Showing posts with label Strategy. Show all posts

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 This cash is therefore fluid—it can be withdrawn at any moment—and, because we’re using the offset accounts instead of paying down the loan as principal and interest (or paying into redraw), interest on the full loan amount remains deductible if and when we do withdrawn cash in the future.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

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

37 – A Few Reasons for Investing in Property

It’s been a hard couple of weeks here. With a bank pre-approval valid for only three months before the reams of documentation would need to be supplied anew, it was go-time for getting agreement from Gemma and setting the wheels in motion with Open Corp for the second investment property purchase. I thought Gemma remembered and understood the reasons for buying the first property—and how that logic extends to a second. As my external voice of reason, however, she was reluctant.

A refresher was in order. I spent a few evenings nagging Gemma to think it over. I drew a few simplistic diagrams on the kid’s chalkboard to reinforce the key points. I asked her to re-read the very readable Property Investing Mini Guide from Open Corp (which I’d helpfully underlined and annotated—because that’s how I roll).

Gemma wasn’t sure about the risks but couldn’t explain to me the basis for her reservations—her default financial strategy is to ‘put it in the bank’ and ignore the negative impact of inflation. Her preference was to take a wait and see approach with the first property, which isn’t a good move if house prices continue to climb and become less affordable. How long do we wait? This first year also won’t tell us much: since the first property is in her name and she’s on maternity leave, we won’t see many tax benefits this financial year.

I argued the experience of the first build went well and the process of buying and tenanting was an exceptionally solid result with Open Corp. We wouldn’t have a long-term view of success or failure for the better part of ten years or more (one property cycle) but doing nothing with our available equity would leave us behind as inflation eats away at out savings at a rate of ~3% a year.

What should be an emotionless decision was quickly becoming a very heated emotional debate between us.

In addition to my points above, I banged on about historical growth rates, leverage, and risk.

Historical Capital Growth

Looking back in time we see Australian house prices growing continuously since the 1970’s (and well beyond). Whatever happened (or started happening) back then—be it government forces, population and other demographic shifts, war, tax incentives, rising incomes, or other market forces—has tended to continue. That’s over forty years of generally positive data.

The past is not a guaranteed predictor of the future but it does provide some guidance. Of course you’ll also find arguments against property investment using similar data—see this article which proposes we’re in a housing price bubble.

Leverage

Buying a property seems expensive but it’s not. We pay the up-front transaction costs (indirectly through a line of credit) and borrow 100% of the cost of the property through a combination of the line of credit and a primary loan. In other words, we put in about $70k to invest $380k. That’s a powerful thing: by my very simple math, if we put in a dollar, the banks put in $5 and the interest costs are largely covered by the rental income, tax deductions, and depreciation. Yes, both the LOC loan and the primary loan are subject to interest rate increases and other legislative changes (e.g. negative gearing) and it’s always wise to take these variables into consideration when doing your sums.

Risk

I’ve written about risk before but the options are simple.

1. Do nothing and inflation calls the shots. Even in a term deposit or a high interest savings account, your position will probably decrease or remain flat (i.e. unproductive). Real estate can be considered as a hedge against inflation given the relationship between GDP growth and demand.

2. Invest in the share market and Ben Graham’s insane Mr. Market calls the shots—in other words, the share markets are unpredictable and crazy; unless you’re investing in the company itself and understand the industry and the internals of the company, you’re betting against the house—so to speak. Plus, you don’t have any control over how your investment is put to work.

3. Invest in real-estate. Land has a long-term history of appreciating in value and putting a house on it will ensure the costs involved in holding the land are manageable. In time, the rental income may cover those costs and provide an income stream. If everything else turns to pot, at least you can live in a house and capital increases are potentially accessible via equity loan.

These aren’t the only arguments to consider but they’re a good starting point and encompass many of the finer details. Here a few more points to consider:

Real-estate investment is relatively easy to understand
You have more control over your investment than you would as a stock investor
You can create value (e.g. by renovating)
As a long-term investment the impact of any initial mistakes are likely to be lessened over time
There’s less volatility in the real estate market than there is with the stock market
Bricks and mortar have a high tangible value (compare to investment in a start-up that may have a product idea but no product and no revenue stream)
Rental income provides a stable income
Housing will always be in demand as our population increases
You have many options for managing your investment (subdividing, doing your own maintenance work, using a property manager or doing it yourself)
Portfolio diversification
And so on

In the end, Gemma came around and the IP#2 wheels are turning. We signed the hold agreement with Open Corp, put down the $1k hold deposit and $2k land deposit when returning the land contracts.

Gemma did caveat her approval of this build: this second property would be our last for a little while. I’m fine with that as this purchase will come close to exhausting the small line of credit we took out for the first build, secured against our PPOR, and the banks may not be too willing to extend us a third loan given the fact I’ll be back on stay-at-home dad duties in the next few months. The general tightening of the financial lending market over the last few years doesn’t help much either on this front (I’m not quite sure how the 26 year-olds in the magazines amass 10 properties in such a short timeframe!).

On request, Open Corp came back to us with a 400sqm property in Victoria, an hour’s drive south of Melbourne. I’ll discuss the specifics—and recount the process to acquire and build, as I did with the first IP, in future posts.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

36 - On Goals

I scared myself silly when we signed up for our first mortgage in 2006 to buy a block of land and cover the ensuing house construction. That mountain of debt looked insurmountable and, considering the higher interest rates at the time, the repayments felt like an invisible shackle binding us to the daily grind of working life. The system had us by the balls and would continue to hold on for the next thirty years—according to the bank’s timeline.

