At Investwisely our goal is to help our clients build sufficient capital to stop working.
There are many ways you can achieve this, property and shares are the assets most people are invested in – property through your residence or investment property, and shares through your superannuation.
The reason that property is a great way to build wealth is simple – leverage. Almost everyone we talk to is comfortable to borrow money to purchase a residential property.
However, if we bring up the concept of borrowing to invest in shares, we get a very different response. This is understandable as most people feel that property is a safer investment than shares. This is mostly due to a lack of understanding of shares, but the reason doesn’t matter.
Leverage is important because it amplifies your gains. Of course, it also results in greater losses if you get the investment wrong - think investing in a mining town the week before the mine shuts.
So how does leverage change an investment.
Let’s take a basic look at an example where $100,000 is saved.
In this example we borrow for property but not for shares.
If we invest $100,000 into shares with no borrowing, and the shares record growth of 7%. The $100,000 investment will grow to $107,000.
If we compare that to using the $100,000 to purchase a $450,000 property. Assume the property grows by only 4%. The growth on the property would be $18,000. This is nearly 3 times the share investment.
Yes, the property investment has costs such as stamp duty, and interest. But as you can see if the property selection is correct over time the compounding growth would create significant wealth.
The goal of any investment plan is to build wealth. But ultimately once you generate that wealth you need to create an income from the accumulated capital.
This is where residential property can be an issue. Unless of course you accumulate several investment properties in which case you may be fine. Why is this the case?
Firstly, because the yields are low. The nett return on residential properties generally ranges between 2% - 4% with areas in Sydney and Melbourne more likely to be 2%, other capitals and major regional areas will generally yield more. There are of course options such as duplexes and granny flats, but we will keep things simple for this example.
Secondly, residential property is not ideal as the owner pays for the repairs and maintenance. If you have a low yielding investment and it requires a major repair, it may even turn into a loss in that year. This can be disastrous if you need that income.
Thirdly can only sell the property at one time. I.e. you can’t sell part of the property. So if you do have cashflow problems you cannot control if you are selling into a strong or weak market.
What then are the options you can consider in retirement?
We will consider the different options for simplicity at the same level of savings, acknowledging that the calculation will be different if you have to sell an asset and pay capital gains tax in doing so. Before you make any decision with your investments it is important to get specific advice for your situation.
For this example we assume $1,000,000 is invested in each investment.
1. Term Deposits or Annuities
These investments will offer a fixed rate of return, and in the case of Term Deposits held with a bank in Australia for less than $250,000, come with a government guarantee.
These investments are not perfect as they do not provide any growth to keep up with inflation, and the interest rate on offer can change if rates go up or down.
If you were to invest $1,000,000 you could safely a 5% return today, or $50,000 in income per annum.
2. Commercial Property
Commercial property can be considered a higher risk investment than residential property mainly due to the potential for vacancies to last longer.
It is important to make sure you research and purchase the right commercial property. The best commercial property is one which has more than one use and is easy to rent.
The reason commercial property is better for income purposes is threefold.
Firstly yields are higher, they are generally 5%-8%.
Secondly most leases include an automatic inflation increase in rent each year.
Thirdly the tenant pays the maintenance and outgoings. This is important when considering you are retired and looking for income certainty.
On average a commercial property should yield 6% or $60,000 per annum. Commercial property should also grow in value over time.
3. Diversified Portfolio
A diversified portfolio would include term deposits, bonds, equities, and listed property. It can also include fixed term and lifetime annuities.
The big advantage of this portfolio is that it can be sold in pieces. If you do need funds unexpectedly – for example to move into Aged Care, you don’t have to sell all the investments.
This portfolio when using Australian shares with franking credits can also be tailored to achieve an income return between 4%-6%.
The disadvantage of this strategy is that it is more volatile. That is why when you proceed down this path you need to keep a solid cash buffer so that you only sell when markets are doing well and use your cash when the markets are down. On the positive side this portfolio should grow in value over time.
This investment should return 4% or $40,000 in income.
4. Residential Property
As per above commentary, after costs residential property is likely to average about $25,000 in income.
Summary
There is no one correct answer to what you should invest in once you retire. What you need to determine is your cashflow needs and longer term plans about where you will live. Once you understand this you can put together the best investment strategy for your needs.
If you only feel comfortable with property, then a commercial property might be an option to consider.
One of the things to consider if you do have residential property is how to transition into a different investment.
If you sell you will have agents fee and capital gains tax which can reduce the capital to be able to invest in the next property.
That is why it is critical to plan. You want to sell ideally in an income year you have no salary. This will allow you to minimise the tax. You might consider additional pre-tax contributions to superannuation in that year to further reduce the tax.
You also want to sell into a strong market. So you might need to wait in retirement for the best timing on the sale. In the meantime your superannuation should be able to provide the income you need.
For more professional retirement planning advice, call 02 9634 6698 or book a free consultation online with our expert financial advisors at our office in Sydney's Norwest.
Please note that this article is very simple in its analysis, and you should not undertake any investment decisions without receiving a personal detailed review of your situation. This article in not intended to be advice and is general in nature only. The estimates for each investment can vary, we have selected an average based on what we see in our practice which may not be typical compared to a broader market.
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