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

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AFIC

The details of the Australian Foundation Investment Company

AFIC is a leading Listed investment company with a long track record and good value management fees. AFIC invests in well known Australian companies, and focuses on investing over a long time.

The fund managers examine the long term potential of the companies, their performance over economic cycles and their capacity for higher revenues. Reliable and increasing dividend yields for investors are prioritised.

AFIC is a type of actively managed fund with very low management fees (currently 0.14%). 

AFIC differs from an ETF or managed fund in subtle but significant ways. Read on to find out more about this listed investment company, and my experience investing in AFIC.

What does the Australian Foundation Investment Company Invest in?

These are easily found on the AFIC 2021 annual report,

I was initially concerned that the outperformance in passive over active investing well proven in the US may not be as valid in Australia. The stock market in Australia is far 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.Here are the top 10 allocations for Australian foundation investment Company

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Australian Foundation Investment Company

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AFI vs S&P 200 Performance

AFIC performance from AFI

Does AFIC Pay Dividends?

Australian foundation investment company pays fully franked dividends twice per year. AFIC is especially popular with dividend investors as the company prioritises maintaining it’s dividend yield, even in a tough market.

Franked dividends avoids double taxation. If the business that made the profit have already paid the tax, this is taken into consideration when assessing dividend income.

When the corporate tax rate of 30% has already paid, you will only need to pay extra tax if your marginal rate is above 30%. If you are on a tax bracket lower than 30%, you will receive a tax refund! This unusual perk means retirees can actually receive tax refunds without paying any tax!

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. 

For 2021, AFIC paid a 2.8% fully franked dividend yield.

AFIC Dividend Smoothing

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. This is quite appealing to retirees, who would prefer regular dividends to maintain them in a low tax bracket.

AFIC TAX ISSUES

What is a Dividend Reinvestment Plan (DRP)?

If you do not need that dividend income right now (because you are in accumulation phase), you can activate the DRP. Instead of being out the fully franked dividend, it will be automatically reinvested. Investors still need to pay tax on the reinvested dividend yield, but the DRP will save on brokerage fees and encourage you to invest more.

What is a Dividend Share Substitution Plan (DSSP)

If you are on a tax bracket higher than 30%, you may wish to consider the DSSP. It is another way to reinvest the equivalent of your dividend yield, whilst deferring taxation.

AFIC 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). 

If you activate the DSSP, the ATO do not recognise this as income as you are rewarded with bonus shares instead of a dividend. You do not have to pay tax on the dividend yield (or receive a franking credit). Instead, the share remains invested until you withdraw it. On withdrawal the entire bonus share will be treated as a capital gain, with accompanying 50% discount if held for more than 12 months.

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. 

This seems an extremely efficient way to save for your kids university fees. 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).

AFIC INVESTMENT

Is AFIC Ethical?

The company is not a dedicated ethical or sustainable fund, but does consider environmental, social and governance issues when selecting investments.

But the primary concern appears to be related to company sustainability due to the inevitable and increasing importance of ESG factors.

Read AFI’s statement on ESG.

Who is the Share Registry for AFI?

Computershare are the share registry for AFIC. When you buy shares, you will receive a letter by snail mail informing you how to log on to the share registry and check your shares, regardless of which broker you are with.

AFIC vs Vanguard Australian Shares(VAS).

A common question among investors trying to choose a fund for their Australian equity allocation is whether to choose a LIC or ETF. AFIC is a LIC, VAS is an ETF. They both invest in Australian companies but VAS is a passive market cap ETF.

-VAS vs AFI – Which Companies are Included

VAS / S&P 300

Australian Foundation Investment Company

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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. AFIC charges 0.14% management fee.  After reading this article, if you are still unsure stop procrastinating, and don’t worry about splitting hairs.

VAS is an index ETF that passively tracks the ASX 300, the top 300 Australian shares with a management fee of 0.1%.

-ETFs are Open Ended, LICs are closed

ETFs such as VAS are a more recent creation, and are also extremely low cost investments. They are an open ended fund, meaning anyone can buy and sell at any time.

LICs are close ended funds, so buyers need to find someone willing to sell their AFIC shares and vice versa. There are a set number of LIC shares whereas ETF shares are unlimited.

-Net Tangible Asset Value vs Share Price Value

VAS sells for whatever the combined value of it’s underlying assets is.

Because of the closed nature of AFIC, there is a supply and demand market for the LIC itself, which pushes it’s share price above or below it’s net asset value.

This means you can snag AFIC shares for cheaper than the underlying asset values, when the share price is at a discount to the NTA. Or you may have to pay more than the underlying assets warrant due to market optimism about AFIC at the time.

-AFIC vs VAS – Dividends & Taxation

AFIC pays fully franked dividends, whilst VAS are only partly franked. 

ETFs cannot withhold dividends or realised gains from investors. This is a bonus for dividend investors, but not so much for tax payers wanting to defer income until after retirement.

Any dividends paid out (even if reinvested automatically) will be taxed by the ATO.

AFIC is unusual in allowing dividend pay-outs to be substituted with bonus shares, deferring tax until the investor eventually realises the capital gain.

ETFs however are more tax efficient internally because of the way they are structured. 

Both Australian Foundation investment company and Vanguard offer a dividend reinvestment plan. Tax / franking credits will need to be paid / reimbursed but the dividend will be reinvested without brokerage costs. A DRP is ideal for those paying less than 30% tax as they will receive a franking credit refund.

goals

I have a more detailed explanation of the differences between LICs, ETFS and index funds.

https://youtu.be/uzY8QC_3nUc what is a lic?

Is Australian Foundation Investment Company a good investment?

This fund has a long track record, and is a widely 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. 

My Experience with the Australian Foundation Investment Company (AFIC).

I started investing in AFIC shares as a result of the Barefoot investor.

Initially we had opened (and regretting) an education bond, then a RAIZ account. I was looking for a way to save for our children’s future.

I chose AFIC as it was an easy way to purchase a widely diversified portfolio with minimal fees. It made sense to me to choose an Australian fund as the savings were earmarked for our kids Australian tertiary education fees.

I also liked the options of a dividend substitution plan (DSSP)/Dividend reinvestment plan (DRP). The ability to choose one, and switch if our financial situation changes gives us more ability to minimize tax on dividends.

We opened a Commsec account and purchased $30,000 AFIC shares during the COVID dip of 2020. I have continued to buy AFIC through Pearler, adding an international ETF to our simple portfolio outside superannuation.

AFIC Performance in the financial year 2021 has been exceptional – 21% and beat the index (slightly)!

How to Buy AFI Shares

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

The price of AFIC 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 AFIC 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 AFIC share price and NTA and doesn’t lend itself to passive auto investing. There is a risk of never buying if you are waiting for a discount.

Which means if you prefer auto-investing 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, to make life simpler!

afic

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.

This year’s past performance has been stellar, but this does not predict future returns.

Whenever investing, read the product disclosure statement and obtain personalised financial advice.

If investing in AFIC is aligned with your financial objectives, seek independent advice and look into whether a dividend reinvestment or substitution plan is the right choice for you.

Aussie Doc Freedom is not a financial adviser and does need offer any advice. 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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