Before you start investing, whether it be in property, shares, commodities or whatever you choose as your investment vehicle. You need to be able to manage your money. Sounds simple doesn’t it?
It’s almost embarrassing to write about it. But if you look at statistics worldwide, whether it be Australian, American or European statistics they all tell the same story. People can’t manage their money. They’re over their head into debt, spending money they don’t have on things that lose their value as soon as they’re taken out of the box and investment returns of the average investor are just miserable.
Heck, the majority of professional fund managers can’t beat their benchmark indexes.
The following, taken from Jamie McIntyre’s book “What I Didn’t Learn at School but Wished I Had”, illustrates the depth of financial intelligence of the average Australian, which I’m sure will be quite representative for the rest of the western world. Jamie states: “If we gave every Australian $10,000 right now, what would happen to that money in twelve months time?
Statistics show that 80% of Australians would have spent all the money and have nothing left, because this is what most of us have been taught to do. 16% of people would have turned the $10,000 into $10,500. Where do you think they would have put it, to get such a handsome return?
Of course, it has gone straight in the bank! Now, we can not call either of these categories financially intelligent and those figures make up 96% of the population! Less than 3% of the population would turn the $10,000 into as much as $20,000 inside twelve months.
If you can do that you would definitely be considered financially intelligent. In fact, if you can do that, there is probably no dream on the planet that you could not afford to buy one day, that is up to 100% return on your money! The remaining 1% of the population can turn that $10,000 into as much as $1,000,000 inside twelve months.”
Not sure where Jamie got his statistics from, but they ring true. So, just think…Which group do you belong to?
I know I’m not in the top 1% otherwise I wouldn’t even be creating this website. I know I’m also not in the bottom 80% or even in the 16% who just made 5%. I’m one of those 3% of people who would make a good to great return on their $10,000 but not necessarily as much as 100% in one year though.
But I also know that 5 years ago I would have been in the 16% who would have made measly 5% and 10 years ago I would definitely just have blown the money and had lots of fun doing so – which is not a bad approach for a twenty something! But once you get older and if you have plans to not work till your 60th, 65th or even 70th that approach won’t work and you need to get smarter at managing your money.
Now, there are plenty of money web resources and books out there that aim to explain to people the basic concepts of properly managing their money. One of them is Robert Kiyosaki, author of Rich Dad Poor Dad who coined the phrase Financial Intelligence and in his books aims to explain a lot of basic money management skills most of us do not learn at home nor at school and therefore go through most of our lifes without them.
And that is what this section of the site is all about. I have summarized all the essential elements from Robert Kiyosaki’s Rich Dad Poor Dad, from the Millionaire Next Door and other classics in these pages and provide numerous external links to great sources of additional information. So everything you need is here.
Now, it’s up to you.
Read. Learn. Take action. Become wealthy.
Analyzing Historical House Prices Between 1960 – 2006 Reveals Interesting Long Term Trends
As part of my general research on Australian property I have been looking for charts showing long term price trends, probably like most other property investors. Unfortunately, I have not been able to find these kinds of charts other than the typical 10 or maybe 20 year trend – but that is not really the long term horizon I want. I want more something showing historical house prices over the last 50 years and I don’t want to pay for the data.
With some persistence I have found two datasets over different time periods, being:
- Median Australian house prices from 1986 to 2006 from REIA as quoted in Michael Yardney’s book “How to build a multi-million dollar property portfolio in your spare time”
- Median Melbourne house prices from 1960 to 1986 from BIS Shrapnel as quoted in Jan Somer’s book “Building Wealth through Investment Property”.
Even though these datasets are different in that the REIA data are median house prices for the whole of Australia and the BIS Shrapnel data is median price data for just Melbourne, I believe that they provide a representive overview when combined as long as you are looking for long term trends. In fact, median house price data is quite unreliable other than for general, longer term trends anyway.
The first chart below, showing historical house prices between 1960 and 2006, is therefore based on the above datasets with the BIS Shrapnel data running from 1960 to 1985 and the REIA data from 1986 to 2006. It clearly shows strong exponential growth, but with periods of limited growth where the curve remains relatively flat.
If you look closely at the supporting data you can see that from a median house price of $8,300 in 1960 it took some 12 years for the median house price to double by mid 1972, but then from mid 1972 to mid 1975 the prices doubled again – just three years. Below, I have summarized the doubling periods taking 1960 as the basis:
1960 – 1972 = 12 years to double
1972 – 1975 = 3 years to double
1975 – 1983 = 8 years to double
1983 – 1988 = 5 years to double
1988 – 2001 = 13 years to double
Interestingly enough most property experts state that Australian residential property values double in 7-12 years with the long term average indicating a doubling in values every 7 years, which suggests an annual growth just over 10%. Now the dataset I have used here is not internally consistent so I have to be careful with drawing conclusions, but to me the data does suggest that the typical doubling period is much more erratic than the established property experts would have us believe. And the averaged annual growth between 1960 to 2006 was 8.7% rather than in excess of 10% annual growth.
You can also see from this that the value of timing the market can be significant – if you can get it right.
Problem is, that most of us can’t call the exact top or bottom of a cycle let alone predicting whether the doubling will be in 3, 5, 8 or maybe even 12 years. So, I personally don’t try to “time the market” and in stead rely on “time in the market”. Not very glamorous and certainly not a get rich scheme, but it is a sure way to build wealth. Hopefully significant wealth.
