49 - Cash savings cost you money

Interest earned has a nasty sting in its tail: it's considered taxable income. Save some cash in a savings account (or term deposit or similar) and interest earned will be included in your taxable income and taxed at your marginal tax rate.

Don't forget to take out inflation too (which was not inconsiderable at 1.9% for 2016/17).

Here's the simple workup:

Invest $10k @ 5% p.a to earn $500
Assuming your income is $87-180k, your income will be taxed at roughly $0.37 per $1 earned. As such, the ATO takes $185 of your $500.
The cost of inflation, calculated on the principal of $10k @ 1.9% p.a., is a further $190 (in other words, your $10k is now worth $9,810 in real terms).
Instead of earning $500, you've only earned $125 (or achieved a rate of return of 1.25%)

Current interest rates are already low and a 5% interest rate is probably unrealistic. Most 60-month term deposit rates are earning less than 3%.

If you're saving cash, you'd better have a very generous interest rate or a very low income—or you're probably going backwards. Let’s not get started on the opportunity cost of not putting those savings into a better-performing (and safer) investment.

Given the above example again, if you’re earning 2.5% interest, your actually working at a net negative interest rate of –0.33% at a cost of $32.50. As a bonus exercise for the reader, compound these examples over multiple years.

If you have a mortgage, get an offset account and stash your money in there right now. Either way, get a good accountant who can help you legally maximise your deductions.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

48 - Making Money Lazy

Up until lately we’ve been on a roll: a few years back the equity loan was approved against our family home—putting that “lazy money” to work for us, and we were approved for and built our first two investment properties using the bank’s money.

But things are tight these days in the banking and credit sector and, with only one income, our ability to service additional loans is viewed as risky by the big lenders. Which of course sucks because we have a sizeable “rainy day” fund, the wife is in a well-paid job, and we have a very strong history of paying our bills on time and saving.

In other words, we still have income coming in but no option (currently) to invest it in additional properties without tying up our own funds. Our mortgage broker said “no” :’(

This situation leads to the holding pattern which is Plan B: reducing interest payable on the investment property loans. In other words, we’ve started stashing our spare cash in the offset accounts attached to the interest-only investment loans. This cash is therefore fluid—it can be withdrawn at any moment—and, because we’re using the offset accounts instead of paying down the loan as principal and interest (or paying into redraw), interest on the full loan amount remains deductible if and when we do withdrawn cash in the future.

While I’d prefer to be building our property portfolio (the median house price moves forever upwards) using the bank’s money and tax-deductible debt to achieve long-term growth, at least we’re saving interest. In fact this is the exact strategy we adopted with our PPOR—but of course, interest on that debt was not not tax-deductible and there were different variables at work there.

The biggest problem I have now is our money could be working harder. Although it could be said we’re retiring debt (sort of), this is good debt and I don’t want to retire it… I want to use our money to borrow other people’s money so it can be put to work for us! Interest rates are low and likely to stay that way for the near-term and if we could buy again now, at today’s median house price or just below, we could achieve cheap capital growth over the next few years.

We’ll review things again in six month intervals—both serviceability but also capital growth of our existing investment properties, which may allow us to leverage that equity to fund a larger deposit for IP #3. But that’s not how I’d prefer to do it.

Enjoy,

Michael

47 – How we saved 1 million dollars tax free

You may not have realised but the mortgage on your family home is one of the most flexible and safest “investment” vehicles available to you.

Let’s start at the beginning, with the basics. Say you take out an owner-occupier, principal and interest home loan from a bank for $750,000; the loan is for thirty years with a variable interest rate of 5.25%.

As an owner-occupier you’ll live in the home (note different factors, such as tax deductibility, are at play with an investment loan). Your interest rate will rise or fall depending on several factors, including the RBA’s official cash rate, regulatory changes—such as those implemented by APRA in recent years, market conditions, and the business outlook of the bank itself (such as exposure to business issues in other industries or countries).

As a principal and interest loan, you’ll start by paying off the interest (mainly) and your regular repayments will likely be about $4,100/month. You’ll pay that amount every month for thirty years. After 360 payments, you’ll have paid off the principal amount of $750k and nearly $750k again in interest.

So in a nutshell, your house will cost you twice as much as the price of the house itself if you take on a mortgage (I’m glossing over deposits and stamp duty, of course). That’s a lot of money!

This is why my #1 tip is to pay off your mortgage as soon as you can. To achieve this, negotiate annually with your bank to secure the best interest rate you can and move banks if you’re not happy; employ an offset account (don’t use redraw) to ensure all of your cash is being used to reduce the principal owing; switch to fortnightly or weekly repayments; throw everything you’ve got at your mortgage until it’s at least well under control if not obliterated—and by this I mean scrimp and save and defer buying the things you want for a few years.

