Do you have an IP Financial Plan to get you to retirement?

[Steve Navra]

Hi see_change,

"It's better to be guided by your dreams than your fears."

I do take cognition of your concerns:

"Prolonged slump" . . . meaning what 10 years, 20 years?? Yes this would be a disaster . . . irrespective of whether you were carrying debt or not.

The world economy hasn't had this type of disaster since the depression in 1930 and I would add that economic systems are far more sophisticated these days to prevent and cope with such a meltdown.

NEVERTHELESS:
One should still plan for severe downsides.
Even with the most severe stress testing, you can still build in buffers to keep the process moving.

The real point is that with a TOTAL LVR of 65% (80% property and 50% shares) the process should always be able to self generate.

The KEY safety mechanism is NEVER to spend more than your previous years CG.

I re-iterate the importance of efficiency (No LAZY Dollars) . . . the process must go on; time wasted constitutes dollars down the gurgler.

Regards,

Steve

 

[Bill.L]

Hi all,

Really interesting thread this one.

Assumptions.

All the different ways to wealth painted by the different gurus, make assumptions about the future. They are usually guided by the immediate past. (ie 10-20 years)
The weakness of all the easy sounding formulas for wealth, are bound by a simple fact that the investment climate changes. To assume 7% growth in property while there is 3% inflation is absurd. To assume a 10% return from shares (dividend +CG) is absurd.

If you look at what happened to some funds (share) from the early 80's to the mid 90's, you get an interesting picture. Some funds some relatives of mine were in (and touted by many FP as good solid conservative investments), had a big run up to 87 and then the big fall. But by the mid 90's when the index had more than trippled from the early 80's, these funds were still below where they started in the early 80's. The reason being they were in the wrong companies.

In property, if you look at what happened in SEQ over a 10 year period from 92 -02, say you had bought property in '94 because the returns were better than the previous few years, then 5 years later there is still no growth AND the share fund you had your money in had gone DOWN in value.

If you go into investments counting on certain things to happen, you are in deep s*** when your assumptions don't come true.

I 100% agree that doing nothing is bad. BUT doing too much can be disasterous.

I fully agree with SC and Quiggles, you need flexability and cannot rely on current assumptions bieng the roadmap for the future.

For those who think about living off equity by using debt, consider the following ....

1/ What if the banks (by govt legislation?) change the lending rules and don't consider annuities as income??
2/ What if the cap gains tax rules change (for the worse) and you have had a prolonged slump and must sell some property (say 15 years into living off equity)???
3/ What if govt introduce a new ongoing property tax that causes you to bail out of your strategy after you have continued to build up debt??
4/ What if everyone tries to do this for retirement??? How can the economy cope with a great % of the population trying to live this way??

Living off increasing debt looks wonderful, sounds wonderful, BUT, BUT, BUT is based on assumptions, assumptions, assumptions.

bye

 

[keithj]

"Prolonged slump" . . . meaning what 10 years, 20 years?? Yes this would be a disaster . . . irrespective of whether you were carrying debt or not.

The world economy hasn't had this type of disaster since the depression in 1930 and I would add that economic systems are far more sophisticated these days to prevent and cope with such a meltdown.

I plan to live for at least 50 years in retirement. What do you think the odds of a prolonged slump are some time in the next 50 years ?

The KEY safety mechanism is NEVER to spend more than your previous years CG.

Therein lies the risk.

How would you compare the risk of 'living off equity' to the more conventional retirement method of living off income ?

KJ

 

[kissfan]

For example if you have $500000 in equity draw down what you can and use it to say invest in shares for dividend or trade for income as mentioned before. Say you make 10% for the year there's $50000 to live off and you still have your equity which should keep increasing.

What about the annual interest bill on the $500,000 you've just drawn down.

Regards
Marty

 

[duncan_m]

1/ What if the banks (by govt legislation?) change the lending rules and don't consider annuities as income??