I am still looking to find a single consistent dataset from 1960 or earlier and will then update this page. In the process I have found house price data for Brisbane from 1970 onwards and developed a similar set of graphs, but with limited commentary.
When you redraw the historical house price chart using a logarithmic scale on the vertical axis you get the chart shown below. It uses the same data, but by plotting it this way you can more easily determine how annual growth has varied over the years. If annual growth had been constant over the years, the graph would be a perfect straight line, like the dashed trend line. Instead, you can see certain periods where growth lagged, typically followed by a few years of accelerated growth – the property cycles we all know about.
Now the graph above can be a bit misleading in that it suggest a very stable growth pattern, but when you annualize the median house price data more carefully and calculate annual price increases you see that there are years of extreme, moderate, low and sometimes even negative growth.
Even though there are cycles within the property market, the annual growth chart above shows that it can be difficult to predict annual growth from year to year. That is why I strongly believe in the age old mantra “time in the market” rather than trying to “time the market”
So we have looked on house prices since 1960, let’s have a look at what the future may hold. Now unlike others I don’t pretend to know what the future holds and I don’t have the ability to develop complex house price models – not that I would want to if I could. Let’s just try a simple approach and add a trend line to the 1960-2006 data and see what that might tell us.
For this I have use the logarithmic chart as it is easier to fit a trend line to and the result is captured in the house price chart below.
Be careful – this is not a prediction!
You may ask, why bother with something as boring as demographics.
It’s simple really, the property market, just like any free market is driven by economics, by supply and demand. And as an investor you can work on the supply side of the equation, but there is precious little you can do about demand. You can however do your utmost to understand what the demand is now and how it is likely to change over time so that when you offer a property on the market, be it for rent or for sale, it will be something that people actually want. Ensuring your investments are in demand is ensuring your investments will get a good price in the market. In short, a little knowledge on demographics can make you money.
The problem is what people want now is likely to change and demographics combined with certain social trends can give us some helpful insights into what the future might hold.
Demographic Trends In The Property Market
Before we look at what demographic trends are developing in Australia’s society and how they might impact the property market we need to get some definitions cleared up. Most of us will have heard the phrases Baby Boomers, Generation X, Generation Y, but do you actually know which age groups they refer to? And what values these groups typically hold?
Just in case you don’t, here is simplified summary of the key generations. Please note that many slightly different years are used for the grouping of generations, here I have deferred to those used by Bernard Salt (Australia’s leading demographer and author of several books on the subject):
- Baby-boomers: this generation was born during the post World War II baby boom between 1946 and 1961. And I mean baby BOOM. In the United States 76 million babies were born into this generation, which is 10 million more than during the following generation. Not only is it a large demographic group, it is also an influential group as boomers control the wealth of most if not all western countries. It was estimated that in the year 2004 the baby boomers in the UK held 80% of the country’s wealth – similar percentages would hold in other Australia or the US. And soon these baby boomers will start retiring and they will change how they live, where they live, how they invest their money and what they spend it on.
- Generation X: this is the generation born between 1961 and 1976 and I am one of them, a quarter of the Australian population belongs to Generation X. A generation too young for the moon landing, the 1970s oil crisis or black and white TV, a generation which has grown up in an unstable world with unstable families (increasing divorce trend) and loss of permanency in the workplace.
- Generation Y: those born between 1976 and 1991. Often a single child of baby boomer parents who grew up in prosperous times. Many still live at home with mum & dad and remain uncommitted in their 20s to marriage, mortgage, children or careers. Y’ers hold different views on loyalty to friends, to workmates or to employers and tend to prefer ‘deals’ rather than contracts and ‘mentors’ to bosses. Highly educated, opportunistic and global in their thinking.
- Generation Z: the generation born between 1991 and 2006, also know as the Internet Generation. This is the generation my kids belong too and for the next 1 to 2 decades they will not have much influence on the property market so let’s leave them out of the picture for now.
A good comparison table shown by Bernard Salt in his keynote speech “Mapping the future — Australia’s consumer demographics” to the 2007 National Consumer Congress is shown below highlights the differences in generational traits between boomers, Gen X and Gen Y.
As property investors we need to take a look at this and try to understand what that would mean for the property market in terms of types property likely to be in demand, areas that will become or remain in demand, what this does to household size and the longer term trend to homeownership.
We can already see number of trends emerging from this generational shift for exampled Gen Y looks for inner city living typically in medium density housing projects close to lifestyle precincts, resulting in revitalization of many previously unwanted inner city suburbs. In addition, Gen Y are unlikely to commit to a mortgage and prefer to rent continuing the long term trend of lower homeownership (see the table below).
- 76% rent accommodation
- 24% share accommodation
- 23% live alone
- 19% rent accommodation
- 86% live in detached housing
- 40% rent accommodation
- 45% have children at home
- 77% live in detached housing
Now that we have a better idea of the various generational groups on how they may impact the demand for property, lets have a look at what the population data from the Australian Bureau of Statistics (ABS) can tell us.
Australia’s Population Is Booming
Let’s start with the overall population growth first. Mid 2008 the ABS released its latest population projections which highlight strong population growth as can be seen in the graph below.
In the graph, the sold black line represents the historical population in Australia with the three solid colored lines representing the ABS forecasts for the three different scenarios (series A, B and C). Similarly the dashed line represents the historical population growth and the three thin colored lines the assumed population growth for each of the three scenarios.
