If you’re on the path to financial independence and follow a few bloggers as they save and invest their way to freedom. You no doubt have come across an investment vehicle that just keeps on popping up everywhere you look.
Exchanged Traded Funds (ETFs)!
The holy grail of investing, according to most in this space. I’m more open to other types of investment classes such as real estate (I can almost hear the boos and hisses) and believe that each asset class has its strengths and weaknesses. But honestly, ETFs are recommended by so many people (Warren Buffett included) for very good reason:
Extremely low management costs (one of my ETFs charge 0.04%)
Low buy in and exit fees ($20 a pop depending on how much you buy/sell)
Can start investing with little capital (investment properties, on the other hand, require considerable start-up costs)
And there’s more but you get the idea.
So ETFs are awesome right! But how does one actually go about purchasing these little bundles of investment goodness?
Directly through Vanguard vsBuying ETFs
This is the most confusing part of the whole thing. So you decide that you want to buy Vanguard ETFs because you’ve been hearing how awesome they are so you naturally do what any computer literate person would do.
You go to Google.
You punch in Vanguard, head to their site expecting it to be awesome and have them basically walk you through buying their product.
Errrrrr not so fast muchacho’s!
Vanguard’s site is crap. Yes, it has all the information you need on there in the form of white papers. But they have absolutely no funnel for a user to purchase their product. You sorta have to figure it out on your own. And to be honest, Vanguard doesn’t really need to rely on a fancy website or app (they don’t even have an app ffs). Their product is so good they don’t waste time and money on advertising and marketing.
Back to the point. You have two choices when it comes to buying a Vanguard product. You can either buy it directly from them (called managed funds) or you can purchase an ETF through a broker.
In a nutshell:
Good if you make large or irregular investments
Requires trading flexibility
Good if you make ongoing, small contributions
Does not require trading flexibility
The biggest factor is probably cost. Because depending on how often you’re going to make contributions, will dictate which method is right for you. There is a really good article that goes into detail about the costings of investing directly through a mutual fund vs ETFs on the Betterment website.
I have never purchased Vanguard products directly from them because it works out better for me to buy ETFs, so I can’t comment. But I have seen videos and it’s basically a signup, get your details, pick your fund type deal. If you have experience please comment below.
I do have experience buying Vanguard products through a broker though (see the video below to see me literally buying some).
Buying ETFs Walkthrough
Log into your broker (I use SelfWealth) and head to trading > Place Orders
Select the ASX (Australian Stock Exchange) code that you want to purchase (a list of all Vanguard listed ETFs can be found here) or use the search function
Set order type as ‘Buy’
Enter in how many units you wish to purchase
Select at market value or list a price you’re happy with
Set an expiry for the transaction
Review your order and hit submit
Here’s an example of what mine looks like
It’s that simple. Proceed to the next screen and confirm the order and you’re done. It will take a few days to process and the money will then come out of your nominated account and boom. You have now bought some ETFs.
If you have any specific questions please let me know and I’ll answer them to the best of my abilities.
Now go forth and fear not the simple process of purchasing ETFs!
There are countless sites/articles/forums about financial independence (FI) on the world wide web. I’ve often come across really clever, well developed calculators that offer a really good visualisation on how long you have to go before you reach FI. But the longer I searched for the best calculator the longer I realised that they were all geared towards other countries.
One of the main reasons I created this site was to offer my fellow countrymen quality information that was tailored for an Australian audience.
The biggest issue I had with every single one of these FIRE calculators out there was they didn’t factor in our Super system. The US system, which is the main system upon which I found almost all of the calculators accounted for, has a fundamentally different way their citizens can withdraw from their retirement accounts.
To put it simply, in the US you only need one portfolio to be at a certain amount before you are considered FI. But because you can’t access your Super before your preservation age (99% of the time) you end up with two. Your Super portfolio and a portfolio outside of it.
So what’s one to do? Do I just keep plugging away at my personal portfolio until I reach my FI number? That seems like a waste since Super has such a big tax advantage. You’re not likely to beat the 15% tax breaks on your Super.
But I don’t want to put money into Super because I want to retire young! And I won’t be able to touch the money until my preservation age (60 for me).
Decisions decisions decisions!
Introducing The Australian Financial Independence Calculator
The above are two screen shots from the calculator showing the basic settings and the graph that it generates.
You will notice there are two lines in the graph. The Pre Super number is what you will be living off until you can access your Super. The Super number is obviously what’s in your Super.