Many banks and financial institutions offer interactive, visual calculators which demonstrate how changes in interest rates and repayment frequency will affect the total cost of your loan. Check out this calculator from CANSTAR, as one example. It was the looming threat of having to pay thousands of dollars every month, illustrated in a calculator like this, and the idea that our house would cost twice as much in interest, that drove me to our strategy of removing our home loan from our lives.

If you’ve got money squirrelled away elsewhere, it’s probably time to liquidate and toss it into you offset account. If you’re using a high interest savings account, the ATO will treat your earned savings as taxable income (which will be taxed at your marginal tax rate). The same goes for capital gains income from other investment vehicles such as stocks. Don’t forget your savings are also being eroded by inflation at a rate of ~3% every year—meaning your cash loses 3% of its value once every year to the point where you position is probably moving backwards.

Ask yourself if your other investments are earning you a return of 5% p.a. or more, after CPI and tax—where the 5% figure is taken from interest rate on your mortgage. You’ll likely find they’re not. Don’t forget to consider your risk exposure with these investments: when the next dotcom crash or GFC arrives, will your investments hold their current value?

By contrast, you live in your home and, while it’s not an income-producing asset, it is a huge (albeit generally low-risk) liability which will undermine your ability to purchase strong assets if not reduced. That said, no matter what happens, your house will provide you with shelter and warmth and privacy even if it drops in value or the worst happens: it’s something you can use.

Suppose you are taming the bear that is your mortgage: you’re chipping away at it using an offset account and making extra repayments. Meanwhile, the value of the security—the land on which your house sits—has likely increased in value. If you need a large amount of cash for that rainy day emergency, it’s immediately accessible to you from your offset account or by redrawing. In other words, your mortgage as a “reverse investment” (if that makes sense!) is not only low-risk but it’s fluid in that it can be rapidly converted into cash.

With the passage of time and increase in value of your property, you may now be able to take out a line of credit, effectively a mini-mortgage secured against the difference between the current value of your property and its original value or what’s been paid down (the equity but this is also called your “lazy money”—set it to work for you!). You could go silly and use this to fund a holiday or buy a fancy car but that would undo your hard work. Instead, use that available money to pay a deposit and costs for your first investment property. Welcome to the world of leverage.

The above is exactly what we did and we effectively paid down our mortgage in full in about eight years (ours was largely a dual-income family on average salaries for the majority of that time). From the line of credit, we’ve been able to extend ourselves into two investment properties, all the while saving somewhere between $500k – $1m in interest (depending on future interest rates), paying no additional tax, and watching the value of what is now our home increase rather than moving backwards, as cash would have.

Enjoy,

Michael

46 – Holiday Homes Make Poor Investments

We spent last weekend five hours South of Perth in Albany, WA. With the kids in tow, we rented a cutesy old cottage for they duration so they’d have their own rooms and space to run around.

Being away in this context soon got me thinking about the many reasons why we veered away from holiday homes/apartments as an investment. With family frequently visiting from intrastate and overseas, a property that could be rented out is when not in use was hugely appealing to us at first glance but many reasons led us to reconsider.

When we first started looking seriously at property investment, one of my first thoughts was to purchase a holiday apartment. I figured something with a few bedrooms in nearby Scarborough might not cost too much and “Scarbs” is an increasingly vibrant area in Perth. It’s also a good spot for visiting tourists with its expansive beaches and nearby amenities. I’ll note this was before I came to prefer land (i.e. a house on a block of land) over apartments and decided to invest for long-term growth rather than cash flow—in short, don’t buy an apartment because the land content ratio is too low…). In general, you’ll likely pay a premium to buy in a holiday location—which may not relate to long-term capital growth. In other words, are you better off buying into a highly-priced holiday location or doing your research to buy into a cheaper suburb that’s likely to grow faster and produce a better return on investment in the long run?

We also had to ask ourselves whether we buy something local for the sake of the visiting relies or choose something further afield in a more interesting (to us) location—either out of town or in another state. If we wanted to make use of the property ourselves, would a “holiday at home” (er, a property in Perth, where we live) be all that desirable?

Regardless of location, the ability to produce an income will always be at the mercy of the local short-term rental market and tourism conditions. Although I’m no expert in this area, I’ll hazard a guess that sites like Air BnB are eating into the traditional short stay markets.

With a normal rental, you have the surety (in a way) of a guaranteed weekly rent for the term of the lease. With a holiday home, you might have a higher nightly rate but the uncertainty of whether the property will be full one night and vacant the next—which, on average, may or may not equate to the same income as a regular rental. Averages are useful but may hide seasonal ups and downs and corresponding cash flow troughs throughout the financial year.