This mortgage was, in many ways, a necessity (of modern life, anyway) as it would fund the establishment of our family home and promote us from the status of mere tenants. As projected, we now have two young children and are proceeding to raise them in the house we built.

In the years preceding the build we rented, paying what felt like dead money to our landlords—around $125/week or so. After repaying a student loan to my mom and moving to Perth we had very little money to our names, despite the fact I’d been working full-time as a professional for two years. My infamous frugality comes to me honestly after several years of having to live on the cheap!

On deciding to buy the block, the savings we had put aside for a deposit were all but spent by the time the deposit (we borrowed 95%, from memory) and stamp duty were paid and then we had that fun little surprise of lender’s mortgage insurance to deal with.

It was around this time I casually voiced my apprehensions about all of this to a work colleague (the CIO where I was working at the time, Colin Macdonald). His simple advice to me—which I would readily pass on to anyone else in a similar position—was to repay the loan as quickly as possible.

The bank had us down for thirty years. Colin’s advice was to clear the loan in ten years.

Say what now?!

I broke out a spreadsheet and projected some numbers forward in time. At best, I thought we might be able to repay the principal amount by 2018 (so ten or eleven years). I played with the bank calculators and quickly realised we could save the value of the property itself in interest costs—hundreds of thousands of dollars—by making extra repayments. I was intrigued.

We had a basic home loan at the time with no offset facility. The bank did include a free redraw facility with this product, however. With the redraw setup, we could manually (electronically) transfer our savings into the mortgage and therefore save the associated interest costs that would otherwise be charged on that amount. Better yet, the redraw funds were fluid, meaning we could redraw, on demand, some or all of funds we put in if we needed that money (in an emergency, to fund a car purchase, for a holiday, or for any reason).

There is one caveat to note with redraw, which I only learned about more recently: the ATO considers funds contributed to redraw to have contributed to paying down the original debt. In brief, if you think you might rent out your property in the future, you’ll only be able to tax deduct costs associated with the loan amount you haven’t yet repaid (even if you redraw the surplus funds). Offset accounts may attract a small fee but are immune from the ATO, work in the same way as redraw, and are more convenient.

And so we set ourselves a goal, which would later become our very basic financial strategy: put it all into redraw. Rather than making interest at whatever low interest rate the bank would offer, we save the interest the bank would charge for some of the mortgage amount (whatever we could put in).

With me working as a contractor and the wife working long hours in a good job (that doesn’t pay terribly well) we continued to live as we had: simply. We didn’t spend excessively—we didn’t often have the opportunity to do so with the wife working 60-80 hours a week. Entertainment costs were out!

Instead of keeping our savings in a regular bank account, we kept them in the redraw account.

Slowly but surely the extra contributions started to add up with the added benefit of reversing the huge impact of compounding interest fees the bank would have otherwise been charging us. The Albert Einstein quote says it all: “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

But today’s post isn’t about compound interest, it’s about goals—specifically the huge goal we set out to achieve nine or so years ago.

Admittedly I’ve been a little distracted by being back to work and the kids and I’d neglected for some time to update my spreadsheet that tracks the balance of our home mortgage and the offset account we now employ in place of redraw. I updated this spreadsheet recently and noticed what I first thought was an anomaly in the data: the negative amount highlighted red I normally show for the balance of our home loan minus the offset balance was no longer negative and it was no longer red: it was black and it was positive. The balance in our redraw account was more than what was owing on the mortgage.

I do keep an eye on our monthly repayments so I knew before this point we were heading in the right direction. In the last six months the monthly interest charge had plummeted steadily from a couple of hundred dollars to less than $10.00.

It then dawned on me: we’d met our goal. We’d met our goal a year early. Although the mortgage account was still open (and will remain so for a couple of specific reasons), we effectively have the option to repay the mortgage balance in full, if and when we choose to do so.

Back in 2006, this milestone was equivalent in my mind to being financially free. Today that’s not quite the case as our commitments—financial and life-related—have increased and of course there is a cost of living in groceries, petrol, clothing, and so on. I can say achieving this goal feels as good as I hoped it would back in 2006—perhaps all the more so because I neglected to watch as the odometer tick over.

This post is isn’t to boast, it’s to celebrate and inspire. From a very low base, ten years of hard work and time has allowed us to meet our single financial goal. Your goal(s) might be different depending on your circumstances: your timeline to repay your mortgage, depending on the value of your mortgage and your income, might be the same or it might be a shorter timeframe or a longer timeframe. You may also favour a better balance in life than what we’ve managed to achieve (I believe strongly in delayed gratification but I’m also nearing forty…). Nonetheless, set a goal and then plan to achieve it. The world can then be yours.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

34 - Getting started, again

As mentioned, we’re looking at doing it all again with a second investment property build on the cards. It’s not so much that the first property has already performed that well (it’s done neither well nor badly—it’s far to early to tell) but we’ve still got unused equity sitting in our family home and, hopefully—if the banks agree, some borrowing capacity. To be clear on this point, we’re not “duplicating” just yet.

Having been through the first IP build with Open Corp, we’re comfortable with the process and the principles. The land purchase, construction, and tenant selection for that property went very, very smoothly and I don’t think we could have expected more in a first purchase/build. I’d be very happy if we can match our first experience a second time around.

Sure, it would be great to see some strong initial growth in the Brisbane market but I’m confident that growth will come—if not in the next few years then in the next ten. The tenants only moved into the house in September and, very simply, we’re in this for the long-term: if the growth takes time, I don’t really care when it comes (assuming it will come eventually, of course!). Remember the Brisbane market has been flat for some time now (years) and everyone in the Australia was saying “it’s Brisbane’s turn in 2015”)… which didn’t happen. Now it’s a question of “when”. The sooner the better as that growth can then be leveraged to duplicate with no dependence on our family home.