In a nutshell, the most optimal way to reach FIRE here in Australia is to:
Step 1. Have enough money to survive until your preservation age (when you can access Super). No matter how much you have in your Super, you won’t be able to retire early and pursue your other goals in life if you don’t have money coming in to live off. Step 1 is not meant to last you forever though. It’s only meant to last you until when you hit your preservation age and can then access your Super. You will notice in the above graph that your Pre Super number goes up and up and up…and then slowly tapers off past $0. This is by design. You want your Pre Super number to be at $0 when you access your Super.
Step 2. Have enough in Super to cover all your living expenses forever! You will notice that the red line (Super) has a number of dips.
The green part of the line indicates how much Super you currently have at the start. This will move slowly up (depending on how much Super you have) over the years as your super grows from compounding interest until you hit the pink arrow.
The pink arrow indicates the time you have reached your Pre Super number. When you have reached your Pre Super number you theoretically should be able to live entirely off that number until preservation age (assuming all conditions stay the same). This means that 100% of your after tax income will be going into your Super account until you reach your Super Number.
Your Super number is not actually your FI number. Your FI number will be reach in your Super account at the very start of your preservation year. But no sooner than that, because that is the most efficient and fastest way to reach FIRE. The calculator works out how many years it’s going to take you to reach your Pre Super number and then does some cool math and works out that you need a certain amount in your Super for it to grow into your FI number the year you can access it.
Pretty cool huh!
Video Of The Calculator In Action
Work In Progress
The calculator has some flaws. It’s a work in progress. If you find a flaw please let me know and I’ll try to fix it.
Enter your email address and not only will I send you the calculator. I will send you updated revisions of it ever time I fix a bug or the laws in Australia change.
Enter death blissfully knowing your financial situation will not follow you to the afterlife
I kid I kid.
But the point I’m trying to make is that the old school conventional way of buying a house in our two biggest cities doesn’t work anymore for the majority of people without financial help from their parents or inheritance.
This is because the game has changed! It ain’t what it used to be when ma and pop were hunting for a house.
And if you live in either inner Melbourne or Sydney, this becomes 110% of the time.
So instead of taking on a mortgage in either of these two cities, why don’t you rent for a few years and invest where it makes sense to do so.
Rentvesting can get you into the housing market without the financial stress when buying in inner Melbourne and Sydney.
How Does It Work?
One rentvesting example might be ‘Harry Hipster’ from inner city Melbourne complaining that the housing market is rising faster than he can save for a deposit.
Harry desperately wants to enter the property market but cannot save enough for the deposit and is unsure if he will be able to make mortgage repayments without at least a 20% deposit. Caution Harry is also extremely hesitant about the Melbourne market being in a bubble and is worried that prices could come crashing down just after he has bought.
He has been very cautious of a potential crash for more than a decade now and year after year he has seen friends and family around him buy real estate and increase their wealth. He’s sick of being on the sidelines but can’t afford to buy in inner Melbourne.
Harry discovers rentvesting and decides to take his savings and invest interstate where the property market is more affordable. The collected rent would cover the majority of costs associated with the investment with plenty of upside for capital growth.
Rentvesting has allowed Harry to get into the property market without the mortgage stress he would have had if he had bought in inner Melbourne. Furthermore, if Harry’s financial situation changes he can adapt quickly.
If Harry gets a raise, he can move into someplace more luxurious. Maybe he loses his job? No worries, he can move somewhere more affordable until he finds his feet again. None of these luxuries can be had once you lock yourself into a mortgage that you’re paying for. The investment property is an asset, not a liability. The mortgage on the IP is not paid for by Harry, he has tenants that are paying that loan off for him.
After a few years, Harry may decide to sell the IP getting back his savings plus whatever capital growth occurred during the years and use this money as a down payment for an inner Melbourne house. The entire time, Harry was in the property market and benefiting from whatever gains occurred instead of missing out on the sidelines. Harry was also not under financial stress and had the flexibility to live wherever he wanted to based on the circumstances he was in that year.
No mortgage stress
You won’t be paying off your home to live in. There is a psychological connection to be paying off something that’s yours. Renting can feel like dead money
Ability to save and invest more
No security in renting. Can get kicked out anytime
Exposure to the property market sooner
Rentvesting is for the disciplined! A mortgage can act as a forced savings mechanism. Rentvesting relies on you having the discipline to stick to a budget and not blow the extra cash.