Who cares? If the finance isn't available.. sell something, its not the end of the world.

2/ What if the cap gains tax rules change (for the worse) and you have had a prolonged slump and must sell some property (say 15 years into living off equity)???

Then you would have had 15 years of an absolutely charmed existence whilst most people your own age would have been slogging it out in the workforce. And then you have to sell some property? Big deal.

3/ What if govt introduce a new ongoing property tax that causes you to bail out of your strategy after you have continued to build up debt??

Hardly the end of the world.

4/ What if everyone tries to do this for retirement??? How can the economy cope with a great % of the population trying to live this way??

Geez, what planet are you on? Suddenly not only is EVERYONE going to start investing, but they're ALL going to do it the same way?

Bill, you really are the original Chicken Little. Your post would have to be one of the all time saddest, most despairing, most doomsaying things I've ever read on Somersoft.. Really, if it all turns to custard, I'll sell something, hell I'll even go clean toilets if I have to.. in the meantime I'll take what-ever "job-free" years I can get my hands on.

Bill, I found a new avatar for you, you might need to shrink it.. but here it is:

 

[DD1]

Cap gains essential

To keep drawing off your equity to live on is ok if the market is continually moving forward and yoiu can use differing properties to use this equity from.
The main problem as previously stated is sustainability unless you have a very large portfolio.

Most people with less than 10 properties would find it too hard to generate enough cap gains to make this work. Personally we supplement this by me doing our renos myself which relates to higher rents to make each property more cash positive.

2 weeks ago a townhouse in Kingston got a complete makeover for $6k, this related to a $30/wk rental increase and was completed in 1 week. As the property had prior to this been tenanted, the carpet replacement and electrical work were classed as repairs and therefore claimable this year and not at sale like a capital expendature if the place had never been tenanted and renoed before any income had been generated from the property.

So achieving a tax loss from doing the reno now as opposed to at sale time is a major benifit, over $1500/yr more rent and a property that will need zero maintainance for the next 3 years. A good outcome when trying to live off your investments.

Equity can take you so far and then you will need to get creative.

DD1

 

[Steve Navra]

I plan to live for at least 50 years in retirement. What do you think the odds of a prolonged slump are some time in the next 50 years ?

The odds of a prolonged slump in the next 50 years are at least equal to the odds of a matching boom in the next 50 years.

Therein lies the risk of seeing the glass as half empty.

How would you compare the risk of 'living off equity' to the more conventional retirement method of living off income ?

Two factors to consider:

Initially the use of equity allows you to acquire a much BIGGER asset base, BEFORE you start living off the equity. (3 times as much each ten years)

Equity is capital and therefore not taxable and so worth up to double the value of taxable income. (Conversely you only need build up half the asset base !!)

The result of course is double the value on 3 times the asset base = 6X better off.

Without being provoctive, I challenge the 'conservatives' (Risk averse) to mention the net equity they have built up over time with their methodology and then to compare this with the net equity built up by the less risk averse members.

It is this very factor of net equity that insulates one against difficult times and is THE BEST BUFFER OF ALL.


Regards,

Steve

 

[Steve Navra]

Duncan . . . whew

I too am very passionate in defense against negativity 'holding members back from achieving their dreams.

However I must spring to the defense of Bill.L:
Opposing views are good! (Add value to the debate)
Each to their own . . .

The reality really is that some will succeed better than others, based on the decisions they have taken.

I forward my views to try as best as I can to help others overcome some of their investment fears.

Reckless investing is NOT a prerogative . . . all I am suggesting is that RATIONAL PLANNING will get a better result.

Let's wait and see if any of the 'Conservatives' take up my challenge )

Regards,

Steve

PS: Conservative is not necessarily bad. (Poor perhaps, but not bad )

 

[duncan_m]

However I must spring to the defense of Bill.L:
Opposing views are good! (Add value to the debate)
Each to their own . . .

