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Welcome back folks!
Are you ready for part 2 of the case study?
In which we answer a question MrsFrugalSamurai sent me:
“Have $AU 1.1m to invest (recent inheritance) + $150k savings
Late 20’s income $100k, partner earns $100k
No kids, no assets, no debt
Aim is to be a homeowner and financially independent at some stage.
How would others split it between:
- PPOR (principal place of residence, i.e. primary residence) buy outright or deposit + mortgage
- Investment property
- Low cost index/ETF/Super
If you missed part 1, or want a refresher – don’t fret, have a quick read of it here. Actually… you should, because part 2 won’t make any sense otherwise.
So onwards to part 2…
Can he afford this?
Well, let’s take a look at his after tax income.
Given they are both on $100k p.a. (another nice, round number), that comes back to $74k p.a. net (calculator here) each or about $150k p.a that comes into their pockets.
Here is where their personal circumstances come into play.
Not knowing their lifestyle or spending habits, it’s difficult to ascertain whether they can afford to repay which level of interest percentage.
Also, will there be future children? And if so, will there be a drop to one income? As well as the level of associated expenses with having kids. What are their future plans?
All imaginary numbers at this point.
So for the purpose of this exercise, I’m going to say yes he can.
But what to invest in?
Well, judging from what his required rate of return is (4.2-5.35% from part 1), let’s have a look at the historical returns for major asset classes for the last 30 years:
As for property, the RBA (Reserve Bank of Australia) states “over the past 30 years, Australian housing prices have increased on average by 7¼ per cent per year”…
Therefore, any of these asset classes would comfortably generate a return over and above his required rate of return.
This would cover shares, real estate, bonds/fixed income and ETFs.
It’s now up to him to choose which asset class he is comfortable with.
What would you do TheFrugalSamurai?
Ummm… if I had $1.1m?
ALL IN ON BLACK BABY.
I would probably put half into a high yielding residential unit block, somewhere like in Brisbane or Perth, they’re the next largest cities after the Sydney/Melbourne debate.
The rest I would just whack into high dividend paying stocks, like the big 4 banks or LIC’s (listed investment companies).
I’m not that greedy, capital gains is nice, but I’d rather have income coming in to buy me the most important commodity in the world.
But why not own a place to live?
Yeah, I get that.
I mean over 70% of transactions in real estate here in Australia is from owner-occupiers, that is, people buying a place to live.
Except I reside in Sydney, and $1.1m honestly doesn’t get you much change from buying a place in a decent suburb, close to the usual amenities.
We could move to a cheaper area of course, but jobs, friends and family are all here.
Which is why, instead of plugging away at a 30 year mortgage, I’d prefer to build up a solid income-producing asset base first, AND THEN look for a more permanent place to live.
That way, should something happen like job loss or worse (God forbid). There’s at least a steady income stream coming in.
What do you think? Right or wrong approach? Let me know in the comments below!
You can lead a horse to water as the saying goes, but you can’t make it drink.
The beauty about this question is that you can reverse engineer any answer you want provided you keep your goals specific… it is a mathematical equation after all.
Step 1 – $X passive income required X 25 = $Y in income generating assets.
Step 2- Work out required compounded rate of return from an online calculator based on starting amount and how many years it will take.
Step 3 – Find out which asset class will give you that return.
Though mind you, this was a pretty fun case study to tackle.
Final final thoughts
Oooo and some of you have noted (from Part 1) that I haven’t talked much about the $150k in savings.
No, this is known as a BUFFER.
For emergency use only.
Also, I haven’t made mention of superannuation (kinda like an Aussie 401k our American friends).
Super in Australia is taxed at 15% and is one of the most tax-effective vehicles out there, although anything going in cannot be accessed until retirement age.
This means we wouldn’t be able to access this until… I’m going to guess 70 at the rate our retirement ages keep on being pushed back.
I’ve personally always looked upon super as a bonus – nice to have but can’t rely on.
Also, there are “other” investments to consider – but why would you? With $1.1m in the bank, I’d think risk allocation and capital preservation is more paramount, unless you’re a gungho ACTION STATIONS kinda guy – who wants to turn $1m into $10m in 5 years…
In which case, I should probably be reading your blog instead!
And final, final, FINAL thoughts.
Above all else, make sure to build a GOOD team around you – not someone who sees you as just dollar signs. At the very least, find a good accountant.
Good luck with it!
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Great case study! When you are living in Sydney, even that lump sum wouldn’t get you a big pad!?
The Frugal Samurai
Ah no… unfortunately it won’t get you much at all!