Flexibility to change your biggest expense (living costs) when it suits you.
Start building your wealth now not later
Invest on your terms. 9/10 the place you want to live in is not the best investment. Rentvesting allows you to live where you want and invest where it makes sense.
Frees up cash flow for more smashed avocado on toast ??
With the two biggest cities in Australia being more expensive than ever, more and more Australians are struggling to get their foot into the property market. Rentvesting can be used to get into the market without having the stress of paying a mortgage yourself.
Rent where you want to live, invest where it makes sense.
My partner and I are rentvestors and have no plans to buy a house to live in anytime soon. This gives us the flexibility and freedom that we want this time in our lives. When circumstances change, we have the flexibility to adapt.
Are you currently rentvesting? Why? Why not?
Thoughts and feelings in the comment section below.
“Are you still renting? Why don’t you buy yourself a house already. Rent money is DEAD MONEY!”
If you rent, I’m sure you have come across one of these people at least once in your life. And it’s most likely coming from a loved one who genuinely cares about you. It’s easy to understand how they come to this conclusion too. At the end of every month you have to fork over hundreds (sometimes thousands) of your hard earned dollars for nothing more than the privilege of having a roof over your head. If you were to buy a house however, at least your payments are going towards something you can call your own. That’s the common theory amongst 99% of Australians (especially parents) at least. If you have the deposit ready, is it always better to buy than to rent?
Why You Should Buy
*Let me just make one thing clear before we delve into this debate. I’m going to be looking at this purely from a financial point of view. There are many intangibles that come from buying a home that you can’t measure in dollars. Your home is your castle that you raise your family in. There is an emotional attachment when buying a home which varies greatly from person A to person B.
I personally only really see one major benefit from buying a house to live in.
It’s a pretty major benefit too. When you rent you are always at the mercy of the landlord. Rent could be raised at the end of your lease. Leaky pipes may never be fixed. You’re not allowed to buy a cat because it’s against the rules. And what happens if the landlord decides to sell to home owners who want to move in and kick you out? You have to find another place to live, and anyone who has ever moved or helped move someone can attest to how they would rather take a bullet than do that shit again. Ok it’s not quite that bad but it sucks trust me (have been involved in 10+ moves).
Some people just can’t save money.
If it’s in their account and disposable, they just can’t help themselves and must spend it. I don’t have this problem personally but I understand that for many people it’s an issue. So how can you save money when you spend every spare dollar you earn?
Unless you’re on an interest only loan, you will be paying some principal in your repayments each month. It’s the principal that actually pays off the home, the interest is just how the banks make their money.
The principal payment therefore are sort of like a forced savings mechanism. I say ‘sort of like’ because it’s a bit more complicated than thinking about it purely as savings. Theoretically if you bought your house for $X amount of money and sold it 30 years later for the same price after paying it off, then yes you would be essentially receiving a lump sum of all your principal repayments you have made during those 30 years (not factoring in buying/selling costs and inflation).
But! What happens if you never sell? What happens if the house goes down in value? What happens if no ones wants to buy your home?
It’s is extremely unlikely that you’re are going to have your house go down in value over 30 years but it could happen (see Japan). And it’s for this reason that savings via equity is not as straight forward as you think.
Regardless of these situations though, for people who struggle to save when they have disposable income, a forced savings plan might be a good thing for them. And the banks do a mighty fine job of making sure you ‘save’ every month. They are even kind enough to visit you if you miss too many ‘saving’ payments.
Why You Shouldn’t Buy
Since already establishing what I consider the single and biggest pro when buying to be security, if find yourself in the dilemma of choosing between renting or buying you must ask yourself, why do I need security?
There is merit for people who need the stability that buying comes with. If you have pets, children, elderly parents who you take care of or something else that would be greatly disrupted if you ever had to move. Then I could 100% see the importance of security.
BUT! With security there also comes restrictions!
When you buy a home, suddenly you can’t just pick up your things and leave. You could rent out your house but that’s a pain in the arse. You could sell your house. That is also annoying and it costs money to do so.
Really, really expensive
Buying a home usually means taking out a mortgage. Having debt on something that does not produce any cash flow is a liability. Some people say your home is an asset, I disagree.
But lets push aside some negatives for the time being and imagine that you are someone who needs stability and believes that they are not going to want to live anywhere else for the next few years. Now you actually need to buy the house and pay it off over the next 30 years. Lets crunch the numbers.
