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Great Articles
by @cristinapop
Case Study - $1.1m to Invest, Now What? Part 1TweetPinFacebookYummly Reading Time: 5 Minutes Wow what a day guys! Glad to see the end of it that’s for SURE. And you know what really capped it off? Yours truly somehow managed to step straight into doggy doo doo. Now normally I don’t mind a bit of dog poo, it’s a sign of vitality duncha know. Usually it sits there, quietly contemplating life and minding its own business. I respect that, it’s comfortable with the world. Unfortunately, JUST like asbestos… it’s deadly once disturbed. Man alive, I only found out AFTER I got back in the car. Driving down the main road during peak hour, suddenly I felt the peculiar need to pass out. “ARGH!” I yelled. For you see, my nostrils were being viciously assaulted. Suffice to say, I could not wind down the windows QUICKLY enough, gulping HUGE lungfuls of clean, wholesome vehicle exhaust fumes. Just another day in paradise you see… OK so what does dog poo have to do with personal finance and development you ask? NOTHING OKAY. Just wanted to let you know how HARD my life is. GeeBERS. Ummm Sigh. “Lets out huge breath”. Just breathe. You got this. Anyway, so MrsFrugalSamurai sent me a question from one of the Facebook groups she is in, it’s finance related and quite good I thought. Here’s the question which I paraphrased: “Have $AU 1.1m to invest (recent inheritance) + $150k savings Current situation: 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 Others?” WHAT a great question and quite a juicy one to answer “licks lips”. So where to begin? Of course, I have to preface this with all the usual disclaimers, seek personal advice, all my posts are my personal opinion only yada yada (point being is PUHLEASE don’t just rely on what I say). OK so let’s begin! The goal What is it? Only the original poster would know. I’m not a big fan of how broad it is though: “I want to own a home and be financially independent”. I mean, what kind of home, where did you want to live, how much would it be, is it a forever home etc. All of these need to be considered. Same as being financially independent – how much is independence, when did you want it by, what are your expenses, how much savings can you afford to invest, how much risk did you want to take etc. All of these need to be considered as well. Gotta be specific! Maybe a rehashed goal can be, I want to have a fully paid off forever home and FIRE by 50 on $100k a year. So how to get there? Now I know what you’re thinking, and most people (indeed most of the FB comments) were jumping on board the “buy a home ASAP” bandwagon. Fair enough, I mean the $1.1m is definitely the elephant in the room. And there’s nothing wrong with buying a home. Here in Australia, your main residence holds tax exempt status, which means you don’t pay any tax when you sell (you do pay stamp duty when you buy though). So let’s say you’ve spent $1.1m on a dream home, and used up a fair chunk of the $150k savings for stamp duty and associated costs. Now what? It’s back to the 9 to 5, chipping away to increase your level of savings. What then TheFrugalSamurai? I’d break it down first. In personal finance, there’s the 4% rule (or 25x rule) which basically says that you have to multiple your anticipated passive income (FIRE) number by 25 to obtain the amount of income generating assets required. It’s worked out that if you withdrawal your principal at 4%, it “should” remain the same to maintain the level of income (given inflation + remaining principal appreciation). So for his rehashed goal of $100,000 passive income X 25 = $2.5m in income generating assets. This would exclude the family home because your primary residence is usually not income generating. Ahhhh Exactly. Next, I would need to determine at what age FIRE is to occur. I’ve plucked a generic 50 as it gives a nice round number of 20 working years for the original poster in order to achieve this. So then I would look at what is needed to achieve $2.5m from a starting point of $1.1m. That being, around 4.2% returns compounded annually (calculator here): So all he needs is to find which investments generate returns of at least 4.2% p.a. And that’s not factoring in his wages and increased earning potential (nor kids and dropping down to one income). But wait TheFrugalSamurai! Didn’t he say he wants to own his dream place! You can’t chuck all $1.1m into investing! Ah – you’re right there. So what to do? So I’m going to assume that he still wants to purchase a place for $1.1m. And after paying the 20% deposit ($220k), leaves 80% or $880k left – which he can finance all through the remaining cash. Or he can borrow. Borrow? Yeah borrow. But not really. You see, he can “borrow” $880,000 as a loan, and then dump all his cash in there – it’s called an offset account. Which means he doesn’t pay a cent of interest, but can redraw (access) the funds at any time – like a big credit card. And if he fully invests the $880,000 – he’ll be chasing around 5.35% returns for $100k a year. Then of course, he’ll be paying interest on the $880,000. At 3% (what he’ll be paying these days) it’s $26,400 p.a. 4% – $35,200 5% – $44,000 6% – $52,800 And so forth. Can he afford this? Well, let’s take a look at his after tax income. Actually… let’s come back next time to look at his after tax income. You see, I’m detecting a distinct odour again… “looks down at shoes”. Sigh. Did you enjoy this post? If yes, put your email in and click on the little “subscribe” button at the top right. So come on, be a subscriber and get it straight to your inbox fresh out of the oven! Or you can follow me here: https://twitter.com/frugal_samurai https://www.facebook.com/thefrugalsamurai/ TweetPinFacebookYummly