It occurred to me that many discussions of achieving financial independence start with the investor asking the following questions:
1. What do I want to do with my life?
2. How much money do I need to do this (to provide an acceptable income stream) and for how long (based life expectancy)?
From there one can made a 'needed wealth' projections based on things like CPI, ability to save, size of portfolio that can be built, toleration of risk, acceptable leverage, yields and capital growth of assets etc.
The benefit of this is that this approach can be applied to most forms of investment, eg shares, cash and property. Conventional financial advisers would likely be comfortable with planning along these lines.
However all this can generate an anxiety about money, especially in recessionary times.
For the panicky investor it could lead to them selling good assets if their value drops.
I am going to suggest a somewhat different method limited to real estate, with the following steps:
1. Examine affordable housing costs relative to people's incomes (Henderson did some work in the 1970s for his poverty index). Public housing defines housing affordabilty as housing expenses being under 25% of income, leaving 75% for all the other stuff like food, transport, health, entertainment etc. http://www.fabian.org.au/903.asp. So let's accept 25%.
2. Assuming your housing costs and expenditures are average, and you wish to conform with the 25% rule, then you will need to own 4 houses outright, not including costs like rates, maintenance and management.
3. Of course all the above costs are very real, and may be around 1/5 (at least) of the total, hence you'll need another house - ie 5 houses fully paid off.
4. To allow a contingency fact for vacancy and bad tenants, another house, fully paid off, would be good, so that brings the total up to 6 houses fully owned.
5. The main exception to 4. above is if you own your own modest house outright in which your costs will be just rates, insurance and maintenance, which should come to under 25% of total income.
6. So for a wide range of cicumstances, you will need the income equivalent of 6 houses paid off: either as all IPs or 1 x PPOR + 5 x IPs. And this is based on a fairly modest expenditure but sustainable indefinitely as there is no eating into capital.
This is pretty much the bottom line for an average existence - if you want more you must buy more (or buy 6 dearer but suffer lower yields, or blocks of units for maybe higher yields).
And note that actual dollars was not mentioned. It would seem to me that while values fluctuate, houses will remain affordable to someone to buy or rent as otherwise no one would. And if you own 6 normal houses outright then there's no doubt that one would be sustainably financially independent provided their personal budget was balanced.
One gets into the dollars and capital growth and strategy in making it happen. There is a line in 6. above that you might have missed but is significant. It is the 'equivalent of 6 houses paid off'. It could be just that - 6 houses and nothing else. Modest, boring but workable.
Or it could be 6 paid off plus 6 more leveraged (but cashflow neutral on average). This could be left as is, with capital gain left to do its thing, or the more conservative might sell up to reduce debt. Or, if you're agressive, 30 houses with 20% equity in each, but note that there'd likely be no net income due to the interest (unless bought years ago when hey were cheaper).
This thinking of 'houses not dollars' goes counter to the conventional financial independence mantra that 'investments are a means to an end, and in this case it is to make money to be financially independent and do/be what you want to do/be'.
Looking at the financial arrangements is no doubt a useful tool for assessing portfolio performance.
But it can lead to anxiety, worry and excessive complexity.
Could some of this be reduced if we think of houses as currency? Equity and progress towards aim could be thought in terms of X houses-worth owned instead of a dollar value (only useful for examining one's own progress, not so good if comparing with others since values vary). This way of looking at it makes fluctuations in value less important, as houses have the same utility (and potential to earn rental income) no matter whether it changes from being 'worth' $200k today to $190k or $210k tomorrow.
All one might need to remember is that ' modest financial independence is the equivalent of 6 houses fully paid off' (but add more if desired).
1. What do I want to do with my life?
2. How much money do I need to do this (to provide an acceptable income stream) and for how long (based life expectancy)?
From there one can made a 'needed wealth' projections based on things like CPI, ability to save, size of portfolio that can be built, toleration of risk, acceptable leverage, yields and capital growth of assets etc.
The benefit of this is that this approach can be applied to most forms of investment, eg shares, cash and property. Conventional financial advisers would likely be comfortable with planning along these lines.
However all this can generate an anxiety about money, especially in recessionary times.
For the panicky investor it could lead to them selling good assets if their value drops.
I am going to suggest a somewhat different method limited to real estate, with the following steps:
1. Examine affordable housing costs relative to people's incomes (Henderson did some work in the 1970s for his poverty index). Public housing defines housing affordabilty as housing expenses being under 25% of income, leaving 75% for all the other stuff like food, transport, health, entertainment etc. http://www.fabian.org.au/903.asp. So let's accept 25%.
2. Assuming your housing costs and expenditures are average, and you wish to conform with the 25% rule, then you will need to own 4 houses outright, not including costs like rates, maintenance and management.
3. Of course all the above costs are very real, and may be around 1/5 (at least) of the total, hence you'll need another house - ie 5 houses fully paid off.
4. To allow a contingency fact for vacancy and bad tenants, another house, fully paid off, would be good, so that brings the total up to 6 houses fully owned.
5. The main exception to 4. above is if you own your own modest house outright in which your costs will be just rates, insurance and maintenance, which should come to under 25% of total income.
6. So for a wide range of cicumstances, you will need the income equivalent of 6 houses paid off: either as all IPs or 1 x PPOR + 5 x IPs. And this is based on a fairly modest expenditure but sustainable indefinitely as there is no eating into capital.
This is pretty much the bottom line for an average existence - if you want more you must buy more (or buy 6 dearer but suffer lower yields, or blocks of units for maybe higher yields).
And note that actual dollars was not mentioned. It would seem to me that while values fluctuate, houses will remain affordable to someone to buy or rent as otherwise no one would. And if you own 6 normal houses outright then there's no doubt that one would be sustainably financially independent provided their personal budget was balanced.
One gets into the dollars and capital growth and strategy in making it happen. There is a line in 6. above that you might have missed but is significant. It is the 'equivalent of 6 houses paid off'. It could be just that - 6 houses and nothing else. Modest, boring but workable.
Or it could be 6 paid off plus 6 more leveraged (but cashflow neutral on average). This could be left as is, with capital gain left to do its thing, or the more conservative might sell up to reduce debt. Or, if you're agressive, 30 houses with 20% equity in each, but note that there'd likely be no net income due to the interest (unless bought years ago when hey were cheaper).
This thinking of 'houses not dollars' goes counter to the conventional financial independence mantra that 'investments are a means to an end, and in this case it is to make money to be financially independent and do/be what you want to do/be'.
Looking at the financial arrangements is no doubt a useful tool for assessing portfolio performance.
But it can lead to anxiety, worry and excessive complexity.
Could some of this be reduced if we think of houses as currency? Equity and progress towards aim could be thought in terms of X houses-worth owned instead of a dollar value (only useful for examining one's own progress, not so good if comparing with others since values vary). This way of looking at it makes fluctuations in value less important, as houses have the same utility (and potential to earn rental income) no matter whether it changes from being 'worth' $200k today to $190k or $210k tomorrow.
All one might need to remember is that ' modest financial independence is the equivalent of 6 houses fully paid off' (but add more if desired).
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, sounds a great perspective.