Everyone is different but lets just go with the standard formula of 25% of the purchase price (20% deposit and 5% buying costs). On a $600K house this works out to be $120K for the deposit and $30K for buying costs. The loan amount is $480K and even though interest rates are at historical lows now, they will eventually go up so lets just go with 7% fixed interest rate for the entire 30 years of the loan.
Firstly you may notice that the total cost of servicing this loan amount for 30 years equals $1,149,643.
Secondly, the dark pink area represents the principal amount of the loan ($480K) and the light pink is the interest. You end up paying more in interest than you do for the actual loan amount… Just think about that for a second. Some say rent money is dead money, well the same can be said for interest too. YOU JUST SPENT $670K ON ‘DEAD’ MONEY!
It’s hard to even think about. If we break up that interest over the 30 years it works out to be $429 a week or $1,861 a month. You could rent a really nice place for that kind of money.
But because you have chosen to buy you have to pay the interest repayments PLUS the principal, which comes to $3,193 per month. That’s a shit load of money leaving your account each month. I don’t know about you, but that would severely impact my lifestyle if I had to make those repayments each month for the next 30 years.
So far we have $120K for the deposit, $30K buying costs and $1.15M for servicing the loan over 30 years. That comes to around $1.3M!
So far we have covered how much it’s going to cost you to buy the house, but we haven’t covered how much extra it’s going to cost you to keep it running.
Here are just some extra items that come with the privilege of buying:
– Home Insurance
– Water Fees
– Body Corp Fees
– If anything breaks in the house (plumbing, electrical wires, air con etc.) YOU have to pay to fix it
That’s $270K over 30 years to keep a $600K house up and running.
Combining the buying costs with the running costs comes out at a whopping $1.53 MILLION DOLLARS to buy and maintain a $600K house for 30 years.
Forget about Equity!
The other big benefit that a lot of people seem to bring up in this debate is that buying a home will make you money somehow? Last time I checked, buying a home TO LIVE IN does no such thing. You can’t collect rent when you live in your home (unless you have kids). And even if the house goes up in value, it is irrelevant because you can’t live in your house and sell it too. If you withdraw equity then I am of the opinion that you’re selling yourself short of the major benefit of buying a home in the first place (security). You could sell and buy another home BUT this was not the original purpose of buying. If you INTENTIONALLY bought a home only to sell it later in life for a higher price then you are actually investing and the ATO investigates these occurrences where couples may buy and sell every couple of years and take advantage of the CGT exception.
When you buy a house to live in, your goal should not be to sell it later for a higher price. Factoring this into account, I stand by my statement that you will not make money when you buy a house to live in. This removes any investment type gains home owners might be privy to when trying to compare to renters. We want to compare apples to apples as closely as possible. When you start talking about how much the house went up in value it should not be factored into the equation because if someone is happy living somewhere and never sells, then the equity gain is void.
Why You Should Rent
Other than your lease period, renters are free to jump from one place to another.
Don’t like the cost of rent? Move.
Don’t like the location anymore? Move.
Landlord not fixing things around the property? Move
I know that moving is a pain in the arse but do you know what’s more of a pain in the arse? Trying to sell your home AND moving.
It seems to be a growing trend among young people to spend their 20’s travelling around the world, studying and trying new experiences. And that’s awesome! I think that your youth, particularly between the ages of 23-29 is an extremely precocious and unique time in your life when you’re not tied down and most likely have finished your trade/degree and working full time.
You have full time money coming in, are young and can do what you want. Why would you want to tie yourself down by buying a house? You are in such a unique position to be able to drop everything and move/explore/discover the world.
Renting can provide you with the flexibility needed to live this kind of lifestyle.
I personally don’t intend to buy a home to live in until I’m ready to have kids, but that’s me and everyone’s different.
If you think rent is dead money, then you must certainly see interest repayments on a home loan to also be dead money. You can work out the percentage of interest repayments quite easily because they are set by the bank. But comparing that to rent repayments is a bit trickier at first but is easy once you realise how to compare the two.
To work out if you are better off renting and saving money than you are buying and forcing savings (through principal repayments), you must know the rental yield of the property. To calculate this you have to know two things;
How much the place you want to rent is worth?
How much does rent cost?