Growth aside, the holding costs for the first IP are almost negligible (a final reckoning will come at tax time but even then we’ll have only a partial picture with the wife having been on maternity leave for most of this financial year).

Having been busy back at work myself for the last quarter, we’re looking to Open Corp again. As noted, I’m confident in their process but not so much in my ability to implement their process. It’s also a risk management thing to my mind, especially with these crucial first purchases. Open Corp have pointed us to Melbourne and identified some initial areas and properties to looks at.

I’ve meanwhile been speaking with our broker from Mortgage Choice, Nathan, to start the finance pre-approval wheels turning. Nathan and I met to go through a pre-assessment completed by Mortgage Choice, which gave us a rough indication of what we might (or might not) be able to borrow and which lenders might be in the mix.

In our case, we had only one lender to consider (one of the big four) following the recent belt tightening by the banks and the banking sector regulators and so we’re moving forward on that basis. As with the IP#1 pre-approval, we had to submit pay slips, credit card statements, bank account and mortgage statements, drivers licenses and passports, and the tenancy agreement for the first investment property.

All just a formality—or so it should be—but it all got a little bit hairy since my employment contract runs out early next year and I haven’t (yet) been offered a new contract. My wife already has contracts signed for when she returns to work from maternity leave and, interestingly, while the bank wouldn’t consider her future income, they were insistent on sighting her contracts. They also requested a letter from my employer stating my current arrangements and that they would (in principle) be on-going.

Mortgage Choice tells me we had a particularly hard bank-side assessor (especially for a pre-approval, thought I!) but we prevailed in the end. I find there’s no point in stressing about financing as the ultimate decision is beyond my control. It’s more a case of follow the bouncing ball, supply the information requested in a timely matter, and hope for the best!

We’re now back to Open Corp and waiting for a block to come available before our pre-approval expires in thirty days.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

21 – Tax Time

I’ve spent the last few days (on and off) gathering together everything needed by our accountant to complete our tax returns. This year’s tax return is more involved than normal because we have the purchase of our first investment property to consider and my wife’s life insurance—part of which may be tax deductible.

We’ve had an accountant prepare our tax returns for many years now—initially because it all seemed a little complicated and now because it is a little complicated.

Back then we had income from one or two employers, bank interest, HECS debts, and deductions like professional memberships and insurances, training, mobile phones, internet, stationary, uniforms, and depreciation of office equipment and furniture. I wasn’t sure how my income and tax returns related to my wife’s and vice versa.

These days, we’ve got more of the same plus private health insurance, life insurance, the investment property establishment costs (any IP is an interesting mess in its own right when it comes to taxation), dependent children, and the occasional minor offset to me as a non-earning stay-at-home parent. And of course the tax laws are always changing in many of these areas, making it hard to keep on top of what we can and cannot do, legally. Next year we’ll have the IP income or loss, interest and running costs to deduct, building and fittings depreciation, and so on.

The first accountant we worked with claimed he would be able to to cover his costs and we always found that to be the case… in other words, he was able to include valid deductions that we probably wouldn’t have considered (plus he didn’t charge us much).

That first year our intention was to use his return as a template for subsequent years but it seemed just as easy to go back to him and so we did.

Although I wouldn’t recommend using your accountant as your financial adviser, our first accountant was the only financial professional we relied on at that point in time and he was able to offer some useful tips. For example, he highlighted the benefits of having private health insurance instead of paying roughly the same amount for the Medicare Levy (of course our insurance premiums increased as we started planning a family and it seems like the Medicare Levy doubled at some point along the way too…).

Now days our accountant is a key member of our broader financial team and we’ve “upgraded” to an accounting firm that deals regularly with clients who own investment properties (WSC Group—I’ve written about them before in the context of financial advice and insurance). WSC were recommended to us by Open Wealth and they’ve offered an outstanding service thus far—note they’re not directly affiliated with Open Wealth.

We pay for the expertise of an accountant but did you know accounting costs can be deducted the following year? Our first accountant also claimed he’d never had the ATO question a return he submitted (I assume tax return audits are fairly random but having a professional submit your return can’t hurt). While I probably could do our taxes, I’d prefer to know the return is correct and, more importantly, that I’ve claimed all of the deductions I can to reduce our taxable income.

If you’re considering the purchase of an investment property, or hold an investment property today, do you know how your quantity surveyor’s report relates to the depreciation of your building and fittings—and therefore you tax return? I’m estimating those two deductions alone will be worth nearly $10,000 in the first year. Don’t know what a quantity surveyor’s report is? Ask your accountant!

I forwarded 7MBs of PDFs to our accountant this morning so that’s my job done for now, hopefully.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

17 – The New Addition and a Change in Circumstances

I’ve been a little quiet on the blog front as of late—for good reason: our second child arrived on Sunday morning, a little boy! If it were a previous age, I’d have extra reason to be excited, now having a male heir to who I can leave my vast riches and estates*… in our time, we’ll divide our assets in two between the kids but I’ll write more about wills another time. In brief, having a second child has highlighted the need to buttress our finances and ensure their well-being.

Benjamin’s arrival also means his mother is now on maternity for the next twelve months, which, not coincidentally, means we’re now a zero-income family. In other words, time for me to hang up my apron and get back to work.

My original plan on this front was to return to the world of IT contracting but the current market situation in Perth isn’t as hot as it was a few years ago, on the back of the resources sector, and there aren’t as many options as I’d hoped for. In truth, I’ve always been pretty lousy at timing these things!

