– Retirement in the eyes of a 24 year old –
When? How much? Where from? These three questions are asked of all Income Solutions’ prospective clients, and from time to time, asked of our current clients as well. Let’s break down what we mean by these questions, shall we?
When would you like to retire? Do you have an age in mind where you would like to be able to clock off from a day’s work, never intending to return? How much income would you need to be able to live your desired retirement lifestyle? Finally, and in my opinion most importantly, where will this income come from?
The first 2 of those questions are quite ambiguous and a bit of an unknown, particularly for a 24-year-old. So, I’ll use myself as an example. I have no idea when I would like to retire exactly. By that I mean I do not know the age when I would like to walk out of works door for the last time. I love my job, and hope to forge a long and successful career as a Financial Planner, however, we all must stop at some point, I am mindful of that. One goal of mine is to volunteer 2-3 days per week of my time in helping 2 charities very close to me: MND Australia/Fight MND and the Epilepsy Foundation. I would like to be able to retire at an age when I can be of some real value when I am volunteering my time assisting these great organisations; whatever age that is, I am not sure at this moment.
I also have no idea how much income I will need to support my desired retirement lifestyle. The obvious answer you may be thinking is ‘as much as possible’. True, but let’s be realistic. I would like to have the affordability to travel overseas on an annual basis. Treat myself to some luxuries in life. Hopefully by then I will have a lovely family to spoil; maybe help pay the grandkids school fees; spend time tending to a little hobby farm I hope to one day have. Most importantly, I do want an absence of financial worry, an income stream I can’t outlive and I would be content if I could leave a meaningful legacy to those whom I love. Funnily enough, this is the definition of the term ‘wealth’ here at Income Solutions.
Now question three, where from? This one is considerably less ambiguous and unknown because I have the capacity to be able to influence this variable of my future now. I do know that to be able to achieve my goals, I need to be in receipt of a passive income stream – preferably one that is reliable, replenish-able and in an ideal world, growing. So, as a prudent 24-year-old, I began to contemplate the best way I can generate the passive income I will need in retirement. To do this I decided to educate myself on the 3 true asset classes available to us all: cash, property and shares.
The old folklore is that cash is safe. It can’t go anywhere; $100,000 today is $100,000 in 10 years. You may have lovely memories of Grandma or Grandpa telling you to put all your cash under the mattress and leave it there. The thing is that inflation ruins this because $100,000 today simply does not have the same purchasing power in 10 years. Plus, everybody knows how mediocre interest rates are now. This interest is the income produced by your cash. It is small, tax ineffective and can only grow if you contribute more cash to your account. This asset option is out.
Then we have the Great Australian Dream: Property. This country is internationally notorious for being obsessed with property. Why? Because we can see and touch it every day. (The GFC was actually caused by the domestic property market in the US – not shares. I recommend you watch The Big Short if you haven’t already) We can drive our friends past our investment properties. We have a perception that because we can touch and feel them it is a safe investment. This is quite deceptive, however, due to the hidden costs associated with this asset. I recently attended a very well run property investment seminar just outside Geelong to educate myself on the stats. A $470,000 investment property in the estate had an average rental yield of about 4.4%. I also learned that for my property to have the best chance of being tenanted I needed to have things like 900mm benchtops, a 1 metre wide fridge space, a sound dishwasher, a microwave compartment and good-quality blinds. These might seem standard for a home, but I learned that without them potential tenants can walk away – which means no rental income for the investor and no passive income. Then, once you have found a tenant, you must hope they pay their rent on time for you to be paid your income. You must hope the hot water system and that sound dishwasher do not break because as the landlord, that’s coming out of your pocket. And in 10-15 years down the track, the walls need to be painted, the carpet updated and the oven replaced. There are types of insurances available to cover these, but, again, these are simply another expense. This asset is asking you to pay for it, rather than it paying you! Most importantly, the rental income you receive – like bank interest – is tax-ineffective. Once you deduct all those expenses from the rent, you need to pay tax on the balance at your marginal tax rate. These are all headaches I do not want to have whilst I am volunteering at one of my charities, or spending a few weeks away escaping the Victorian winter whilst I am retired.
You might be reading this and are thinking to yourself something like ‘The capital growth seen with property over the past few years has been off the charts, why hasn’t he mentioned that?’ Good question. Yes, the capital growth of property is going bananas at the moment. Corresponingdly, as is the rapid rise in household debt. A home is worth what a buyer is willing to pay for it, which means whatever sum the bank are willing to loan to them. What happens when these record-low interest rates (which are already increasing) go up 1 or 2%? People are willing to pay less because the bank will give them less. So you’ll see a drop in the perceived capital value of property. Also, you cannot spend capital growth unless you sell. This brings in market timing risk, loads of transactional costs and is an issue I do not want to be worrying about when I need some cash fast.
This asset option is out.
Lastly, we have shares. Thanks to our friends in the media, the populous of this country have an ingrained fear of shares. ‘Share market crash’, ‘Sell while you still can’ and ‘Billions gone’ are all quotes you may have heard about the share market. The media paint horror stories out of anything to sell newspapers and increase viewership. Admittedly, the capital value of shares is volatile in the short term. We can thank the media again for that. If we can ignore this, and simply focus on the long-term and the income generated by shares – not their capital value – we start to see the true value they hold.
Having attended Common Sense Investing at Income Solutions, I learned the Australian share market has returned an average of about 12.5% over the past 100 years. Last financial year, it returned closer to 14%. This was the same year we saw Trump elected president, potential nuclear war in North Korea, Brexit and continuing warfare in the Middle East. All the while, the companies of this country endeavoured to carry on business as usual, and made a lot of corporate profits. As a shareholder, these profits are distributed to you in the form of a dividend. You did not need to worry about the air conditioner at your investment property breaking. How enjoyable does getting a call on Sunday afternoon to fix a front window or the hot water service sound? Or having to make a call to your property manager asking why rent hasn’t been paid for 3 weeks. You simply lived your life as you would, and relied on the businesses of this country living theirs. This sounds like passive income to me. The clients that Gareth Daniels looks after, shared in over $850,000 of investment distributions this past financial year. Without putting in an ounce of effort or worrying about the state of their investment property.
These investment distributions are a result of people paying their utility bill, filling their car up with petrol, shopping at Coles and even making the monthly trip to Bunnings to buy something to fix an issue at their investment property. All these things contribute to company profits. Most importantly, the income received as dividends is tax effective thanks to Paul Keating implementing the Franking Credit system. This is a real trump card for retirees; as they do not pay tax from an account-based pension in retirement!
Now the prudent 24-year-old in me is thinking that this asset sounds good. It does sound like a passive income stream that is generated by human consumption and endeavour. If businesses in this country keep on keeping on, human consumption and endeavour will never stop. The only thing I need worry about in retirement is where in the world do I want to go to next?