Unlike a typical suburban house rental where we’re renting a property to a tenant as a place to live, as their home, with a holiday home we’re dealing with a different set of variables. How closely are holiday makers vetted? How do we insure the property? Will neighbours object to the comings and goings of visitors at unusual hours? What happens if China crashes and the Chinese tourists suddenly dry up? We had a global recession not all that long ago; are the Yanks still flying in to little old Perth at the same rate they were before the dot com and housing market crashes?

At the very least, you’ll need to estimate vacancy, affix a nightly rental price tag that fits the market and attracts the right kind of holiday makers or travellers, and then consider marketing costs (for your online listing, membership with the local tourism body or visitor centre, etc) and cleaning costs. Of course the property will also need to be furnished with not only furniture and appliances but linens, cookware, books/DVDs, artwork, etc. Other running costs will include electricity, water, gardening, and possibly cable and internet, as well as the usual rates and insurances.

Don’t forget, if you want to use the property yourself, the ATO will require you to exclude the period when the property was not available for rent as a percentage of any deductions you might want to claim (i.e. negative gearing). On the upside, you may be able to claim a higher rate of depreciation (4% p.a. over 25 years instead of 2.5% p.a. over 40 years).

If you want to use the property yourself during peak periods, then you’ll likely have to forego any income the property would otherwise generate during that time.

The property we rented in Albany, although lovely in an historic kind of way and very practical for our young family, has zero appeal to me from a practical and maintenance standpoint. Although the main house felt sturdy and sound, the back extension (these places always have a back extension, right?!?) had a definite lilt to it despite being the newer construction.

Then my wife plugged in the kettle for her morning tea but it wouldn’t switch on because she’d unwittingly tripped the circuit. Of course we just thought the kettle was a dud—until it came time for a shower and we had no hot water from the instant gas system with its electric ignition. It took a very upset wife and a call to the neighbouring manager, at 8:30am on a Sunday morning, to sort that one out.

We’ve been living in a relatively new house in Perth for going on a decade now and although it’s been a pretty easy run there are always things to deal with—we’ve already had to replace the hot water tank, for example. I cannot begin to imagine the countless number of ongoing issues to be found with an older house. On the one hand, it’s established and “bedded in” but how soon until the roof needs replacing or the foundation restumping? Insects and damp or mould may be problematic in older houses and the electrics may be shady.

Although I’d love to have a nearby holiday home for the relatives or a beach shack down south that we can use periodically, as an investment we’ll be sticking with suburban houses for now and fork out for a week or two in that holiday rental when we want to get away.

Enjoy,

Michael

45 - Financial Exercise

There’s very little I can share with you about physical exercise—other than the fact that I avoid it and any “workout” of mine is entirely coincidental… think mowing the lawn and carrying the kids around. I know exercise is good for me but I prefer to flex my financial management and discipline muscles instead.

Of course since we can’t easily practice buying real investments without making costly mistakes, what follows is an overview (from simple to hard(er)) of what I do regularly to keep my mind on the money, so to speak.

Check your accounts regularly

I regularly log in to the web sites for our bank and credit card accounts to review the list of recent transactions. I quickly scan for high dollar value debit transactions: anything more than $100. I ask myself whether I recognise the transaction (i.e. did I buy something?) and check the transaction description and date. I also check for credits like refunds and payments to make sure everything is as I think it should be.

It’s also worthwhile keeping an eye for really small transactions ($1.00) as this may be a fraudster probing the account.

I also check our monthly statements when they arrive—especially for any interest charges.

Review and revise your financial goals

I set our financial goals annually. I list the goals for the year ahead and then short, medium, and long-term objectives. In our case, short-term is defined as 0-2 years, medium-term is 2-10 years, long-term is 10-30 years+. I review our goals every so often as a reminder to keep my train of thought on track.

Have you written down your financial goals? If not, do this now:

Spend five minutes thinking about your future. Brainstorm—think small or large but just think. Think about next year and think about how you’re going to retire and then die.
Write down at least one or two financial goals that will help you to achieve your future reality.
Edit later.

Drafting your financial goals is vitally important to shape and inform everything else you do in life. Your goals and objectives form the foundation of your financial existence and ultimately shape your personal existence.

Start small and build, reviewing what you wrote down and editing periodically to cull things that no longer make sense and add things that do.

Save your receipts and keep a log book of costs

The office supply store sells a basic accordion-style folder for about $5 containing a pocket for every month of the year and a few to spare. I buy a new one each year.

I always ask for a receipt when I purchase something and file it by month. For online transactions, I print to PDF and save the PDF in a similar manner.

