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.

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