I could continue at home and enjoy this period with my wife and children. I’m sure we’d scrape by. I could also leave it for a while and revisit in three to six months. But the idea of having no income between the two of us, the fact we’ll be needing to support our first investment property financially—at least in part—from around August/September/October, and our plans for an overseas trip which will cost thousands in flights alone, leaves me wanting for some pocket money. What a pain, this working stuff!

I’m also considering whether I want to take on a job with less responsibility and a correspondingly low rate of pay or do something a little more stressful but that will generate a higher return on my time invested. It’s tricky this one: do I make it home for dinner every night or just push hard and maximise the limited time I’ll have back in the workforce?

On a related note, I spoke with our mortgage broker about the possibilities of a taking on a second IP sooner rather than later—presumably once I’m working full time again but while the wife’s still on maternity leave. We still have plenty of equity in our PPOR and the sooner we get one or more investment properties built, the sooner we can leverage the equity in those properties to duplicate.

Nathan at Mortgage Choice noted many lenders are wary of considering potential future income from a woman on maternity leave because—in percentages—many women do not return to work. He noted a letter from the wife’s employer would be required at a minimum. We left it there for now but decided to reconvene on the subject in August once I’ve hopefully been back at work for a little while.

In the meantime, I’ve lined up a second call with Michael Beresford at Open Wealth to discuss our options for IP #2. No reason not to at least have a chat!

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

13 – Life Insurance

As part of a review of all matters financial I initiated in the middle of 2014, one of the items I added to my list of things to mull over was life insurance. The matter surfaced for me when I realised I no longer had any insurance cover through my superannuation fund by virtue of not working (i.e. being a stay-at-home parent) and not contributing regularly to my super account.

I’m not planning to die or be critically injured any time soon but I remember when we took on the mortgage for our PPOR in 2006: the commitment felt almost too large handle. I used to commute into the city regularly by bicycle but, having recently moved to Perth from Adelaide—with a related increase in minor accidents, and as one of two income earners critical to our ability to repay the mortgage, I felt it was time to stop riding. With a few years of wisdom on my side, I don’t feel the same way this time around with the investment property but, conversely, I now have kids and want more than ever to protect my family from the risk of loosing an income/resource.

From personal experience again, my father died at the age of 56 and my grandfather at 65 so I joke that I’ll likely expire at 45. Specifically, my father had a life insurance policy worth $500k when he died and had only recently opted not to increase that policy to $1m. The $500k has served my mom well over the years as she retired and downsized the family home but she also weathered the 2001 tech bubble and then the GFC with most of that money in the stock market. With the payout she’s been comfortable; without it, I don’t know that her retirement years would have been as amenable as she was expecting had my dad lived to retire with her.

When we were working, my wife and I both had automatic life and salary continuance insurance (SCI) (also called income protection) through our super funds. We didn’t pay directly for these policies but they were funded through the fees we pay to each fund (a percentage of our super balances). Notably, the amounts insured were very small—a couple of hundred thousand each for life and SCI.

We had the option, of course, to increase the benefit amounts and do everything through super but I soon came to learn there is a better way—an approach that not only pays for some of the premiums from our otherwise inaccessible (preserved) super balances (we’re not running SMSFs) but also offers tax benefits.

By way of background, I’d scheduled a complimentary meeting with a financial advisor through our accountants at WSC Group (through Jigsaw Financial Planning—again no affiliation here). I took with me our written financial goals and described to Matthew Laird (the advisor) what we’re doing with real estate, where we are with super, and that I’m not looking at stocks or mutual funds. It soon became apparent we didn’t need much in terms of paid financial advice… yet. We did, however, talk about insurance and Matt promised to get some numbers together for us. Importantly, he highlighted the concept of a partial rollover from our super funds to pay some of the premium costs, reducing our out-of-pocket expenses and thereby removing what had been the single biggest blocker, to my mind, to insuring ourselves adequately: cost.

The first thing Matt’s team did was prepare a Personal Protection Plan document for us which summarised our current position in terms of income, assets, expenses, liabilities, goals, and existing insurance. This offered a framework for understanding our insurance shortfall and potential requirements into which the planner injects their recommendations for level of cover and ownership structure. There was no charge for this.

It’s worth quickly describing the different types of insurance because I found this enormously confusing at first. I like to categorise insurance into two simple groups: living benefit, which you receive if you’re not dead, and death benefit, which your estate or nominated beneficiary receives when you die.

Living Benefit

Total or Permanent Disability (TPD). A lump sum payout when you’re declared totally and permanently disabled—and can’t work. These policies might exclude heart attack, stroke, cancer and others. A very important distinction to be aware of between TPD policies is that of “Any Occupation” versus “Own Occupation”: with an Own Occupation policy, you’ll receive a payout if you can’t work in your own profession; with an Any Occupation you’ll only receive a payout if you can’t work in any occupation (as Matt says, “as long as you can lick stamps…”). The premium is not tax deductible and the payout is typically not taxed.
Trauma (also called Critical Illness or Living). A lump sum payout that covers heart attack, stroke, cancer, and other specific conditions. The sum insured is typically lower and this cover overlaps somewhat with income protection. The premium is not tax deductible and the payout is typically not taxed. For us, I felt this was very much an optional insurance given our SCI cover (see below) and we didn’t buy any trauma.
Salary Continuance (SCI) (also called Income Protection). Pays ~75% of your income on an on-going basis, after a waiting period, to the age of 65 if you can’t work. SCI covers heart attack, stroke, cancer, etc. The premium is tax deductible and can be paid through super but I’m told it’s best to pay this one yourself for maximum tax benefits. The benefit is classed as taxable income. With the wife’s insurer, the maximum monthly benefit they’ll underwrite is based on 75% of her highest income year in the last three years.