I'm no stranger to holding opposing views on this forum.. But really, Bill appears to hold fears bording on irrationality (the entire population of the country suddenly start investing AND living off equity!?)..

I take my hat off to your staid patience Steve, a quality I'm sorely lacking.

 

[OSienna]

Without being provoctive, I challenge the 'conservatives' (Risk averse) to mention the net equity they have built up over time with their methodology and then to compare this with the net equity built up by the less risk averse members.

That's a rhetorical question. It goes without saying, the higher the risk the greater the expected return. Try posing that question to someone who played the tech stocks during the recent IT boom.

 

[Glenn]

Duncan . . . whew

I too am very passionate in defense against negativity 'holding members back from achieving their dreams.

However I must spring to the defense of Bill.L:
Opposing views are good! (Add value to the debate)
Each to their own . . .

The reality really is that some will succeed better than others, based on the decisions they have taken.

I forward my views to try as best as I can to help others overcome some of their investment fears.

Reckless investing is NOT a prerogative . . . all I am suggesting is that RATIONAL PLANNING will get a better result.

Let's wait and see if any of the 'Conservatives' take up my challenge )

Regards,

Steve

PS: Conservative is not necessarily bad. (Poor perhaps, but not bad )

Hi Steve, Bill L

The conservative point of view to this date has not accounted for one very important thing that changes the amount of risk involved in investing.....WE GET BETTER AT IT THE MORE WE DO IT.

You cannot tell me that somone with the ability to buy 10 properties did not get better at it during the course of their investing life. On a personal note, I realise some of the mistakes (or things that could have been done differently) that I made with my first and last purchase and will use that to guide me with future purchases.

Glenn

NOTE: I am an omptomist and expect good things will happen each time I wake up

 

[Bill.L]

Hi all,

OK Duncan , I'll bite.

Let's imagine over a 5 year period where at 80% lvr, you have not gained. But you were at 30% before you started with a new riskier structure.

Before I continue.. Do you really think it is not riskier???

You have a property that you purchased for $300k (and have $300k loans). A few years later when you start your new "live off equity" life it is worth $1m. You gear up to 80 % lvr and live the good life.

You have no growth for 5 years, and find the rules to lending have changed. Your answer is to simply sell the asset.

Lets see how this works. Sell for $1m pay REA $25k, loans $800K, pay cap gain tax 25% of 700K = $175,000

Well at least your square.

Now let's see where you would be if you had just owned the property as an IP, where you would be?? asset worth $1m debt $300k, but more than likely cash flow positive, putting money in your pocket every week, for more than just the 5 years.

You obviously don't understand risk, to the extent that a FALL in values after you had instituted your plan would be in what Steve calls a "disaster".

I have never said "don't invest the sky is falling" in fact I am dead against the "doom and gloomers" who turn up on the forum from time to time. I just like to question the assumptions that many choose to believe in.

Yes Duncan , it is easy to ASSUME you can cover any particular single event easily, and label the possibility of a combination of things going wrong as unlikely.

As Steve often points out living off capital is not taxable, BUT should you have to change your plan and sell an asset you have geared up, you WILL pay CGT.

AND of course I would be out of my mind to suggest that a future govt could possibly change the Tax rules (to the detriment of investors)

bye

 

[keithj]

The odds of a prolonged slump in the next 50 years are at least equal to the odds of a matching boom in the next 50 years.

Therein lies the risk of seeing the glass as half empty.

So you're saying there is a 50% chance of a prolonged slump ? And therefore a 50% chance of 'disaster' (your words to SC). I'm all for seeing the glass is 1/2 full, but I'd consider the glass is mostly empty if there's a 50% chance of disaster.

Two factors to consider:

Initially the use of equity allows you to acquire a much BIGGER asset base, BEFORE you start living off the equity. (3 times as much each ten years)

Equity is capital and therefore not taxable and so worth up to double the value of taxable income. (Conversely you only need build up half the asset base !!).