The three scenarios identified as Series A, B or C are based on a different set of assumptions for population growth factors like net migration, birth rate and life expectancy as follows:
- Series A: assumes the TFR will reach 2.0 babies per woman by 2021 and then remain constant, life expectancy at birth will continue to increase until 2056 (reaching 93.9 years for males and 96.1 years for females), NOM will reach 220,000 by 2011 and then remain constant, and large interstate migration flows.
- Series B: assumes the TFR will decrease to 1.8 babies per woman by 2021 and then remain constant, life expectancy at birth will continue to increase each year until 2056, though at a declining rate (reaching 85.0 years for males and 88.0 years for females), NOM will remain constant at 180,000 per year throughout the projection period, and medium interstate migration flows.
- Series C: assumes the TFR will decrease to 1.6 babies per woman by 2021 and then remain constant, life expectancy at birth will continue to increase each year until 2056, though at a declining rate (reaching 85.0 years for males and 88.0 years for females), NOM will reach 140,000 per year by 2011 and then remain constant, and small interstate migration flows.
The base case scenario (Series B) suggests that the current population of 21.5 million will grow to about 34 million people by the year 2050 and to just under 45 million people by the year 2100. That would mean that in the next 40 odd years Australia would come to house another 12.5 million people, the majority of which will choose to life in and around the capital cities.
Queensland Is The Winner
According to ABS population estimates New South Wales has the greatest population of all Australian states, accounting for one third of all persons followed by, Victoria (25%), Queensland (20%), Western Australia (10%), South Australia (7%), Tasmania (2%), Australia Capital Territory (2%) and Northern Territory (1%).
The projections suggest that by the middle of the century, the portion of total Australian population by state will change significantly. Although New South Wales will still be home to the greatest number of residents, it is projected that the state will only have 29% of all Australian residents compared with the 33% it currently houses.
In contrast, by then Queensland will be the second most populous state and will house one quarter of all Australian residents compared to 24% of all residents which are projected to live in Victoria. Queensland is projected to overtake Victoria as the second most populous state in 2050. Western Australia’s portion of the Australian population is also projected to increase with its population growing from 10% of the total Australian population as of now to 12% of the total population by 2050.
Australian capital cities will record an increase in population by some 10.4 million people persons and be home to 23.5 million persons – that means 67% of all Australian residents will live in a capital city area compared to an estimated 63.6% currently. The population growth within capital cities of 1.2% equates to significant demand for housing. In order to cater for this projected growth, significant densification of capital city areas will be required, which is likely to be achieved through higher density forms of housing.
Melbourne is the capital city, which is projected to see the greatest increase in population between 2007 and 2056 with the population expected to increase by almost 3 million persons.
Combine this with the trend from the last 30 or so years as shown in the slide below:
Population In The Capital Cities
In Series B all capital cities are projected to increase their share of their respective state or territory population over the next 50 years. By 2056 Melbourne, Perth and Adelaide will have the largest shares, with 80% of all Victorians living in Melbourne (73% in 2007), 78% of Western Australians living in Perth (74% in 2007), and 75% of South Australians living in Adelaide (73% in 2007). Hobart will experience the largest gain in share, increasing by 7 percentage points to 49% of Tasmania’s population in 2056 (from 42% in2007). Brisbane will experience the smallest gain, increasing to 46% (from 44% in 2007). Sydney’s share of New South Wales’ population is projected to increase to 68% in 2056(from 63% in 2007) while the Darwin’s share is projected to increase to 61% (from 55%in 2007). Conversely, each balance of state/territory’s share will decrease over the period 30 June2007 to 2056. The populations of the balances of Queensland and Tasmania will remain larger than their respective capital cities, with 55% and 51% of their state’s population respectively.
The potential workforce is the number of people in the population of workforce age, which is usually defined as 15–64 year olds. The actual workforce will depend on the proportion of 15–64 years olds that seek to actively participate in the workforce and those 65 and over who continue to work.
In recent years Australia’s potential workforce has been growing by over 200,000 people each year. At June 2008, the number of people of workforce age was 14.2 million people (67.5 per cent of the population). The three different ABS series show quite different outcomes in the number of people aged 15 – 64 (see figure below).
GRAPH – WORKFORCE
For example series A shows continued strong growth in Australia’s potential workforce to 2101, whereas series C shows very little growth at all.
People not in the workforce are generally less likely to be paying taxes and are more likely to be dependent on pensions and other forms of government support. Therefore another useful measure is to compare Australia’s potential workforce against Australia’s total population. This analysis shows similar trends for all three ABS series, with the proportion in the 15-64 year age-range steadily declining from 67 per cent in 2008 to between 59 and 61 per cent in 2051 and between 56 and 59 per cent in 2101.
These population show that the ageing of our population will continue. This is the inevitable result of fertility remaining at low levels over a long period and increasing life expectancy. In 2008, around 13 per cent of Australia’s population was aged 65 and over, by 2050 this figure is expected to be between 22% and 24% – slowly increasing to between 25 and 28 per cent by 2100.
Household Size And Formation
The significant growth of persons in the 65+-age bracket is an important phenomenon for future housing demand. Persons in this age category are more likely to live either alone or in a couple, contributing to a decline in average household sizes. Also, this age group represents the greatest demand for lifestyle and retirement properties, as such, demand for developments catering specifically for this target market will become more common.