Death Benefit

Term Life. A lump sum payout at death or when you are declared terminally ill (i.e. before you die but with less than 12 months to live). You’ll likely purchase “term” life insurance, in which your premiums cover you for death up to a certain age. You might also be able to purchase permanent life insurance, although I’m not sure this is available in Australia. The premium is not tax deductible and the payout is typically not taxed (but it may be if paid via a super fund or if paid to someone who isn’t a financial dependent—i.e. not your spouse or children).

Note that life insurance tends to get more expensive the older you get—I suppose because you’re more likely, statistically, to receive a payout. I was specifically told by Matt insurance gets a lot more expensive past the age of 47.

The other problem you might face the older you are relates to your medical history. In my (young) case, I broke my back in a snowboarding accident at the age of 21. So my insurance policy includes a blanket exclusion on spinal cover—with no reduction in premium, of course. Basically if my back suddenly gives way tomorrow I’m not covered but if I’m in a car accident and break my back I would be covered. Of course, some insurers may offer you a policy with increased premiums to cover the additional risk. My suggestion therefore is to get yourself insured as soon as you can, as a young person, so you at least have something in place even if health problems do present as you get older which might preclude you from becoming insured.

In the same vein, you’ll also want to be careful what you tell your GP—and what they record in your patient file (the insurer will request your patient file from your GP as part of the assessment process). One thing in particular to be mindful of is mental health—depression, anxiety, etc. If you’re having a bad week at work and mention that when you visit your GP for an unrelated reason—and let’s say your GP recommends you see a counsellor, the insurer may take that into consideration when assessing your application.

With some insurance products like SCI you can insure at indemnity value or agreed value. Indemnity value means the benefit is paid as a percentage of your earnings (i.e. 75%) whereas agreed value means your benefit is whatever fixed amount the insurer has agreed to cover.

Your premiums will also increase annually (these are called “stepped” premiums)—beyond the rate of inflation. You may have the option to pay a higher, “levelled” premium that remains constant throughout the course of your policy. If you can afford to, a levelled premium seems like the way to go to me—assuming premiums will increase beyond the levelled premium and you’ll save money. That said, part of me thinks “the house always wins”.

Our risk of death increase as we age but we conversely approach the end of our careers and our income generating potential. In other words, we should theoretically have a lessened need for insurance as we get older. My aim therefore is to wind back insurance over the next twenty years, with the assumption that we’ll be further progressed in our financial lives and less dependent on income or a large payout to set us in good stead. I’ve therefore opted for stepped premiums.

With other products you can purchase a lower-cost “rider” policy. For example, if you have a trauma rider to your life policy and claim against the trauma policy, your life policy benefit will be reduced by the amount you claim for trauma.

With the concepts out of the way, we started by defining our insurance goals, i.e. what costs would need to be paid for if one or both of us could no longer work. With my wife as the only income earner, we would firstly want to reduce debt and replace her income. With me providing child care, we would also want to cover the cost of child care if I couldn’t provide that function. Pretty simple. Anything else is a bonus—i.e. paying down property debt. In short, we calculated benefits from income, factoring in living expenses and debt. As with most things we do, we insured for modest amounts. Since income protection would be paid at 75%, I opted to go for the maximum amount we could purchase however.

From there, we were able to structure the insurance so the premiums are partly held through a superannuation account. This is accomplished through a partial rollover from our own super funds to the insurer’s zero-balance fund for the amount of the annual premium. In other words, that percentage of the premium for the policy held in the super fund is paid with super dollars that I otherwise cannot touch until I reach preservation age or retire. Yes, that money is no longer earning money for me in my super account but at least I’m not having to pay out of pocket for something as mundane as insurance (and in all honesty I consider the balance of my super as dead money… I’ll look at an SMSF one day).

In my particular case since I’m not working, I wasn’t eligible for an Own Occupation policy or SCI and all of my premiums were covered by the partial rollover. My policy covers me for life and TPD.

In the wife’s case—interestingly—the advisor recommended a different insurer and she’s covered for life, TPD, and SCI. Premiums are again paid through a combination of a partial rollover and a personal contribution. Interestingly, dear wife is with an untaxed super fund so there’s the little catch that rolling over from an untaxed fund to a taxed fund will likely result in tax being payable on the rolled over amount. This is still being resolved but it sounds like a tweak to the ownership structure will sort it out.

Finally, I should mention buying this insurance didn’t cost us anything in broker fees. The broker received a commission from the insurer which is detailed to us. I didn’t think insurance was sold this way so that was a nice cost savings and, since I know nothing about these types of insurance companies, saved me a lot of research. Yes, brokers are selling products that make them a commission which may vary from product to product but WSC Group (through their subsidiary Jigsaw Financial Planning) seemed very professional and above board in their dealings with us.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

9 - Performance Measurement

My wife is my yardstick for measuring reality. I’m admittedly a bit of a dreamer at times (with the ability to get mired in the details, mind!) but my Dr. wife, being smarter than me, is always ready to offer the checks and balances I occasionally require to cool me off when I get carried away.

Part of that is because she hasn’t learned what I’ve learned so she asks a lot of tough questions which forces me to think hard about the answers. She’s also far more conservative than I am and could probably be labelled a reluctant partner in all of this—her preferred approach to investment is to save cash in the bank.

Related to all of this, Cam McLellan over at Open Wealth, with who we’re building our first investment property, did an early podcast on the subject of what he calls “Dream Crushers”. A Dream Crusher tells you what they think (i.e. which is usually a negative, subjective view about what you’re thinking about doing) without having the experience or objective education on the particular subject to support their comments. This commentary gets you down and ultimately prevents you from taking action. The wife is effectively my lead Dream Crusher—although she usually comes around, either because I babble at her so much she wants to shut me up or because what I’m saying makes sense to her and she comes to understand my intention.

