The Barefoot Investor, page 14
That’s the brutal truth I confront each time I open one of those handwritten letters.
When you get to those last 13 years of your life … it’s too late to do anything.
So let’s make sure you never get into this position.
Contrary to popular belief, it’s not sharemarket crashes that wipe out retirees. It’s something much more insidious, and it creeps up without you even knowing.
Let me explain.
Faceplanting on a treadmill
Have a look at the following ‘shopping list’ and see how prices have increased since the 1970s.
Since 1970, the price of a basket of goods and services has increased 11-fold — at an average annual inflation rate of 5.2 per cent, according to the Reserve Bank of Australia.
I’ve already mentioned inflation in this book a few times, and we all have at least a sketchy idea of what it is. Well, now I’d like to explain so that you ‘get it’ — and never forget it. Because if you don’t understand inflation (and take steps to beat it), you’re destined to be one of those frail blue biro letter-writers.
Here we go.
Think of inflation as a treadmill chugging along at level ‘3’.
If you step on the treadmill, you have to walk fast enough to at least match the current speed, right?
What if you just stand still?
You’ll do a giant faceplant.
Inflation is like a moving treadmill. Prices don’t stand still — they keep increasing year on year (5.2 per cent per annum over the past 49 years in fact).
If you stick your money under the bed, or in a transaction account earning 0.1 per cent interest per annum, then you’re doing the equivalent of standing still on that moving treadmill.
It’s not safe. It’s incredibly risky and it will have a devastating impact on your retirement.
The final quarter of your grand final
How old will you be when you croak?
I asked you this question in Part I — Plant — but if you didn’t answer it then, do it now.
Once you have your (admittedly rubbery) figure, subtract your current age.
That’s how much time you’ve got left on the planet: that’s what you’re preparing for.
Armed with your ‘how-many-years-till-I-croak’ figure, I want you to look at the new ‘shopping list’ below and pick the decade you’re likely to die in. (So I don’t completely freak you out, I’ve used a conservative 3 per cent inflation, not the historical 5.5 per cent.)
If you’re currently 40 and think you’ll live till 87, look at the 2066 figures.
You’ll be paying $100 for a steak and $10 for a loaf of bread!
How will you pay for it if you retired at 60 and haven’t been paid a wage for 27 years?
Let’s return to the treadmill analogy.
Picture yourself at 87 painfully shuffling on that treadmill, gasping for breath, falling over and bloodying your nose. (If you can’t picture yourself at 87, picture your parents or grandparents.)
And now for the solution …
Over the long term the sharemarket has never failed to outpace the rise of inflation.
If you have your long-term savings in growth assets like shares, you’ll have enough energy to run at level ‘8’ for the rest of your life, well above the level ‘3’ of inflation.
This is why we invest.
Okay, so you could get ‘lucky’ and die early, and step off the treadmill of life. But I wouldn’t count on it. There’s a 50 per cent chance you’ll be blowing out 90 birthday candles, according to the NAB.
(And my youngest son, who was born in 2015, will probably reach 100. At which time he’ll upload his personality to iTunes and download a new, fully automated body from Tesla. Then he’ll be right for another 1000 years — as long as he keeps his iTunes account topped up.)
Anyway, the future is going to be expensive — and the way we pay for it is by investing. And the best place to invest your money for the long term, regardless of your age, is super.
Here’s you: Dude, I already have super — my employer pays it.
Here’s me (as I casually eat a mandarin, throw it on the ground, get right up in your grill and scream …): BUT IT’S NOT ENOUGH! (Little pips and bits of citrus hit your face, and you recoil in disgust.)
Yes, it’s true, your boss puts 9.5 per cent of your wage into super. But you are being set up to fail (though not if you follow the Barefoot Steps, of course).
So, with your home deposit saved and your home bought, it’s time to give your super contributions a boost.
How much? Read on.
Never worry about money again — boosting your super to 15 per cent
Yes, I want you to put 15 per cent of your gross wage (that is, pre-tax) into super. (The official term for making pre-tax contributions is ‘salary sacrifice’, but that phrase just makes me think of Elton John.)
Remember, your employer is already chipping in 9.5 per cent, so you only need to bump it up by a further 5.5 per cent to reach 15 per cent in total.
Here’s you: Hang on, I’m a bit freaked out by the whole treadmill thing. Shouldn’t I put in more than 15 per cent?
Here’s me: Patience, grasshopper. Right now you’re going to need the extra money to get through the rest of the Barefoot Steps. And remember, super is locked up until bad things happen — like getting old.
Here’s you: Good point! Should I put in less?
Here’s me: No! I do not want you to write me a letter one day with a little blue biro. You’ll ruin my day.
For you guys at the front of the class, here’s some additional reading: the UK Office for National Statistics released a 595-page report that you’re not going to read — so I’ll summarise it in one sentence: from now on, you need to save 15 per cent of your income to avoid dumpster dining in retirement.