The place you want to rent is currently being advertised for $400 a week and you think it’s worth about $600K because the place next door is nearly identical to it and is for sale for $600K. Rental yield is calculated using the following formula:
Rental Yield = R/PP
Where R = Rent (Per Year)
And PP = Purchase Price
In our above example this would be
Rental Yield = $20,800/ $600,000
Rental Yield = 3.5%
Can you find a bank with a lower interest rate than 3.5%? Right now the answer is no. The average interest rate for a standard variable loan is 5.1% and that’s with today’s historically low cash rates.
Considering today’s rental yields are 3.5% and 4.4% for houses and units respectively in all Australian capitals, you would either have to be paying above market rent or find a killer bargain for it to work out cheaper to buy than to rent.
It’s simple, is the rental yield you’re paying more than the interest rate you would have to pay if you bought? For the vast majority of Australians I would say the rental yield is going to be lower. There are a few places I have seen in the country where the rental yield is quite a bit higher but I have yet to see it in the capital cities, especially Sydney and Melbourne.
And this is not even factoring in all the other crap that comes along with buying (stamp duty, rates, insurance Etc.)
To compare to our example above. If we rented at $400 for 30 years and factoring in inflation at 2.5% we end up paying $913,176 in rent. This is being pessimistic too because I didn’t factor in inflation for the rates, insurance, body corp etc. above so it would have actually been even more to keep the house running over 30 years.
Still, this means that renting over 30 years come out over $600K cheaper than to buy.
However, the person in the above example now owns the assets outright and at worst is sitting on about $1.23M of equity ($600K over 30 years at 2.5% inflation rate) where as the person who rents has no equity.
** 27/03/2018 EDIT ** There seems to be a lot of comments about me using 2.5% in the above calculation. Australian property (all of Australia not just Melbourne and Sydney) has risen by 2.8% (real rate of return) during the last 30 years (SOURCE)! You could even put the return @ 5% and renting would still come out ahead.
I can’t account for all rates of returns. These are the numbers I have used with a source to back them up. Obviously if the return for properties increases in the future the results are going to be different. ** /EDIT **
BUT! The person who rents has a far greater cash flow position than the person who buys. The renter should have just over $600K (total cost to buy over 30 years minus paying rent for 30 years) extra over 30 years if they managed their money and saved the difference. This works out to be an extra $20K per year the renter has up their sleeve.
Lets assume that the renter realises this advantageous position and instead of blowing the extra $20K, they invest it yearly in a diversified portfolio. Suddenly something strange happens.
At $20K per year over 30 years with a rate of return of 9% (historic average) can you believe that the renter can amass a net worth position of $2.7M!!!
Sweet baby Jesus.
I don’t know about you, but I would much rather have $2.7M invested in income producing assets and have no house to my name than having a money draining house paid off with around $1.23M of equity that you might never tap into after 30 years!
Why You Shouldn’t Rent
Landlords, Leases and Leaks
Have you ever had that real asshole of a boss that is always checking up on what you’re doing, invading your privacy and never fixing the things that are broken at work?
This can be what it’s like when you rent. There are good landlords out there but there are also terrible ones.
Since you are sort of borrowing their house to live in for a while (renting), you can’t make changes to it as you please. For some people this is not an issue but for others (my old man included) it can be hard because they like to tinker, fix things and customize their home to their liking. You can’t exactly knock down a wall to expand your living room without receiving some sort of angry letter from your rental agent. Even if you’re helping to fix the property you can get into trouble. This sucks when there are issues with the rental, like broken heaters, leaky taps, out of service hot water systems Etc.
I hope you didn’t have your heart set on this place either. Because the landlord has just decided to sell the property when your lease period ends to the higher bidder. There is a chance that the next owner could want to rent it out too but there is also the chance that it’s a new family who want to move in straight away. Which means you will have to move out!
Luckily the new owner does intend to rent this pace out. You have lived there for 3 years and have a great history looking after the place. The new landlord offers you another lease and at first you are very happy, that is until you read the fine print which says they have just upped the rent per week by $20 bucks!
Might be time to move places, which of course means attending multiple open days, submitting application after application in hopes that you land one that suites. When you finally find one that you have been offered it’s now time to have a weekend from hell carting all your crap around town to the new place.
FINALLY settled you now sit back and relax in your new abode. 10 months pass and you receive another letter saying that the owners wants to sell… FFS!
No forced savings
If you have a hard time sticking to a budget than renting might not be the smartest move. It’s definitely possible to come out ahead when renting if you are discipline and can invest the money saved while you rent. But not all people can do this.