I agree entirely. However, the question was

'How would you compare the risk of 'living off equity' in retirement to the more conventional retirement method of living off income while in retirement ?'


Cheers,

KJ

 

[Bill.L]

Hi again,

Steve a quick question about your quote

"The KEY safety mechanism is NEVER to spend more than your previous years CG".

What if the previous years CG was negative?? Should you be putting money into the system/strategy rather than taking it out??
For a retired person living off equity where would this come from??

bye

 

[quiggles]

Actually Quiggles ,this is my concern about the whole system.

Darn, I should've used the quote function. I was referring to 2 things - the level of debt that concerned you (I'm MORE comfortable having 80% LVR on $10 million than 80%LVR on $1 million) and I'm entirely unconcerned about Alan H's perceived risk. it's the Real risk vs reward tht is the problem.

As your later post points out, the risk/reward ratio is substantially worse when the plank is 50 meters up, since the downside is greater (huge damage/death) but the upside hasm't changed (you get across the plank).

But chewing up the equity which should be your engine of growth - and why should you stop growing before you die? - does not agree with my tactics. I would instead increase my cashflow and spend that, while allowing the CG to proceed along its merry way.

Put differently, I will spend more when my assets earn more - I will not spend more by spending my capital.

Finally, I reckon 10 million is pretty achievable. It'll take a while, (probably another property cycle for me) but I can lick the marshmallow, rather than take bites out of the side.

 

[duncan_m]

Let's imagine over a 5 year period where at 80% lvr, you have not gained. But you were at 30% before you started with a new riskier structure.

I've never advocated kicking the process of at an effective LVR of 80%.

You have a property that you purchased for $300k (and have $300k loans). A few years later when you start your new "live off equity" life it is worth $1m. You gear up to 80 % lvr and live the good life.

I'm already well into the millions and I havent started the "new life" yet.. when I do start it.. my porfolio value will be even higher and I'll only be drawing down HALF of an inflationary rate of growth.. Bill, my LVR is hardly going to move.

You have no growth for 5 years, and find the rules to lending have changed. Your answer is to simply sell the asset.

That IS a POTENTIAL solution to the issue. Personally, I'll be able to sustain a lot more years than 5 before I had to consider selling something.

Lets see how this works. Sell for $1m pay REA $25k, loans $800K, pay cap gain tax 25% of 700K = $175,000

Well at least your square.

Based on your somewhat self-serving example. yes.

Now let's see where you would be if you had just owned the property as an IP, where you would be?? asset worth $1m debt $300k, but more than likely cash flow positive, putting money in your pocket every week, for more than just the 5 years.

I gave up the idea of living off rental income years ago when I realised how incredibly long it would take to acquire enough 'gap' between Rental Income and Interest payments.. and how reduced a lifestyle I'd be living.

You obviously don't understand risk, to the extent that a FALL in values after you had instituted your plan would be in what Steve calls a "disaster".

Re-read what I've said above.. there's an enormous amount of fat in my (albeit unwritten) plan.

I have never said "don't invest the sky is falling" in fact I am dead against the "doom and gloomers" who turn up on the forum from time to time. I just like to question the assumptions that many choose to believe in.

Bill, you're fairly in the "sky is falling camp" when you put forward a fear that the a large percentage of the population of Australia might start investing AND do it the same way is just too bizarre for me to contemplate for too much longer.

Just for everyone elses viewing pleasure, let me requote you:

4/ What if everyone tries to do this for retirement??? How can the economy cope with a great % of the population trying to live this way??

As Steve often points out living off capital is not taxable, BUT should you have to change your plan and sell an asset you have geared up, you WILL pay CGT.

Yes, and given A) the 50% discount and B) the Trust structure, multiple beneficiaries that I have access to, its pretty manageable.