Which leads me into the subject of today’s post.

The investment strategy I had yet to—until yesterday—articulate to my beloved wife was to complete construction of IP #1 by mid-year (ish) and look at identifying and securing finance for IP #2 (and possibly IP #3) through the end of Q3 and the start of Q4 2015. This would tie in well with the fact I’d be back at work full time by that point, which the banks would hopefully look at favourably in terms of debt serviceability.

Then my wife hit me with her strategy: evaluate the performance of IP #1 before rushing forward. To me that was the sound of the cord being pulled and the lights going out. Fizzle. Zap. “No more property investing for you, dear hubby!”

We didn’t speak more on the matter initially but her comments certainly got me thinking: what is the detailed set of criteria we might use to define performance?

I’ve honestly been a little bit stumped about how to measure performance for a while now.

The easy one, of course, is a doubling in value (capital increase of 100%) every 7-11 years for good metro properties. The market will generally do this for you unless you’re adding value somehow (i.e. through renovations or infrastructure projects coming online).

Gross—or better yet—net rental yield is a good starting point as it’s a metric that’s easy to calculate and track.

Perhaps more important is the transition from negative gearing to neutral or positive gearing within a timeframe you can afford. Let’s say 1 to 5 or 7 years. This might happen in a number of different ways. Rents increase. Debt might be reduced or retired (but I wouldn’t take this approach) and interest rates might move—down like we’re seeing these days. You earned income may increase as you progress in your career, allowing for more effective tax deductions.

The conclusion that I’ve come to is performance must be measured over specified time intervals: 1 year (or less initially); 3 years; 5 years; 10 years; 15 years; 20 years. My strategy is to hold for the very long term and hence I believe performance should therefore be measured over the long term too. Hopefully in that time our property would have become positively geared and seen reliable capital growth.

Simply looking at results year on year doesn’t work for me. A property might be sitting pretty one year but take a step backwards the next before recovering again in year three, for example. The contextual economics need to be factored in to your assessment at the very least and this will happen automatically by measuring performance over a multi-year period.

More importantly, deciding to invest or not invest in a second property, which will likely be in a different suburb if not a different market (i.e. a different capital city), based on the performance of the first property isn’t an equitable comparison.

There are also other factors that I’ll say are beyond your control, for lack of a better expression. Let’s say you buy a negatively geared property in the years before you retire. Your income is hopefully at the highest level it ever has been and so your tax deductions go further and, were you to keep working, that negatively geared property might be able to generate a positive cash flow for you in a few years.

And then you retire, hopefully with structures in place that will minimise your tax burden. Realistically your income will likely decrease in retirement. But what about those deductions?! That negatively geared property might remain that way for longer than you anticipate if you’re not able to pay down debt. At worst, it might eat into your retirement income and put a hold on your big retirement plans. Moreover that property may have seen only insignificant capital growth in the short term, making any sale not worthwhile despite the potential CGT savings.

If you’re younger, as I am, what if you’re working full-time one year but not earning at all the next? This is my reality as a stay-at-home dad. Bring forward tax deductions, yes, but that muddies the waters somewhat across the financial year boundaries.

Tenant churn might be a problem. That is, you might struggle to retain tenants, leading to more vacancy periods than another investor might have with an elderly couple who’ve been in the rental for a decade—doing their own light maintenance no less! (I read an investor profile just like this one in API). If you’ve got a strong property manager now, what happens if he or she moves on and you’re left with an average manager?

What about bad tenants? Insurance claims? Construction defects if you’re building new?

Interest rates may (will) increase, reducing positive cash flow.

Special circumstances may also intervene. Let’s say you lose a tenant for a length of time greater than you planned for because a major industry pulls out of the local market and rental demand evaporates. Or a flood leads to a broad stagnation in the market in terms of capital growth (as per Brisbane). I can only imagine what impact the earthquakes in New Zealand had on rental property there.

If you’re holding long-term, these sorts of events that occur in one year, or even over a number of years, don’t necessarily mean you’ve bought a dud. It might, if you’re being forced to subsidise a negatively geared property you easily can’t afford—in which case you’ll probably want the situation to come good within a defined time period (i.e. five to ten years); you’ll also need to decide whether that subsidy is worth the cost to you—especially if it’s not a burden. The selling costs (agent’s fees, possibly CGT, timing, etc)—coupled with the costs to acquire a replacement property (stamp duty, possibly LMI, time lost in the market)—make selling off an “underperforming” asset problematic.

I’ve written previously that time heals all problems but the flip side to this statement, of course, is that time is not on our side! Even for me as a relatively young man I’ll only get two to three decades (two to three growth cycles) before we both retire and our earned income dries up. With a goal of holding 6-10 properties at minimum, and natural constraints around how quickly we can do that, time is most definitely not on our side!

I’ll keep working through this one but I wanted to share while the subject was front of mind.

I’ve been reading a lot of Robert Kiyosaki lately so I’ll close by highlighting a recurring theme in all of his Rich Dad books: don’t buy investments that will cost you money. Speaking to us Aussies, I’m pretty sure he’d say “buy positively geared properties, mate”. That doesn’t completely solve our performance question—a positively geared property could revert back—but it’s a sound idea where it’s possible to find and buy such an asset.

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

6 – Think Rich

Immediately after writing my last post “How to Spend Money”—in which I advocate being frugal and not spending money unnecessarily, a library book I’d reserved came available: Robert Kyosaki’s Rich Dad’s Guide to Investing. The first section of this book is almost entirely dedicated to the concept of retraining and refocusing your mind to think like the rich do. In other words, instead of pinching pennies as part of a frame of reference where money is scare, change your mindset to one in which money is abundant and don’t be cheap.