They see spare change in their account like an expiring gift voucher becoming invalid on Sunday afternoon. They MUST SPEND IT on the weekend with no time to spare! And even though it may be better financially to rent and invest the savings, not everyone has the will power to do this.
I think too many people (especially younger people) get caught up in what is ‘normal’ and buy homes young when they don’t even know what they want to do in life. If rent money is dead money than so is interest repayments, which are much higher than rental yields for the majority of Australians.
You do not make money when you buy a house to live in. You may get lucky and sell it at a profit later in life, but you never hear about all the people that sell at a loss, only the ones that triple their money in 4 years (bullshit artists). You shouldn’t be thinking about making money when looking at a home to live in anyway. It’s first and foremost your home to make your own and to raise a family in. If you want to make money, look at actually investing into income producing assets (stocks, bonds, rentals).
Don’t get caught up in the stigma and shame on renting, break down the numbers and work out what actually costs more. If it’s cheaper to buy then by all means go ahead and buy, if it’s cheaper to rent, ignore the misinformed who try to make assumptions that you can’t afford to buy or that you must be doing it wrong.
Try to break out of the Matrix and look at what is best for YOU not what others think is best for you.
Please feel free to share this article around if you know someone who may be tossing up between the two, it may help them decide.
Until I discovered the concept of FIRE at around the age of 24, my life was on track to becoming pretty ‘normal’. What is normal anyway? I guess it’s what the majority of the people around you are doing?
The ‘normal’ where I live goes something like this:
> Go to school and study hard
> Go to either Uni or get a trade
> Get a job after you have finished your degree/trade
> Find a partner
> Get married
> Buy a home
> Have kids
> Raise kids for the next 20-30 years
> Start to seriously plan for retirement
> Spend the next 10 or so years adding to whatever nest-egg you have in hopes that you can retire soon
> If you’re one of the lucky ones you retire around 60 with enough investments to see you live comfortably for the rest of your life
This model of ‘normal’ usually involved around 40+ years of 9-5 full-time work.
Let me repeat that. 40 years of work…
When I first started working full time I was blown away by how much life you actually lose each week. I knew the hours and that you work Monday to Friday, but it wasn’t until I actually started work that I felt like so much of my life was being wasted. I didn’t even hate my job either, in fact, I quite liked it. But there were SO many other things I’d rather be doing than my job. I knew there had to be a better way. I just couldn’t accept that a human being living in one of the richest counties on earth is required to work the majority of the day for 5 days a weeks for 40+ years in order to finally retire. Which is when I started to learn more about investing and the concept of FIRE.
If you know anything about investing then you most likely have come across the term ‘compounding interest’. Albert Einstein is quoted to have said
“Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.”
If Einstein is saying it’s the 8th wonder of the world than you know it’s some pretty epic shit.
Compounding interest is when your interest earns interest. It’s basically like a big snowball that gathers more and more snow as it rolls down the hill. To get this snowball started you need to supply your own snow. But once you have ‘something’ started then the snowball will roll down the hill gathering little bits of snow along the way (your gains).
After a year of your snowball rolling down the hill slowly collecting other bits of snow, you discover that it’s grown by 5%. Because your snowball is now a bit bigger, the following year it gains even more snow since as it can cover more ground now. This has a flow on effect and after years of rolling down the hill, the snowball has grown to such a size that the amount of snow it can now collect after just a single year of rolling is enormous.
There are two critical components to compounding interest, the initial amount you start with and the time in which you start.
Let’s consider two different examples:
Mike is 25 and he decides to place his life savings of $50K into a savings account that returns 9% per year compounding annually (meaning that the additional interest is paid every year). He makes a promise to himself that this money will be used for his retirement and he must never touch a single dollar of it until he reaches 60.
Ben is also 25, but retirement to him is so many years away that it’s not remotely on his mind. He knows that one day he will probably need to save for retirement as he doesn’t trust that the government will be able to look after him once he can’t work anymore. Ben puts retirement on the back burner and YOLO’s through his 20’s, settles down in his 30’s and has kids.
The years fly by and suddenly Ben is 50. Ben and his wife start discussing retirement seriously and decide to start putting away a decent chunk of their income each year into a similar savings account that Mike used, this account also returns 9% per year compounding annually. Since Ben and his wife started their retirement account later in life they now have to sacrifice their lifestyle and scrap together all the spare change they can get. They miraculously are able to save a whopping $50K each year to add to their retirement fund.