And there’s a nice bonus, you’ll pay less tax.
Tax cuts!
The government understands that the future is going to be expensive — that’s why they bribe you with tax cuts. If you’re earning $80 000 a year, you can slash your marginal tax rate by more than half by diverting money to super!
Let’s do that one more time for the Twitter crowd:
Money in super = less tax = $$$ in retirement
That’s why super should be the centrepiece of your long-term investment program, and why it’s the ultimate way to automatically build your wealth.
No willpower needed
Why am I so obsessed with making it automatic?
Because I have as much willpower as a daddy ram in a paddock full of ewes. Yes, I’ve sat where you are right now. And there are a dozen compelling reasons why you won’t get around to doing this.
I get it.
But this is the one thing that your future self will high-five you for.
Look, I’m a little freaky when it comes to talking about super.
I’m like your mate who’s just discovered the paleo diet and can’t shut up about it: ‘Dude, I ate the leg of a goat on Friday and it was so freakin’ awesome. I’ve seriously never felt this good before! Here, put down that beer and have some of my bone broth, bro.’
I’m not really like that. Well, maybe a little. But it’s with good reason.
Anyway, here’s a teacher to give you a final lesson before recess:
Jane is 30, single and a primary school teacher. She earns $72 000 a year and has $50 000 in super.
She reads this book (which is a bit hard because she’s already in it — this book has more random segues than Harry Potter and the Magical Undies) and decides to put her investing on autopilot, boosting her super to 15 per cent, which works out to be an additional $330 per month.
Assuming 8 per cent growth, and 2 per cent inflation, guess how much more Jane has when she retires at 67?
$569 073
Even better, she’ll retire a double miyonaire!
(She’s on track to retire with $2 063 179 in super.)
And she’ll pick up a handy tax deduction every year she does it. Way to go, Jane.
Automatic millionaire super scripts
Call your super fund and use the following scripts.
To boost your super to 15 per cent (‘salary sacrifice’)
You: Could you please email me your standard salary sacrifice form.
Super rep: Have you checked that your employer will allow you to salary sacrifice?
You: Yes, I have. But I also understand that anyone under the age of 75 (who satisfies the work test) can claim a tax deduction for personal super contributions.
Super rep: We’ve got a live one on the line!
You: So what do I have to do?
Super rep: Just fill out the form I’ll email you, and write down that you’d like to salary sacrifice an additional 5.5 per cent of your gross salary, on top of the employer contribution, and then give it to your employer. That’ll bring your total to 15 per cent.
You: Anything else?
Super rep: Yes, keep a copy for your records.
If you’re self-employed
You: I know I’m not legally required to pay myself super, but I like a good tax dodge. So I’d like to set up a quarterly payment into my super account of 15 per cent of my gross income up to my age-based, pre-tax limit.
Super rep: Okay, here’s our BSB and account number to make the transfer.
You: That’s it?
Super rep: Were you expecting a parade, and balloons to fall from the sky, sir?
If you’re earning under $53 564 per annum (‘co-contribution’)
You: I’d like to make an after-tax co-contribution towards my super.
Super rep: Smart move. The government will pay up to 50 cents for every dollar you put in after tax, up to certain thresholds.
You: I’m a stay-at-home mum and work three days a week as a bear-catcher, earning $37 000 a year. Please calculate how much I should put into super to get the most from the government.
Super rep: If you make an after-tax contribution of $1000, the government will give you an extra $500.
You: I just made a 50 per cent return! When will I get the money?
Super rep: The government will pay your super fund within 60 days of you lodging your tax return.
You: Well, I better ring Old Stubby Fingers my accountant!
Boost your super to 15 per cent
My 15 per cent super strategy is time-tested. It’s totally tax-efficient. And it works. Once you do it, you’ll forget about it. After a few months, you won’t even notice it. Only problem is that most people never actually get around to doing it.
That’s why you’re going to make it the centrepiece of this monthly Barefoot Date Night (and to be clear, save this menu for when you’re up to Step 5, after you’ve bought your home).
ENTREE:
Whip out your phone and call your fund, using the scripts from page 160.
MAIN COURSE:
Next, fill out the forms to salary sacrifice an additional 5.5 per cent of your gross wage (making a total of 15 per cent), directly into your super fund, and then email it to your payroll officer. If your fund doesn’t have a form, you can simply email your boss and ask them to set up the additional pre-tax 5.5 per cent payment on your behalf. It’s really simple.
DESSERT:
Even though I don’t have a sweet tooth, I never pass on a dessert on Barefoot Date Night. Reason being, I want my brain to become conditioned to celebrating when I score a win (and nothing says ‘well done!’ like consuming 4000 calories). Or at least that’s my justification, and I’m sticking to it.