A further increase in the number of people living alone over the next 20 years will be as a result of people delaying marriage (Gen Y) and an expected increase in divorce and separation.
In the 2001 Census, there were 1.8 million Australians living alone. This figure is projected to blow out to between 2.8 million and 3.7 million, taking into account factors such as fertility rates, migration and life expectancy.
How This Impacts Property Investing
So what do these population changes mean for housing? Although confidence is currently low and there are few buyers and lots of sellers, the projected rate of population growth suggests that ongoing demand for housing will continue to be strong.
Based on supply fundamentals increasing demand for housing, stock is likely to translate into future pressure on housing prices.
One of the fundamental issues associated with population growth is ensuring appropriate levels of infrastructure, including transport, health care and schools are planned for and rolled out strategically. Planning and development of this infrastructure should precede or at the very least run in parallel with population growth rather than follow it, as has often been the case in the past. This is particularly essential for new affordable housing options being developed in the outskirts of the nations metro areas. It is these areas where commute times and costs make affordable housing an undesirable option for most of the market.
SLIDE – WHY POPULATION SHIFTS ARE IMPORTANT
SLIDE – HOUSEHOLD FORMATION & SPENDING
What Property To Invest In?
Obviously Gen Y will provide the lion’s share of rental demand, followed by Gen X and then not a lot of rental demand from the baby boomers. But what type of property do these demographic groups require?
Matusik says, “If I was an investor and I was particularly looking for stronger cash flow – better rents and more consistent rents – or weigh that up against buying a house on a 900 square metre block of land in the outlying areas – you’d be looking to buy an apartment or the like. And you’d look for one that could accommodate more than one demographic type.”
“So you may buy a one-bedroom apartment and I believe there’s an argument for smaller apartments of, say, less than 50 square metre product, so that someone living alone can actually afford it in the future, paying $300 or $400 a week and be able to afford it. But you’ll find that the best apartments which have gone up in price and particularly in rent are two-bedroom, two bathroom apartments that are designed for two couples, a couple and a single, or two lone persons.”
Furthermore, Terry Ryder from www.Hotspotting.com.au wrote the following in a December 2008 article titled “Gen Y will spark real estate revolution”:
Australia is on the cusp of a “real estate revolution”, according to Colliers International. Its residential research director Jonathan Rivera says the emergence of Generation Y homebuyers is a demographic shift that can’t be ignored. “Within a few years, Gen Y is tipped to inspire great change across residential landscapes,” Rivera says. “They will comprise the most influential generational group in property since the baby boomers.”
He says there are 5.5 million Gen Ys – that’s 200,000 more than Baby Boomers and 700,000 more than Generation X.
“Gen Y people are very accepting of density and the majority believe they do not have to move to the suburbs once they have kids,” Rivera says. “They are interested in close-knit neighbourhoods. They like to belong or identify themselves in relation to where they live.”
“Our findings have shown they are seeking ‘destination developments’ where connectivity is key.” Compact urban developments in middle-ring suburbs (5-15km from the CBD) with strong social and amenity networks will be the future if developers wanted to tap into the $48 billion spending power of Gen Ys.
“We’ll see a greater shift of Gen Y toward home ownership in 2011 and 2012,” Rivera says. “Half a million of these Gen Ys earn at least $1000 a week.”
He says Gen Y is outward-looking and civic-minded and will want these values to extend into the corporate structure of their builder or developer. “They’re looking for diversity in the form of clustered single family dwellings, townhomes and apartments,” he says. “Developers should be offering location-driven housing of reduced product size but with a bigger focus on design and layout.”
“Opportunities lie in middle-ring suburban infill and Greenfield sites.”
Gen Y buyers will be drawn to developments with unique features like a roof-top common area instead of a penthouse in Queensland or “fire pit” in the colder states where residents can meet.
“They are the most connected generation in our history and place high value on staying connected with friends and family,” Rivera says. “Creating density with space are the characteristics needed to support this lifestyle.”
- Between now and 2101, Australia’s population is expected to grow from some 21.5 million persons to 44.5 million people
- By 2051, people aged over 65 years will number between seven and nine million.
- The number of workers (from 15 to 64 years) is expected to fall from 67 per cent (in 2004) to between 57 and 59 per cent by 2051.
- In 2001 there were 1.8 million Australians living alone. This will be between 2.8 million and 3.7 million by 2051.
- Gen Y will have a major impact on the property market, with very different demands on housing.
- A large proportion of Gen Y will still be forced to rent.
So you want to be wealthy and use property to get you there. Well so do I, but did you ever think about what wealthy means to you? Is it just being rich or maybe there’s more to it? Most will agree that money without having family or friends, without having your health or without having time to enjoy your money is not the complete picture. Sure money is an important part of the wealth equation, but only to the degree that it allows you to make the choices you want to make, after that it won’t increase your happiness.
As Harvard psychologist Daniel Gilbert writes in Stumbling on Happiness:
“Economists and psychologists have spent decades studying the relation between wealth and happiness, and they have generally concluded that wealth increases human happiness when it lifts people out of abject poverty and into the middle class but that it does little to increase happiness thereafter.
Americans who earn $50,000 per year are much happier than those who earn $10,000 per year, but Americans who earn $5 million per year are not much happier than those who earn $100,000 per year.
People who live in poor nations are much less happy than people who live in moderately wealthy nations, but people who live in moderately wealthy nations are not much less happy than people who live in extremely wealthy nations.