This makes a lot of sense to me. I won’t make a full about-face in follow up to “How to Spend Money” but am inclined to adjust my thinking somewhat. The standard disclaimer I include with every blog post includes a note that I’m learning too, so here’s direct evidence of that! Most importantly, I’m learning and have a very open mind on financial matters as I’m not yet prejudiced by a lot of experience; I’m therefore willing to adapt and adjust my thinking on the fly and explore new ideas and concepts like this one.

A note: I realise this post isn’t directly related to property investment but—for me—property investment is simply a means (a “vehicle” in rich dad speak) to wealth.

Amazon.com Widgets

Although I’ve not necessarily been cheap, I’ve definitely been frugal often and modesty always has been—and always will be—a pillar of what it means to be me.

Rich dad wisdom suggests being frugal is okay but there’s no sense in being rich but living poor. As an extension to that, it’s worth pointing out another Rich Dad pearl, which suggests having a low income and high expenses is superior to the traditional goal of having a high income and low expenses. In other words, use good expenses to reduce your taxable income (and to tie that back to our current discussion: don’t be cheap by trying to keep your expenses low). I’ll add this book is by far the best of the three Rich Dad, Poor Dad books I’ve read to date—it’s very conceptual but so worth the read—see the Amazon.com link above to check it out.

Frugality I would define as choosing to not be extravagant in your daily spending habits (for me this also relates directly to my greenie sensibilities: I choose not to be a consumer and pollute my environment with unnecessary packaging and products). I always prefer to buy quality and do not buy to throw away—this is and always will be a way of life for me. If I were cheap, I would buy poorly made, disposable things in quantity—at the very least.

To quote from Kiyoaski’s book: “My rich dad would say, ‘There are two ways to become rich. One way is to earn more. The other way is to desire less. The problem is that most people are not good with either way.’ […] this book [is] about how you can earn more so you can desire more.”

I’ve not been too bad on the desiring less front but I do look at people around me who seem content spending a lot of money and wish I could be less frugal, if not less cheap! I certainly want to be more generous and focus the money I must spend on the positive aspects of life.

Kiyosaki also cites another article on this subject which suggests the wealth you can build by living as though you were poor is finite (the article cited also discusses penny pinching in the context of becoming not just a “millionaire” but a “multimillionaire”).

The book doesn’t offer much in terms of definition between frugality and cheapness but the author does leave us with another rich dad quote: “‘If you want to be really rich, you need to know when to be frugal and when to be a spendthrift. The problem is that too many people know how to be cheap only.’” I think this point also extends beyond the black and white argument of frugality versus cheapness and into the broader educational context of the investor: do we understand the difference between good debt and bad debt, good expenses and bad expenses, assets versus liabilities, taxation laws, ownership structures, etc, etc? In other words, are we being constantly cheap or are we being selectively cheap? I mentioned in the previous post not spending money on a depreciating asset like a car; that’s not frugality but rather understanding how not to waste money quickly.

Notably, Kiyosaki goes on to write (later in the book) that rich dad focused on delayed gratification in the short term in favour of a long-term reward. I think this is key and really at the crux of what I was suggesting in my earlier post. Nonetheless, I do believe in the power of setting goals and ‘thinking yourself’ into the reality you desire.

As a final thought, I’ll suggest not being cheap doesn’t mean splashing out at every opportunity. Meanwhile, keep thinking rich!

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 learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

5 - How to Spend Money

This is simple but for so many people the concept is something from the stratosphere. My rules are as follows:

Don’t spend money
Use other people’s money (a mortgage to buy property, interest free periods on a credit card) when you have to spend money
Build your credit history (if you’re new to borrowing)

Let me explain in a bit more detail…

1. Don’t Spend Money

This is really the golden rule. Some people might choose to read this as “don’t spend money you don’t have” but see Rule #2 before you adopt that approach. But there’s no need to interpret the wording at all: just don’t spend money!

Although simple in theory, this is extremely difficult for many people to implement in practice. We’re used to spending money and our culture conditions us to spend more money than we need through marketing and advertising and by watching our friends and families succeed. Break the habit, become wealthier, spare the planet the extra plastic, and change the world, maaaaan!!! Ignore the adverts and recognise and accept your friends might be earning more money than you are/in a different financial situation to yours/stupider than you are. Spending money is not a measure of success or intelligence.

If you don’t need something, don’t buy it. Live frugally, is what I always say (rather than calling myself cheap!). Don’t live in the moment and buy impulsively. The time for spending money will come but right now you need to accumulate money and wealth and the easiest way to do this is via the magical effects of compounding, a subject on which I’ll write more about in detail another day. For now, just understand the less money you throw away, the more money you’ll have to make more money.

Before you whip our your credit card, stop and think whether what you’re about to buy is going to increase the number of days (or months or years) you’re going to have a mortgage to repay—or increase the time it’s going to take to save up a deposit for a first home loan. Ask yourself if this doodad, that beer, this seemingly insignificant expenditure is really necessary to your wellbeing and fulfilment. Can it wait another month? Another year? I remember when I first reviewed the interest costs on our PPOR mortgage: over the thirty year term, we would ultimately end up paying the bank the value of our home again. The quicker we could repay the principal, the less we’d pay on interest.

The best way not to spend money is to understand what you need to spend to survive (i.e. a plan or budget—anything), spend that amount and record the transactions against your plan or budget, and treat yourself occasionally but in moderation.

There are also many subtleties at play here. Never spend money on a depreciating asset like a car—i.e. don’t buy cars, at least not new ones, until you can genuinely afford to. Don’t buy an ultra HD curved OLED television. Don’t waste food. If you’re spending more than $50 a month on booze, you’re spending too much. Definitely don’t smoke or quit if you do. Take it easy on the holidays. Don’t eat out too much.