AND of course I would be out of my mind to suggest that a future govt could possibly change the Tax rules (to the detriment of investors)

Bill, I never said they wouldn't, in fact I guarantee they will.. but I'm not wasting any time considering it as that scenario will be TRUE for ALL investment approaches.. even "buy and hold and live off rental income"

Bill for some reason your approach to this discussion is to take the example of someone who can only BARELY invoke the Equity Approach.. why not appreciate that when you kick off the process with a sub 80% LVR _AND_ a conservative draw down of capital that the plan starts to look extremely risk/event tolerant and extremely self sustaining.

 

[duncan_m]

Bill for some reason your approach to this discussion is to take the example of someone who can only BARELY invoke the Equity Approach.. why not appreciate that when you kick off the process with a sub 80% LVR _AND_ a conservative draw down of capital that the plan starts to look extremely risk/event tolerant and extremely self sustaining.

Bill,

Here's a rough spreadsheet for someone with $1.3M in equity.. good rental income, and is capable of living on about $70K a year, there's columns you can play with for Growth, Interest Rates, Equity Draw Down percentage.. there's a column for inflation (to index the rental income), there's a column for Net Worth because we're drawing down less than our portfolio is growing at in some years.. There's a column for the increase in interest costs due to the new draw downs..

Please show me where a foreseeable set of circumstances is going to cause this person to come off the rails (not my own figures). And please also show me where that SAME set of circumstances wouldnt also affect the person living off JUST rental income...

Note that this is a BARE BONES approach, the drawn down equity is just SPENT, not re-invested AND the ever-decreasing LVR is NOT put to use in other asset classes in cycles that are maybe inverse to the property market at that time.. in other words the LAZIEST, MOST risk prone way to invoke this strategy. Gosh, and even with an average growth over 30 years of just 5.19%!

This is of course assuming that the borrowings will always be available.. if they ever WERENT then you'll note that the NET WORTH column which has been steadily increasing would enable someone to sell the lot, pay CGT, and then invest the proceeds in other income producing investments.

 

[duncan_m]

Put differently, I will spend more when my assets earn more - I will not spend more by spending my capital.

Hi Quiggles,

This is just a mindset though, at the end of the day (at least for me) there are TWO things that are important to me:

1. Increasing my Net Worth.
2. Having money in my wallet to spend each day.

As long as the strategy mix I invoke delivers BOTH of those outcomes, I dont care if the readies in my wallet come from traditional rental income, or if its spent equity.

I wont be spending ALL of my capital, not even close to it.. Just a little bit each year. My NET WORTH continues to climb, dramatically. And I can nearly do it NOW rather than waiting for a whole 'nother cycle to go past.

 

[natmarie73]

What about the annual interest bill on the $500,000 you've just drawn down.

Regards
Marty

Good question,

In regards to my admittedly hazy plan for retirement, I would expect that my positive cashflow rents would offset this interest payment. I would also hope that I made more than 10% a year on income producing assets, at least enough to offset any tax deductible interest payments as well as provide a decent amount to spend or reinvest.

Selling property here and there also forms part of my plan, both to access capital gains and to pay down debt.

As I see it, accessing your equity for living expenses will also incur interest so there does not seem to be any way around it. At least it will be tax deductable if used to generate income.

Nat

 

[Steve Navra]

Soooo many questions:

That's a rhetorical question. It goes without saying, the higher the risk the greater the expected return. Try posing that question to someone who played the tech stocks during the recent IT boom.

Hi OSienna,

My point is that with the correct safeguards (Buffers) the risk is NOT higher . . . with a better return.

IT Boom?? That’s a bit like buying highrise units off the plan and hoping for a good result. The most basic investment criteria is to do due diligence and assess what a good / bad investment is BEFORE buying. IT stocks represented a huge inflating bubble with little or no real value. P/E was unacceptable, D/E was unacceptable, performance history was unacceptable and many more reasons NOT TO TOUCH these shares!!