Economists explain that wealth has ‘declining marginal utility,’ which is a fancy way of saying that it hurts to be hungry, cold, sick, tired, and scared, but once you’ve bought your way out of these burdens, the rest of your money is an increasingly useless pile of paper.”
So wealth will not automatically give you happiness, but it can give you freedom to choose what you do for a living and for how much longer. And that can be a great contribution to your happiness.
One more important reason to create wealth is the security of your pension – inflation eats away at your future buying power and the aging of our societies will continue to put more and more pressure on the levels of old age pension until one day we may find that the old age pension does nothing more than keep you alive – is that how you want to spend your retirement? Surviving or would you rather be thriving?
To become wealthy you first need to create a capacity to generate wealth and in simple terms that means that you generate more income than you spend.
Capacity to Build Wealth = Income – Spend
You have to manage both Income and Spend and this is where the majority of people in western countries go wrong. They focus nearly all their attention on their income and do very little to control their spending. If anything over the last decades the modern day consumers have become used to the concept that if they want a new car or the latest greatest flatscreen TV they don’t have to first save for it, they just buy it on credit, that is with tomorrow’s money, money they don’t yet have. They’ve deserved it haven’t they. In fact it’s their right isn’t? Sure, whatever, just don’t complain if you never get ahead because you’re paying double-digit interest rates on multiple maxed-out credit cards. And when the bubble bursts, as it is doing right now, you might want to learn a thing or two from the average Chinese, Indian or Vietnamese worker who has been lending all this money to the average westerner for the last couple of deceades. Asian families have double digit saving rates.
Want to know more about building wealth, how the average American is doing and more interestingly who the average Millionaire is? Read The Millionaire Next Door. Great read in my mind and a book that despite some repetition really opened my eyes and got me working. Definitely worth buying.
Who Becomes Wealthy
Building wealth can not be be left to chance, if you do not take positive action to create wealth you will end up at the wrong side of the statistics: if we consider 100 young Australians today and see where they would be at the age of 65, you’d find the following:
24 would be dead, usually by avoidable causes, as life expectancy in Australia, just like most Western countries around the world is well over 70, pushing towards 80
54 would be on government pension of around $ XX,XXX per year (in today’s money) – but that is hardly wealthy. More surviving than thriving.
16 would still be working, mostly because they had to, not because they wanted to. Similarly, in the US one in four Americans has to work till they die just to put food on the table.
5 would be considered financially independent, but only just. They have sufficient wealth to support themselves and can afford some luxuries like a nice holiday once a year, but they will still need to watch their expenditure carefully to stay financially independent.
And 1, just one out of a hundred will be wealthy.
One important warning.
Many people get caught up in appearing to be wealthy, instead of becoming wealthy. They spend what they earn or more and in doing so they accumulate bad debt instead of good debt, leverage themselves to the hilt. And then they are surprised that Joe who owns his own trucking business is a millionaire and that the only millions they have are those they owe to the bank. The current credit crisis will stop some of this consumerist behavior for a year or two – perhaps longer. But once the good times are back they’ll get themselves back into trouble. Nature of the beast, I guess.
Life is a risky business, not one of us is going to get out of it alive. You could try to avoid all risks in life and do nothing, however, you will just risk wasting your entire life. Now there is a risk I most certainly would not want to take!
The question is simple enough, but it can be quite a difficult one to answer. And that’s primarily because the answer typically depends on such a wide range of variables and assumptions. The result is that many of us simply avoid the question – but as we all know not asking the question doesn’t solve the problem.
There are many different approaches to determine how much money you will need to retire and none of them are right. They are all nothing more than an estimate and in some cases not much more than a guestimate. Some approaches are quite scientific and others are not much more than using a simple rule of thumb.
The main thing is that you need to be comfortable and confident with how you plan for your retirement, but you do need to be realistic and take into account some key issues many people forget or simply ignore, like healthcare or the issue of inflation.
So in this article I will look at the 3 basic questions you need to answer to determine how much money you need to retire, these are:
- How long will you live?
- When do you want to retire?
- What level of retirement income do you aim for?
There are many more issues that can come into play like inflation, how risk averse you are, what tax structures you have in place, what level of insurance do you need etc. but those can all be dealt with at a later stage. After we have the three basic questions answered we’ll look at some of the common approaches to determine how much money you’ll need to stash away.
So let’s start.
How Long Will You Live?
Easy question and if you want to give an easy answer you just use the current life expectancy, so in Australia that is 79 if you’re a man and 84 if you’re a woman (based on ABS Life Tables, Australia, 2006–2008, 3302.0.55.001, updated in December 2009).
Personally I am an optimist and I also like to be conservative so I simply use 100 in my own calculations, but being too conservative is not advisable either as you’ll end up working / saving too long. So when we get close to our retirement target I might just bring that expectation back to statistical reality.
Then again, studies in the US show that life expectancy might well just reach 100 years of age by 2030! At least, that is the claim of Stanford University biologist Shripad Tuljapurkar, who bases his finding on biological advances and anti-aging technology. If Tuljapurkar is right, then many people now in their 50s will live to at least 2050. If they were to retire at age 65, that means 35 years in retirement. Then it’s not just a question of having enough income each year during your retirement, but a key concern is whether you will outlive your retirement savings. We’ll cover that later.
For now let’s just run with the average life expectancy so we can determine how long you will be living without a regular income and that brings us to the next question.
When Do You Want To Retire?