There are also some really easy things you can do. Buy store brand ketchup instead of Heinz ketchup. Mow your own lawn. Change your behaviours by wearing your clothes for a second season instead of refreshing your wardrobe every three months. Use grocery store fuel vouchers to save on petrol. Pay your bills on time to avoid fees. Ensure you’re never in a position where you have to pay late payment fees or, worse, credit card interest. Make your lunch and take it to work instead of buying lunch every day. Cancel your cable TV subscription. Become a vegetarian and stop eating meat. Ride a bike to work instead of catching the bus or train (or worse, driving your car and paying for parking). As you start thinking like this, you find all sorts of ways to save a few dollars and as my mom always said: “every penny counts!”

Keep the achievement of your long-term goals front of mind and what you give up today is easier to bear. We took on a $700k+ mortgage in 2006; it’s all but paid off less than ten years later through moderate (minimal, really) spending and careful saving.

Edit: Please read my follow up post “Think Rich”—it explores a valid counterpoint to this concept.

2. Use Other People’s Money

If you insist on spending money, don’t use your money, use someone else’s money—at least for as long as you can and if you can do so for free.

Credit cards are considered intrinsically evil by some people but if these facilities are not abused they can be used to your advantage. As long as your balance owing is paid by the due date—that is, you have the cash flow to afford what you’ve purchased—you won’t have any interest to pay for the privilege of borrowing that amount for up to sixty days.

We buy everything (EVERYTHING—except purchases that attract a fee) on a single credit card with a reasonable limit and we pay the credit card bill on time. Our typical credit card bills run between $2,000 and $3,000 (more around Christmas, sometimes less after a really good month); instead of being paid for immediately from our cash, the value of our monthly spend is being lent to us at no charge by the credit card company. During that interest free period, that lent money is working for us in our offset account—reducing the amount on which mortgage interest is charged.

The added bonus is having the majority of our transactions centralised on one card, which makes it easy to know how much we’re spending month to month; it’s also easy to spot any problems. I typically pay off the credit card, in full, a day or two before it’s due to maximise the credit benefit.

The key takeaway here is to never pay interest on your credit card. Most cards will charge interest at an annual rate of around 20%. This adds up to lot of money—I’m always astounded how my credit card statement tells me if I only pay the minimum amount I’ll pay off the closing balance in “58 years and 07 months” and “end up paying an estimated total interest charge of $22,828”! That’s crazy talk.

If you get stuck with credit card debt, plan on getting rid of that debt first before anything else because it will most likely be the highest interest rate you’re faced with (apart from a bad car loan, perhaps). Call your credit card company and have a chat with them about a repayment plan or an interest-free period—ask to speak to the manager if necessary. If your card company won’t help—and by help I mean be very generous to you—roll over the balance on the card to a new card with a 0% introductory balance for 12 months or whatever period you can find. Hopefully that will give you enough time to clear the debt without the interest burden accumulating on top of the original amount.

Finally, I don’t use cards that incur an annual fee just for the sake of a few perks.

When it comes to your home loan, you also need to be careful. If you have a number of debts (i.e. a car loan, credit card, personal loan, etc) you may be offered the option of consolidating all those loans into your home loan. The benefit of doing so is a better interest rate: instead of a 20% rate for your card debt, you’ll be paying 5% at today’s rates. The downside is that debt will follow you for the term of your home loan, meaning the interest on the amount you’ve consolidated will compound every year until it’s repaid—along with x number of years of interest. You could end up paying off that new car for thirty years—long after the car is gone!

You might similarly be tempted to refinance your home to free up equity for a holiday or a new toy (boat?) or a swimming pool. This is easily done but, again, be mindful that in doing so you’re hiding the true cost and using money you can’t really afford.

Credit cards and home loans are generally considered “bad debt” because it’s money that doesn’t work for you. Consider the alternative: “good debt”. This is money borrowed that you in turn use to make money through investing in real estate, a business, or stocks. In contrast to the loan on your PPOR which will cost you money on interest (this interest cannot be claimed as a tax deduction), a investment property mortgage will serve to earn you money. So as a footnote to this section, if you’re buying an investment property, use the bank’s money—secured by the equity in your home—instead of putting down your cash that can be better used elsewhere.

A student loan like a HECS debt is also someone else’s money. If you have the option to reduce interest by making early repayments, ask yourself if the cost of holding onto that loan and not making early repayments will allow you to use that money more productively elsewhere. How much will you save by making early repayments? How much do you stand to make by investing the value of those repayments elsewhere (e.g. in an offset transaction account, saving you interest of say 5% at today’s rates on your PPOR mortgage)?

3. Build your Credit History

If you’re new to property and are looking to take on your first home loan in the next twelve months or so you’re probably also saving for a deposit and implementing a lot of the tips I’ve offered above—good on you. The next step is to ensure you have some form of credit history for lenders to look at when assessing your eventual loan application. To carry on from Rule #2, the easiest way to build your credit history is to take on a single credit card, use it, and ensure it’s paid off in full by the due date. This will help identify you as a borrower with a proven track record of debt repayment—through both intention and financial means.

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 learning too and expect to make many, many mistakes along the way.

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

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

37 – A Few Reasons for Investing in Property

36 - On Goals

34 - Getting started, again

21 – Tax Time

17 – The New Addition and a Change in Circumstances

13 – Life Insurance

9 - Performance Measurement

6 – Think Rich

5 - How to Spend Money

1. Don’t Spend Money

2. Use Other People’s Money

3. Build your Credit History