Yes I know many people got burnt in this sector . . . 80% : 20% rule.
For the record I DIDN’T buy any IT stocks at that time for the reasons mentioned above. (Despite many, many, many people telling me I was missing the whole 'new economy".)

Let's imagine over a 5 year period where at 80% lvr, you have not gained. But you were at 30% before you started with a new riskier structure.

Before I continue.. Do you really think it is not riskier??? (NO I DO NOT!!)

You have a property that you purchased for $300k (and have $300k loans). A few years later when you start your new "live off equity" life it is worth $1m. You gear up to 80 % lvr and live the good life.

You have no growth for 5 years, and find the rules to lending have changed. Your answer is to simply sell the asset. (NOT NECESSARY)

Lets see how this works. Sell for $1m pay REA $25k, loans $800K, pay cap gain tax 25% of 700K = $175,000 (N/A)

Well at least you're square. (NO, NO, NO . . .)

Now let's see where you would be if you had just owned the property as an IP, where you would be?? asset worth $1m debt $300k, but more than likely cash flow positive, putting money in your pocket every week, for more than just the 5 years.

Hi Bill.L,

Original position before structure as per your example:
$1,000,000 property and <$300,000> Debt
LOC at 80% = $500,000

NO growth following 5 years:
No growth = NO SPEND!!
Therefore You still have $1,000,000 property and <$300,000> debt and a $500,000 LOC
Okay so no better and no worse.

Now:
Imagine you put the $500,000 into the share fund:
Firstly the cost will be say 7.5% for the drawdown = <$37,500> per year.
Also you margined the shares to 50% at 7.5% = <37,500> per year.
Total cost = <$75,000> per year.

Assume NO growth in shares also!
So $1,000,000 of shares = $1,000,000 No loss in capital BUT what about the costs?

1) Dividends at 3% to 6% (Fully franked) = Cover the expense of borrowing. (Yes tax benefit/ write off required.)
2) Distribution (Which is the realized profit between buy prices and sell prices . . . Dollar Cost Trading) @ 10% = $100,000 per year.

So you will be $25,000 per year better off . . . compounded for 5 years = $152,627-50

Next question is can DCT produce the 10%??
To date it ALWAYS has . . . BUT:

If you assume ZERO volatility for the five years. (IE the shares stay at the identical prices) then NO you won’t make this return.

THIS HAS NEVER HAPPENED!! I suggest that a portfolio of shares will remain absolutely static (Zero volatility) for about as long as you can hold your breath!!

So you're saying there is a 50% chance of a prolonged slump ? And therefore a 50% chance of 'disaster' (your words to SC). I'm all for seeing the glass is 1/2 full, but I'd consider the glass is mostly empty if there's a 50% chance of disaster.

WHY??
As long as you have COVERED the downside disaster (Buffer) then the upside is all to gain.

50% : 50% odds imply that we cannot be predictive . . . equal chance either way.
Long term trends seem to indicate that markets do trend up in the long term so I suppose the odds are more against than for the downside.

However, as long as you do not spend your capital before you make it, then you will never be worse off than if you had done nothing.

I agree entirely. However, the question was

'How would you compare the risk of 'living off equity' in retirement to the more conventional retirement method of living off income while in retirement ?'

The risk is IDENTICAL:
Same rules as above . . . Don’t spend it before you have made it!
Then, besides having built up an enhanced portfolio, the value is up to double, because it is not taxable.

Steve a quick question about your quote

"The KEY safety mechanism is NEVER to spend more than your previous years CG".

What if the previous years CG was negative?? Should you be putting money into the system/strategy rather than taking it out??
For a retired person living off equity where would this come from??

Hi Bill.L,

No you don’t need to put the money back in . . . you would be in the identical position as if you had done nothing and your asset value will be down to the same extent as the negative CG in both situations.

I REPEAT: You can only SPEND the equity when you have MADE it.

Put differently, I will spend more when my assets earn more - I will not spend more by spending my capital.

Hooray


Regards,

Steve