All you need to give is a simple number: 60, 55, 50 or even 45. Start with your ambition not what you think you might manage or what people around you would expect you to do. This is you life so you need to decide. Love your job? Then 60 might be just fine for you. Some of us, have held down a job which hasn’t done too much for them other than pay the bills so they may well want to get out early. 50 anybody?
Really there is not much more to it at this point, just pick an age. Once you start crunching numbers you’ll soon enough see if you need to adjust the age, your lifestyle expectations or in some cases both.
To avoid too much frustration do start with something challenging and reasonable. If you’re 35, have piles of bad debt, no savings or investments aiming for retirement at 45 is unlikely to work unless you aim for an extreme adjustment in your lifestyle or are expecting a windfall.
What Level Of Retirement Income Do You Aim For?
This is where you really need to sit down and start doing some homework. It’s easy to say I want $100,000 a year, but in many cases that won’t fly. I would recommend you do two things at this stage. First you use a simple rule of thumb to determine your required retirement income and after that you sit down and develop a detailed annual budget. Put the two numbers together and you can come up with a reasonable first estimate.
So, first we apply the general rule of thumb, which says that the income you’ll need in order to be “comfortable” when you retire is between 65% and 70% of your pre-retirement income. This figure was first set by a Senate committee looking into the adequacy of retirement savings in Australia. The figure has since been adopted by industry bodies, financial planners and the media – in other words all the “experts”.
Another option is to invest a certain percentage of your portfolio in precious metals. Investing in gold and silver and act as a hedge against a global economic crisis. By rolling over your 401k to gold you have essentially bought insurance for any unforeseen events in the future.
Bear in mind that the higher your pre-retirement income, the higher the retirement income you’ll need. And the higher the income you need, the more capital you need to accumulate before you retire. If your income in the years before you retire is, let’s say, $100,000 a year, then a “comfortable” retirement according to the generally accepted view is something between $65,000 and $70,000 a year.
In my personal view, the 70% rule of thumb is way too crude and this is why I’m suggesting you should do a bit more homework and develop an annual budget. If you don’t and simply go blind on the 70% assumption you risk either working till you die as you’ll never be able to afford your unreasonable lifestyle expectations or you’ll suffer a far from comfortable retirement, 20 years or so at the poverty line.
Remember, I am writing this article with a view on retiring early, nothing extreme but simply with the intention of escaping the rat race a bit earlier. And the art in retiring early will be achieving a balance between the lifestyle you want and the money you have. The more you want the later you can retire. Keep that in mind when you develop your annual budget.
When you develop your annual budget think about: food, accommodation, transport, regular household costs, health insurance including allowances for excess health costs, life insurance, travel and of course leave some money for having fun and just discretionary spending! Add to add anything ‘unique’ like whether you still have kids at uni, have an ex with kids to support etc.
And don’t forget the taxman!
Calculating How Much You Need To Retire
Now that we have the basic questions answered we can crunch some numbers. And to make things a bit easier to follow, let me introduce you to Jake and Helen. They are both 38 years old and have a combined income of $100,000 a year. Their ambition is to retire at the age of 55 and having done their homework the believe they can live quite comfortably off $55,000 a year, but they also know that they want to do a lot of travelling in the early years of their retirement so they’ve increased their desired income to $70,000 per year. To keep things simple they assume a life expectancy of 85 for both.
Now the question is: how much do they need to retire?
A simplistic approach would be: 30 years of retirement from the age of 55 till 85 at $70,000 a year would require Jake and Helen to accumulate a nest egg of some $2,100,000.
The ‘true’ situation is a little more complicated than that and possibly a bit less daunting. Remember, when you stop working your money should continue to work for you assuming you have invested it wisely. On the flip side you also have to allow for your worst enemy when it comes to retirement planning and that is inflation. That $70,000 might be fine in today’s money for Jake and Helen to do what they want to do, but by the time they retire in some 17 years that same $70,000 will only be worth around $41,000 in today’s money. When Jake and Helen are 75 that $70,000 will buy them less than $23,000 worth of goods and services in todays prices.
And this is where the complications come in.
First of all you need to estimate at what rate your investments will continue to grow whilst you are retired. Secondly, you need to allow for a certain amount of inflation. Thirdly, you do need to realize that your living expenses tend to be highest in the early years of your retirement and then gradually reduce as you age. Your healthcare costs on the other hand are likely to increase as you get older. Bottom line is, your retirement income needs won’t be constant from year to year. So that’s another factor that complicates the calculations.
At this stage a financial planner can be an invaluable ally when it comes to working out things like this. However, in my experience most retirement advice is too simplistic and does not account for the fact many of the variables like investment returns and inflation will go through big variations during your retirement. If you are lucky enough to retire with a full nest egg and encounter 10 bull years on the stock markets you’ll be fine, but if you’re unlucky enough to encounter the worst bear market in a century when you’ve just gone into retirement you may well have to come out of retirement before the first few years are over.
Doing these calculations can become very complex, and so the industry has established another rule of thumb, which suggests that it would be safe to withdraw 4% of your next egg each and every year without running the risk that in the last few years your bank account would be empty. This 4% is sometimes also referred to as a safe withdrawal rate. It basically means that if you have $1,000,000 invested you can spend $40,000 a year – each and every year, whether it’s a bull or bear market as over time they will even out and your initial $1,000,000 will remain intact.