Lets recap for a second. Mike invested a once-off lump sum of $50K at 25 while Ben and his wife invested a total of $500K ($50K X 10 years) between 50 – 60 years of age. Let’s compare how much money they have when they both turn 60.
Mike is represented by the pink columns and Ben and his wife by the blue ones. Mike ends up with over a million dollars in his account with Ben trailing by over $100K on $878K. Keep in mind that Mike made a once-off departure with $50K at 25. T
He also YOLO’d his way through the rest of his life, he didn’t have to save a cent past 25, he didn’t have to sacrifice his lifestyle for 10 years saving $500K and yet he STILL came out over $100K ahead of Ben when they reached 60.
Mike had the power of compounding interest working for him for 35 years. During that time, his $50K nest-egg grew from $50K to over $1,000,000 dollars without him ever having to add or do anything to it.
Historically the S&P 500 Index has returned 9.04% with dividends reinvested so you might not be able to find a savings account that’s going to give you 9% (you won’t) but it is entirely possible that you could have invested $50K and have it return something close to 9% over 35 years. What I’m trying to say is that Mike’s story is entirely achievable. Yes, I left out a lot of things (market swings, inflation, income growth etc.) but fundamentally, if you start young and let father time do the hard lifting for you, It’s 100% possible to build a small fortune with little to no effort thanks to the power of compounding interest.
A Final Thought
I hope that you now fully appreciate the awesome power of compounding interest and how it can work in your favor. I think that the majority of people are doing it wrong when they hold off saving for their retirement. You should start young and be consistent with small amounts rather than trying to play catch up later in life. Get the snowball rolling now not later!
PS* The above graph was made from the smartmoney.gov.au site which can be found here. It’s a really great calculator that lets you compare two different strategies. Have a play with it and you will be astonished at some returns you can end up with if you invest early and consistently.
With my most recent purchase of property number 3 I thought it would be a good chance to clear up any misconceptions about how much it really costs to buy a property and what are the hidden fees, extras and everything else involved right from step 1 to getting the keys.
The most important part of the transaction. The purchase price is where you can really set yourself apart from an investor that knows what they’re doing as opposed to the investing n00b that rolls into a Metricon display home and picks a house off the shelf (this was actually me on my first IP LOL). It’s probably the most important part of property investing, sure you make a woad of cash over the years as compounding interest does its thang. But to really steamroll ahead in the investing game, getting a bargain on each property you buy is vital. It not only gives you a buffer in place in case you had to sell, but more importantly you will see growth WAY sooner than if you bought like 80% of people do, at market value or over.
Yes, I know what some are going to say “Whatever you buy at IS the market price”. True to an extent, but what really matters is how much the bank values the property at. And they usually undervalue the property a tad to mitigate their risk. So if the banks valuation comes back higher than what you paid for it, well done!
The big one. All that hard work and years of savings form your deposit. How much deposit do you need though? Everyone has a different opinion on this one but here’s my take.
If you’re buying a home to LIVE in and not to invest then how big a deposit you put down doesn’t really matter. You probably want to avoid lenders mortgage insurance which is an insurance you have to pay for the bank when your deposit is less than 20%. Isn’t that funny? The banks see less than 20% deposits as high risk so they rightfully take out insurance to cover themselves in case you default on your loan. If that was to happen, the banks would get paid out by their insurer and the insurer would then come after YOU! The funny thing here is that you have to pay for the banks insurance. Imagine if every landlord started charging each tenant-landlord and home insurance because they see them as high risk. It just wouldn’t happen. But the banks have the mula $$$ and they make the rules. So us mere peasants just have to cop it on the chin…OR place down a 20% or bigger deposit.
If you are investing in property however my view on this is a bit different. You can put down less than 20% and pay the extra in fees (thousands of dollars extra depending on the size of the loan and your deposit %) if you are desperate to get into the market because you think it’s rising faster than you can save. For example, lets say that you want to buy an IP for $400K which would require a deposit of $80K (20%) but you only have $60K right now. A year passes by and now you have the extra $20K but now you discover that houses are selling for $500K instead, that means you would now need an extra $20K for your deposit. If you had bought the property at the start with a lower deposit, you would have had to pay the LMI but you would have seen a $100K increase in equity after one year which easily offsets the pain of paying the LMI.