At month end, I pull out the receipts for the current month and record, at a minimum, the date, supplier, amount, and any relevant notes. I use an Excel spreadsheet for this purpose and add a new row for each receipt.

On my log I categorise each transaction by type (e.g. grocery, petrol, utility, clothing, children, communications, vehicle, entertainment, etc) and sub-type for each of those types (e.g. utility includes gas, water, and electricity). I also include a Yes/No field to indicate if the expense should be flagged to the accountant to be tax deducted, and note how the payment was made (cash, card, PayPal, etc).

Because I’m a geek and an ex-manager, I have an Excel pivot table sitting over that data, which allows me to dynamically filter this information by time/type/tax deductible/etc in order to consolidate and analyse our expenditure. For example, let’s say I want to know if we’re spending a little bit more or a lot more on gas or electricity… since last year or last season or since we had the kids. The pivot table tells me this. It also gives me a nice overview of how our annual expenditure breaks down into the categories I’ve specified.

Now when you apply for a loan and you’re asked how much your family spends each month, you can amaze and impress by providing an exact dollar figure to two decimal places!

In separate logs, I also track things like income (salary), credit cards, and specific things I want to manage closely throughout the year. For a very macro-level view of our situation, I can now see how much we earn to how much we spend (I express this as a ratio) and how much we’re saving.

Do you know how much you’re spending? If so, how and how precise is your understanding?

Budget

Using the information I have from our receipts helps me to budget more accurately.

with our combined income (earned income—i.e. salaries, government payments, superannuation, investment returns, etc), I divide that number by all the big ticket things that make life expensive.

An annual budget is a good starting point but life tends to work in monthly, fortnightly, or weekly intervals and a budget will likely be more meaningful if you if think short-term. If you’re working electronically, I find it easiest to plan at the week or fortnightly level and then aggregate those figures as monthly or annual figures.

Starting with some of the aggregate numbers from my log and our financial goals and objectives for the year, I can decide where we need to cut costs and where we want to spend (or save) more. If you’re working with a calendar, you can then plot how to achieve that by ramping up or down on specific costs over time (but I feed this information back to our financial goals and objectives).

Some areas of a budget will be easy. If you’re saving for a home deposit or something else like a trip, put a dollar figure against that item and adjust later if you need to. For things like savings and paying off debt, I’m aggressive and stretch ourselves to prioritise these items.

Some areas seemingly won’t provide much wiggle room. We all need food, shelter, clothing, petrol, and things like utilities, phone, and maybe internet. I’ll occasionally look at those areas in detail to see you if I can find a better deal on our energy or mobile phone plans, for example.

The online ASIC Budget Planner at https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/budget-planner is a great place to start if you’ve never laid out a budget for yourself.

Once you have a budget in place, your receipt log allows you to determine how you’re tracking to budget and where any variances sit.

Research

I regularly review the official interest rate and the interest rates applicable to our various loans. The cash rate is pretty boring these days (for now) but the interest rates at the lender end are constantly jittering around and there’s always the question of whether it’s time to refinance for a better deal.

realestate.com.au allows you to subscribe to a feed of new real estate listings for a specific criteria and I receive regular updates from that channel for the suburb where our family home is located and the Brisbane suburb where IP#1 sits. I don’t use this information other than to keep tabs on the market and, as buy and hold investors, we have no intentions of selling. I am interested, however, in house prices both from an equity point of view and to understand our return on investment position. Of course the advertised price for a property rarely tracks it’s sale price.

You can also do the same thing with the rental market and properties sold.

The more I’ve learnt about property investing, the more interested I’ve become in the things that impact it and to that end I at least try to read about some of these demographic and economic indicators (for example, the free Monthly Housing and Economic Chart Packs produced by CoreLogic). I supplement some of this summary-level information with detail from the ABS, such as population growth and and unemployment.

Enjoy,

Michael

About Me

Hi, I'm Michael. I'm a first-time property investor living in Western Australia. I'm also a stay-at-home dad and husband. Follow along with me as I recount the day-to-day activities of buying a block of land in Brisbane and building a new house for investment purposes. If you're thinking of doing the same, I hope you'll learn something from my mistakes--which I'll share openly. If we're successful this time around, I hope one will become two and two will become four and so on... as interest rates no doubt increase and the Australian economic landscape shifts and slides and evolves. Should be interesting! Thanks for reading.

Property Investment

Pages

49 - Cash savings cost you money

48 - Making Money Lazy

47 – How we saved 1 million dollars tax free

46 – Holiday Homes Make Poor Investments

45 - Financial Exercise

Check your accounts regularly

Review and revise your financial goals

Save your receipts and keep a log book of costs

Budget

Research