So, for Jake and Helen who wanted to retire at the age of 55 and expected to live another 30 years with an annual income of $70,000 they would require a nest egg of $1,750,000. Still a very sizeable chunk of cash, but nonetheless it is some $350,000 less than the initial calculation we made.
Various people have looked at this subject in great detail and have actually done statistical simulations based on actual historical investment returns etc. to see whether this 4% safe withdrawal rate is indeed safe enough. There are no easy conclusions, but some key warnings are put forward. Firstly, the 4% withdrawal rate might be too optimistic if you retire young or end up living very long. Secondly, some argue that investment returns are coming down and as a result a withdrawal rate 4% could not be deemed safe anymore.
Most of these studies are based on the performance of US stocks and they have indeed not performed well in the last decade and are unlikely to be your best for good growth for the coming decade. So maybe it’s time to consider other markets or other asset classes like property. Personally we have invested in Australian Real Estate and have kept a portfolio of (index) funds on the side, which I do expect to grow steadily over the coming years.
So, How Much Do You Really Need To Retire?
By now, you must see there is no simple answer to that question. But if you insist, I would say that the 4% rule is probably the best place to start with. However, I’d strongly encourage you to read much more about the various aspects of retirement planning which I have only briefly touched upon here. Then over time you can figure out what you will feel confident and comfortable with.
Property and especially Australian property is an excellent investment. Not only is it much harder to lose money in property than in the stock market, but with property investing you also benefit both from steady capital growth and from rental income. And as rental income increases over time it protects you from inflation. At the same time you can borrow money to buy property and despite Australia’s high taxation environment, property investment can be very tax efficient.
Let’s have a look at these advantages and some other positive aspects of residential property investment in a bit more detail.
1. An Investment Market Not Dominated By Investors
First of all, you need to realize that some seventy percent of all residential property is “owner occupied” and only thirty percent is owned by investors.
Add graph showing home-ownership in Australia over time
That means that residential property is the only investment market not in fact dominated by investors, which means that there is a natural buffer in the market that is not available in the share market. To put it simply, if property values crash by 10%, 20% or even 40% we all still need a home to live in and so most owner occupiers will simply ride out any major crash rather then sell up and rent (compare this to the stock market where a major drop in prices can easily trigger a serious meltdown).
Sure, property values can and do go down but they simply do not show the same level of volatility as the share market and property offers a much higher level of security. And if you don’t believe me when I tell you that residential property is a safe investment, then just ask the banks.
Banks have always seen residential real estate as an excellent security and that’s why they’ lend up 90% of the value of your investment property; they know that property values have never fallen over the long term.
2. Sustained Growth
Property prices in Australia tend to move in cycles and historically they have done well, doubling in cycles of around 7 – 12 years (which equates to about 6% to 10% annual growth). We all know that history is no guarantee for the future but combined with common sense it’s all we have. There is no reason to think that the trends in property of the last 100 years would not continue for the next few decades, but to be successful in property investment you must be prepared and capable to ride out any intermediate storms in the market, but that applies to any investment vehicle you choose.
And here is some evidence, the graph below shows Australia’s median house price between 1986 and 2006 as published by the Real Estate Institute of Australia (REIA) and it shows that back in June 1986 you would have bought an average home for $80,800. That same home would have been worth $160,500 in 1986, which is pretty much double of what you paid 10 years earlier. Another 10 years later in 2006 that average home was worth some $396,400. So between 1986 and 2006 that average home went up by nearly 400% or about 8.3% per annum.
Add graph showing historical house prices.
Not bad. And quite in line with the longer term history.
Michael Keating points out in his blog on 24th January 2008 (Why Melbourne’s properties will keep rising), that the above growth is actually on the low side compared to the historical average. Australia’s property prices have been tracked for something like the last 120 years and according to Michael they have on average risen some 10% per year. Just in case you might believe that had to do with Australia being a newly found colony, and don’t believe this would be sustainable in the long term, consider this: in the UK records of property sales go back till 1088 and analysis of the data shows that in those 920 years UK property on average has gone up by 10.2% per year. If you want to know more, read my research on historical house prices (Add link to detailed article on house prices) which clearly supports this although the long term growth is a bit less than 10%.
What is also interesting about the above graph is it’s shape – it is a classical example of the property cycle, but we won’t go into that here.
3. Buy It With Other Peoples Money (OPM)
Now just in case the above has not been enough to convince of the value of residential property investment, let me tell you one of the great secrets of creating wealth, which also applies to investing in property. The secret is OPM. Other Peoples Money.
Secret? No that’s just marketing hype you see on the web, but the power of Other People’s Money or more common referred to as leverage or gearing is absolutely critical to building wealth. And, in the case of property the leverage you can apply is substantial. As I mentioned above, banks love residential property as security and therefore will easily lend you 80% or 90% of the value.
It was Archimedes who said, ‘Give me a lever and I’ll move the earth’. Well, as an investor you don’t want to move the Earth, you just want to buy as much of it as we can!
When you use leverage you substantially increase your ability to make profit on your property investments and, importantly, it allows you to purchase a significantly larger investment than you would normally be able to.
Let’s have a look at how this works. Imagine there are five investors each with $50,000 to invest. Say they all buy an investment property that achieves 10% growth per annum and has a rental yield (or return) of 5% per annum. Investor A borrows 90% of the value of his investment property (Loan to Value Ratio or LVR of 90%) and investors B, C and D borrow 80%, 50% and 20% respectively. Investor E doesn’t borrow at all and goes for an all cash transaction.