Paying LMI in this case is beneficial but if the value of the property doesn’t rise then you will be stuck with a property with a loan to value ratio (LVR) of greater than 80%. The issue with having a property with an LVR of greater than 80% is that if you want to pull out equity, lets say upto 90% LVR you will have to pay LMI again 😐 . This actually happened to me on my first IP and was quite a shock. I’d already paid LMI to purchase the property but then they slugged me AGAIN when I pulled out equity. Lesson learned. I now only withdraw equity when my property is less than 80% LVR. The banks (my bank at least) allows me to pull out equity up to 80% LVR with no charge attached and it’s a pretty straightforward process.
I put down 20% for each IP that I buy these days but I don’t put down any more than that. Why? Because a 20% deposit I feel is the sweet spot for not only dodging such extras as LMI but also providing a big enough buffer in case anything went wrong and you had to get out.
Some people say the bigger the deposit the better. I disagree. One of my favourite ways to evaluate a property (or any investment) is to calculate the cash on cash (COC) return. The formula looks something like this:
COC = (INCOME-EXPENSES) ÷ CASH INVESTED
I like it so much because it can tell you how quickly you are going to get back your initial outlay that you parted with to buy the investment to begin with. Using this formula you can work out that it is not always the best idea to put down a bigger deposit. Lets for example say that you are looking at purchasing a positively geared house in the country that doesn’t have the brightest future for capital growth but has a really strong rental yield. The purchase price is $170K (yes these houses do exist if you look outside of capital cities) and it is currently tenanted at $290 P/W. Rounding the figures off lets just assume that all the expenses including interest, rates, water etc. all add up to be $9K P/Y. That’s roughly $15K a year from rent and expenses of $9K, which is fantastic positive cash flow straight off the bat of $6K P/Y. Lets say you purchased this deal with a 20% deposit. At 20% deposit you are forking out $34K plus 5% overall buying costs which brings you up to $42.5K OVERALL cash invested. If we plug that into the formula
COC = $6K ÷ $42.5K
COC = 14%.
Assuming no capital growth and not adjusting for inflation this means that at the current rate of return with all things being the exact same, I will get back my initial capital that I invested into this asset back after roughly 7 years. Every $ after those 7 years is pure profit. Now lets change the deposit size and see what happens to our COC return. Let say I was to only put a 10% deposit down instead of 20%. I’m now paying an extra $850 (assuming interest rate @ 5%) bucks each year because my loan is bigger and lets say LMI is going to cost me $3K. My cash flow now changes from 6K P/Y to $5.15K but my total cash invested also changed from $42,5K to $28.5K. So if we now plug those figures into the COC formula we then get the following
COC = $5.15K ÷ $28.5K
COC = 18%
The higher the COC percentage the quicker you get back the money that went into any investment. We could do the formula again with 0% deposit (banks don’t currently let you do this now, they did once upon a time) and the COC would be even bigger, sometimes over 100% meaning you’re making real money from the very get-go.
It’s all about how comfortable you are with risk. I’m not saying to put down the smallest deposit possible I’m just saying that purely from a mathematical point of view you are not always better to be putting down 30% to 60% deposits when you’re investing in real estate. If you want a place to live in then it’s different because your primary goal is not to make money. But if you are looking to make money from investing in property then there are better ways to do it then to put down a big 40% deposit on a property that’s going to take 40 years to generate enough income just so you can be back at square one from where you started from.
This will vary on a number of things but I have used the 5% rule in the past and it has been pretty much spot on for all three of my properties so far. It’s pretty simple really. 5% of the purchase price is usually what it’s going to cost you to buy the property. This covers everything like building and pest inspections, stamp duty and legal fees. It’s a bitter pill to swallow sometimes because if you are buying a property worth $500K, using the 5% rule would mean you are paying $25K just to own this asset. That’s a LOT of money just to buy something which is why a lot of property investors don’t like selling once they have bought. It’s expensive to get into the market and even more so sometimes to exit. I would have to agree with this mantra. You lose enough money as it is through buying fees let alone selling ones. Below is my actual buying costs of the latest property to give you an idea not only of the prices but also the timelines on which I had to pay them. FYI the purchase price was $250K
Building and Pest inspection
More of the deposit
Rest of Deposit
Legal and conveyancing fees
Land Titles Office
From my experience, I have found that I can quickly and easily work out how much it’s going to cost me to buy a property using the 5% rule and 20% of the purchase price. For me, it works out to be 25%. The 5% rule can be applied for most purchases but the other major part to the buying cost is the deposit which will differ from person to person. Do you always aim to put 20% deposit down? Maybe more? Maybe less? I’d like to know your reasoning behind it in the comment section below.