Up next I’ve got another way to make you feel all warm and fuzzy.
Stop for a minute and think about how different your life would be if someone had given you this book when you were in your final year of high school.
The truth is, if you’ve made it this far, you now know more than most people about investing.
Should I buy an investment property?
You want to get ahead.
I get it.
That’s why you’re reading a finance book and not Fifty Shades of Grey.
You’re probably starting to earn some bucks, and naturally you want to translate that into a serious return on your money.
And, given that you’ve always lived in a property, you understand it. So it would be un-Australian not to at least think about an investment property.
So let’s talk about whether you should jump in.
But first a disclaimer.
I love property.
I own commercial property, agricultural property, inner-city property and my own home.
But do you know what I love even more than property?
Maths.
You’ve probably heard so-called experts say, ‘Property doubles every seven to 10 years’.
Well, let’s run my trusty Casio over that well-worn claim.
On my youngest son’s first birthday, the median value of a Melbourne home was $740 995.
That’s for your garden-variety metro home (the median price for an inner-city pad was in fact $1.27 million, but for this experiment let’s stick with an average metro Melbourne home).
If property doubles every seven to 10 years, let’s see how much my son will have to shell out for his own place when he gets older:
By the time he’s in primary school, an average Melbourne home will be selling for $1.5 million.
By the time he’s in high school, it will be $3 million.
By the time his 22nd birthday rolls around, it will be $6 million.
By the time he finds the love of his life and settles down at 36, it will be a cool $24 million.
And you think housing affordability is tough now!
Poor old mate and his fiancée will have to stump up a $4.8 million deposit!
But it’s not all bad. By the time my son retires at 64, it will be worth $384 million, and if he hangs on till his 70s it will be worth $768 million!
Okay, the fact that I’ve ended the last three lines with exclamation marks is a giveaway that I believe the ‘doubles every seven to 10 years’ line is rubbish when it comes to property.
Let’s talk to a real expert, Professor Nigel Stapledon from UNSW, who researched long-term Aussie property prices for his PhD. The professor found that the average price of a Melbourne property from 1901 to 2015 increased by an average 2.1 per cent per year, after factoring in inflation.
But wait, there’s more: that 2.1 per cent doesn’t include the money spent on paying interest to the bank, or maintenance spent on the home.
Professor Robert Shiller, of Yale University, looked at long-term US property prices from 1890 to 2004 and found that inflation-adjusted house prices increased by a miniscule 0.4 per cent annually.
And just to round out the Western world, Professor Piet Eichholtz of Maastricht University looked at property prices in Europe, specifically on one of Amsterdam’s most significant canals, Herengracht. He was able to track the buys and sells of a single property for a full 345 years.
The result?
A return of 0.2 per cent per annum after inflation. Real home prices did roughly double, but they took nearly 350 years to do so, says Shiller.
Now it’s true that, in some areas in Australia, property has doubled every seven to 10 years over the past 24 years — but not when you factor in inflation, interest costs, upkeep and maintenance.
What’s more, these figures only show the sale price, not the money spent building or renovating. Say I buy a house for $500 000, demolish it and spend $1 million building a new home. I later sell it for $1.5 million. How much have I made? Zero. Yet the house price data reports that the price has gone up 200 per cent.
When you look at the past 24 years from a historical view, this period has been an outlier — a once-in-a-lifetime boom — brought on by some unique factors:
mortgage interest rates falling from a peak of 18 per cent in the late 80s to around 4 per cent today
household debt ballooning to 175 per cent of household income, the highest in the world
tax breaks for negatively geared properties, which have encouraged Baby Boomers to borrow on the equity in their homes to buy loss-making investments.
Hardcore, huh?
Don’t put down this book!
People have very strong feelings about property. I know that.
And at this point, 50 per cent of you probably agree with me, and 50 per cent probably don’t.
And if you’re one of the ones who don’t, you’re probably skimming this while watching The Bachelor, thinking ‘I was enjoying this book … until now’.
And there’s perhaps a 10 per cent chance that what you’ve just read has made you so angry that your left eye is twitching as you mumble: I made three hundred grand on my apartment, Barefoot, so stick your 2.1 per cent up your arse!
Again, I love property. I mean, I’ve even made buying a home one of the Barefoot Steps.
But I don’t for a moment believe there’s a goldmine in my back yard.
The reason house prices are at record highs is that we’ve taken on record debt at a time when interest rates have fallen to record lows.
It’s been a wonderful run for the past 24 years, but will it be for the next 24?
Why borrowing to invest kills compound interest
Albert Einstein said that compound interest is the 8th wonder of the world.
What is compound interest?
It’s when you reinvest your income so you earn interest on your interest.
When it comes to buying an investment property, the interest you pay on your borrowings reduces — and, in many cases, totally eliminates — your rental income.