The table below shows the results after one year:
What does this tell you?
Let’s start with cashflow, which is here simplified to rental income minus interest paid. Investor A, who geared 90%, has a negative cashflow of $15,500 for the year whilst Investor E who borrowed no money at all has a positive cashflow of $2,500. But that’s not the whole picture because each of the investment properties increased in capital value and once we include that the picture changes significantly, Investor A has a net worth increase of $34,500 whilst Investor E who didn’t gear increased his net worth by only $7,500. In terms of return on investment Investor A achieved a 69% return on his initial $50,000 whilst investor E achieved a return of 15%.
That’s pretty impressive for one year. And if the investors let their properties grow one or two full cycles we’re talking about serious wealth creation. And once the investors have enough equity in their investment property they can use that to fund a second purchase which after a few years growth will allow the purchase of a third and we’re on our way to wealth! That is, those investors who geared as Investor E is not going anywhere fast.
However, it is not all that easy. As you saw Investor A incurred a negative cashflow in his first year and would continue to do so for a few years until the rental income had grown sufficiently to pay his interest. He has to fund this annual shortfall from his salary. And this is called negative gearing – you borrow money to generate capital growth in your property but incur an annual shortfall in the near term. For most investors this means there will come a limit on how many investment properties they can buy with negative gearing, as they don’t have too much spare income. If you look in our strategy sections you can read more about negative gearing and techniques to avoid paying the shortfall out of your own pocket. We also address cashflow positive properties.
But let’s get back on topic and have a look at some other compelling reasons to invest in Australian residential property.
4. Income That Grows
We’ve discussed that Australian residential property investment is safe, with long term growth prospects and combined with the right level of leverage can create significant wealth. We also briefly touched on the fact that it generates a rental income. The good thing is, that over the years the rental income received from property investments has increased and this increase has outpaced inflation. In fact the last few years have shown tremendous increases rents – I know because the rent on my investment properties has been booming. Still is actually.
Ok, but are rents likely to keep growing? Well, statistics show that the level of home ownership is slowly decreasing in Australia. There are a number of reasons for this like demographic trends but, in particular, as property prices keep rising, fewer people are able to afford their dream homes. The latest Australian Bureau of Statistics figures confirm that more and more Australians are renting and many industry commentators are suggesting that the percentage of Australian who will be tenants in the near future will go up to 40%. So demand is growing. We also know that supply of good quality rental properties is limited (very low vacancy rates across all of Australia) and the government is having difficulty providing public housing. So all in all, it is very likely that rents will continue to grow at a pace faster than inflation – good news if you intend to become a property investor!
Include graph on historical rents
5. Tax Efficient
When it comes to property investing, your best friend is the bank as they provide the leverage you need to accelerate your wealth creation. Your second best friend is your tenant, as without a tenant your investment property would stand empty and your third best friend is the taxman.
The taxman? Absolutely.
How can that be when Australia is not known for attractive tax rates, in fact the opposite?
Well, first of all the interest you pay on the loan to buy an investment property is fully tax deductible and if you own the property longer than a year you only pay capital gains tax over 50% of the gain. Add to that various depreciating allowances and you have the makings of a very tax efficient investment. If you do your homework, the bank will happily give 80% or 90% of the money you need to buy your investment property and once you own it, your tenant and the taxman will pay your interest and your rental expenses. Guess who gets to keep the capital gains, you!
Talk about OPM.
6. Millions Of Millionaires
And if the above doesn’t get you going, consider this: most of the world’s richest people got rich by investing in property. Those that didn’t get rich from property typically invested their newfound wealth in property.
So, if the majority of wealthy people have used investment property to increase their wealth than why not use that knowledge to you advantage and do the same! There’s nothing wrong with seeing what successful people do and applying those principles to your own life.
Even McDonalds make more money through its real estate than through selling burgers and fries as it owns most of the land and buildings in which it’s franchises are located!
7. You Can Do It Too
Before you say, it’s ok for the rich, but how the heck am I going to get into property investing, let me tell you this. You do not need to be very wealthy to get into property investment; it really doesn’t take large sums of money to get involved. And that’s because many of the banks will lend 80%, 90%, 95% and sometimes even 100% or more of the value of a residential property. As long as you have a steady job and a little starting capital (spare equity in your home) you can afford to buy investment properties.
It has been shown over and over again that careful and intelligent use of real estate can enable ordinary people, like you and me, to become property millionaires in about 10 years. If you truly intend to become one of the wealthy people in the future, you should probably take a serious look at using property to your advantage.
8. Too Much Hard Work?
There are many ways to make money and some say that property investment isn’t that easy and takes a lot of time and effort. It takes time to get an understanding of the property market and how to go about investing in property. It can take weeks if not months to research areas and find the right investment property for you. And then it only gets worse, you have to organize finance, get a solicitor to deal with all the legal work. Just the finance and legal work can take 30 to 60 days. And once you own the property the work isn’t over, as you need to look after it and do your tax!
Nobody said it would be easy. Nobody said you didn’t have to get your hands dirty.
Iit will take time and you will have to work at it and educate yourself. But hey, if you are serious about creating wealth and retiring early then property is a great way to achieve that. And once you’ve started and get some experience under your belt, you’ll see that I gets easier, and actually the process of building a investment property portfolio can be very rewarding and a lot of fun too.