  Returns over the long term are expected to grow faster than inflation but future performance is always unknown. Unfortunately, no one can tell you whether any investment will under or over perform over the next ten years. 

Tax Considerations – Do AFI shares pay fully franked Dividends?

Australian foundation investment company shares pay fully franked dividends.  VAS are partly franked. 

Franked dividends are when tax has been paid by the company before the remainder is paid out to you, with an adjustment to ensure you only pay tax at your marginal rate.  Unfranked dividends are when the company has not yet paid tax, pay the full amount to you, on which you pay tax at your marginal rate. 

It doesn’t make a great deal of difference if your Australian dividend is franked or not. You will pay tax at your marginal rate (whether you see it or not).  Australian Foundation investment company aim to provide shareholders with a steady income from dividends. They will purposely hold back dividends in order to smooth out the income.

ETFs are more tax efficient internally because of the way they are structured.  So VAS may save you some money under the surface. 

BUT Australian Financial investment company is one of only two companies that allow a dividend share substitution plan (DSSP). 

This has lots of potential for a high tax bracket investor (or double high tax paying couple) or children owning shares in their own name (taxed at a whopping 66% after they earn $417 in investment income). 

Those on a high income should prefer to profit by capital gains – taxation is then delayed until withdrawal and discounted by 50%.  Any dividends paid to you today will be paid at your marginal rate (up to 45%).

By activating the DSSP, instead of dividends you will receive bonus shares in the same company (without brokerage costs).  Tax is deferred until you withdraw and then paid as capital gains tax with the corresponding 50% discount. 

High income earners would ideally defer withdrawing until a low/no income year (after retirement, sabbatical) and children would defer withdrawal until they turn 18 and are subject to normal tax rates on investment income, with a 50% capital gains tax discount.  This seems an extremely efficient (without the unreasonable fees of investment education bonds) way to save for your kids university fees, or start up fund.  Kids may be able to withdraw while earning little or no income at school or -university, or while working their first, likely low-income job.  They will pay between 0 and 22.5% tax (if earning/withdrawing > $180,000 in a tax year).

Australian Foundation investment company and Vanguard also offer a dividend reinvestment plan. Tax / franking credits will need to be paid / reimbursed but the dividend will be reinvested without brokerage costs. Best for those paying less than 30% tax who wish to reinvest dividends.  

What does the Australian Foundation Investment Company Invest in?

Some investors are concerned that the outperformance in passive over active investing in the US may not be as valid in Australia, due to the Australian stock market being so much smaller and concentrated on banking and mining sectors. 

Perhaps some cheap active management to tilt to a more balanced portfolio may improve performance in Australia? It turns out AFI, like many managed funds, tends to hug the index.  It invests in similar assets to the ASX 300, in slightly different ratios.  Both investments allocations are found in their PDS.  Here are the top 10 allocations for Australian foundation investment Company and ASX 300.

Australian Foundation Investment Company

VAS / S&P 300

What Dividend Does AFI Pay?

Listed investment companies (LICS) are known for “dividend smoothing”. This means retaining profit that can be used to bulk out dividends in bad times. This is popular among dividend investors and retirees who like a smoother income. There are no guarantees of anything, but Australian foundation investment company have prioritised paying out dividends to keep their shareholders happy. A smoother year – to year income does minimise the risk of tax bills in retirement.

How to Buy

You can buy Australian Foundation Investment company shares on the ASX. To buy either you will need a broker account. The ASX code for Australian foundation investment company is AFI, that for VAS is VAS.

The close ended structure of LICs including AFI does add complications (and possibly opportunity) here though.

A close ended structure means there are a set number of AFI shares available at any time. In comparison, an infinite number of VAS shares could be sold (and Vanguard just buy more of the underlying assets). A limited number of anything means supply and demand will affect price.

The price of AFI shares will go up and down, not only based on the underlying value of the assets it owns (net tangible asset) but also on the level of demand for shares.

That means you can buy AFI shares at a premium, or discount to the Net tangible asset (total value of assets owned by AFI). Ideally, you would want to buy at a discount, but this involves active monitoring of the share price and NTA and doesn’t lend itself to passive auto investing. There is a risk of never investing if you are waiting for a discount.

Which means if you want to auto-invest you have to accept you may buy at a premium sometimes (and other times a discount). Or you have to actively monitor and purchase at times of discount (too much of a pain for me).

Or this may be a reason to go with VAS.

Should I Invest in Australian Foundation Investment Company?

Alas, no one can give you the answer to this question. If you like the DSSP option, I would look further into AFIC, but if this is not important to you and you prefer the simplicity of not having to consider share price vs NTA, look at VAS.

Aussie Doc Freedom is not a financial adviser and does need offer any advise.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

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