The Barefoot Investor, page 15
Now most property investors don’t really care about the cash their property puts in their pockets — in fact, some are more than happy to accept a loss in exchange for a tax deduction (that’s called ‘negative gearing’).
This works in a once-in-a-lifetime boom when house prices continue to rise, but at any other time it’s a recipe for disaster.
And yes, you can make the same argument for borrowing to invest in shares as you can for borrowing to invest in property — in both cases, the interest you pay the bank reduces (or eliminates) the amount available to you to reinvest and compound over time.
Therefore, if you can avoid debt and focus on savings, that’s the way to go.
Let me level with you … right now I know I sound about as sexy as picturing your parents on their wedding night. You’d probably find it more titillating to read From 0 to 130 Properties in 3.5 Years (another Wiley title, actually), but what my book is about — hell, what I’m about — is keeping you and your family safe.
Debt is a four-letter word
The greatest investor in history, Warren Buffett, is cut and dried when it comes to borrowing to invest: ‘Stay away from debt. If you’re smart you don’t need it. If you’re dumb you got no business using it.’
He once described debt as like ‘driving a car at 100 miles per hour down a hill with no seatbelt … with a dagger taped to the middle of the steering wheel’.
Well, that sure gets to the … er … guts of it.
The dude doesn’t do debt. In fact he famously keeps $20 billion in cash on hand to take advantage of the inevitable opportunities that arise from people getting into trouble from taking on too much debt.
Of course, your brother-in-law may disagree with all this.
That’s fine.
Then again, your brother-in-law hasn’t achieved a mind-boggling 2 744 062 per cent return over his investing career now has he?
The truth is this:
Debt always makes things more complicated.
Debt always adds more risk.
Debt always adds more stress (whether you admit it or not).
And if you can avoid getting into debt, you should.
A tale of two investors
To show you what I mean, let’s look at two investors, Peter and Paula: one who buys shares and the other who buys an investment property.
The share investor
Peter saves up $5000 and invests it into the Australian Foundation Investment Company (that ultra-low-cost share fund I mentioned at the start of this chapter).
While sitting on the can one day, he opens up his CommSec Share Trading app, types in ‘AFI’ and purchases $5000 worth of AFIC shares.
The fee for the trade (brokerage) is $19, and two days later the money is debited from his bank account.
Two weeks later he receives confirmation in the post, along with a dividend reinvestment plan (DRP) form that allows him to automatically have his dividends (the regular income payments from his shares) reinvested. He ticks ‘yes’ on the form and sends it back.
That’s it for 10 years.
When Peter goes to sell, it’ll be another $19 fee, and the money will be in his account in two days.
The property investor
Paula attends a nerve-racking auction where she knocks out other bidders and buys a two-bedroom apartment for $585 000.
It’ll be a 90-day settlement.
Straight up, Paula pays an additional $30 170 in stamp duty, as well as $3074 in transfers and legal fees, and $58 500 as a 10 per cent deposit.
She rents out the apartment for $450 a week, for 52 weeks a year, and earns $23 400 a year (see box).
Trouble is, her costs — home loan interest, managing agent fees, insurance, accounting, body corporate, rates, maintenance — amount to $31 402.
So, in the first year she’s lost $5 121 … and that’s after the negative gearing tax break.
Here’s Paula’s problem.
She’s losing money every single year, so the only way she can make money is via capital gains — that is, selling the property for more than she bought it (and then, she’ll be hit with capital gains tax, which will push her into a higher tax bracket).
So how much does she need to sell it for in 10 years’ time just to break even?
Let’s do the figures:
Total annual losses: $51 210
Agent’s selling commissions and legals: more than $15 000
Stamp duty, legals: $33 244
So Paula needs to sell her apartment for $100 000 more than she paid for it, just to break even. And that’s before taking into account any capital gains tax.
Of course, no-one knows what the next 10 years of returns will bring, but we do know the costs she’ll be lumped with along the way.
No doubt if Paula is like most people, she’ll gloss over the almost $100 000 in out-of-pocket costs, and she’ll only calculate the difference between what she bought it for and what she sold it for!
How to really make money in property
Okay, so I’ve told you how to lose money in property (or just break even). Now let me tell you how I make money in property.
A few years ago I invested in a property play called the BWP Trust, which trades on the Australian Stock Exchange.
You’ve probably never heard of it, but I guarantee you’ve been in one of the buildings it owns. That’s because BWP Trust owns 75 Bunnings Warehouse properties (not the businesses themselves … just the big green sheds they’re housed in).
At the time I made a bold prediction to my Barefoot Blueprint investment newsletter subscribers: over the next 10 years I would triple my money.
Even better, I’d do it without the hassle of buying an investment property.
No bong-smoking renters … the tenant is Bunnings, owned by conglomerate Wesfarmers.
No 12-month lease turnovers … Bunnings signs up for 20-year leases, with options thereafter.
No upkeep costs … it’s written into the lease that Bunnings is lumped with all upkeep costs.
No dealing with uninspired rental agents … the Trust handles all that for me, and automatically reinvests my rent into buying more.
No worries about banks jacking up my interest rate … because I didn’t borrow any money.
No guesswork on my returns … they were based on set yearly rent increases underwritten in ultra-long rental agreements.
And what about my prediction of tripling my money over 10 years?
As I write, BWP has returned 178 per cent — I’m well on track to tripling my money.
I’ve used this as an example of the intelligent way to invest in property. It’s really quite simple. When I purchased BWP it was earning me an 8 per cent rental return — with no costs — versus an average property investor who earns a 3 per cent return less costs.
When it comes to any investment, it’s all about the cash in your pocket. Everything else is speculation.
A word of warning
Although BWP Trust was a great deal when I bought it, at the time of writing this book, I no longer advise my subscribers to buy it, because it’s gone up so much. I just used it to point out that buying an investment property ain’t the only way to make money in property.
Property vs shares
Listen, I don’t do Holden vs Ford and I sure as hell don’t do property vs shares.
What I do is take an unemotional view of historic returns, together with what actually puts cash in my pocket, and invest accordingly.
Know this: you will hear many weird and wonderful things about investing over your life, mostly from people who want to sell you something and hence have a vested interest in underplaying the risks of borrowing (whether it’s for property, shares or emu eggs).
I’m giving you the same advice I give my parents, my sister, my friends and myself.
How to be a hero — investing for your kids (or grandkids)
You may not have kids. You may not even like kids. But you know someone who has kids, right?
Well, you have the ability to change the course of a young person’s entire life.
Huh?
According to ASIC, the majority of Australians ‘don’t have the basic numeracy skills required to meet the demands of everyday life and work’.
That’s not you.
You’re smart enough to be sitting here with me, reading a finance book, making massive strides to getting your own money sorted.
And I’m guessing that means you probably have a lot of influence over your family and friends when it comes to their money matters (whether you realise it or not). So I’m now going to arm you with every bit of information you need to help change a young person’s life.
I count myself extremely privileged to have helped a lot of young people get a handle on money, and I can tell you it’s been the most humbling experience of my life.
And now it’s your turn.
What follows is a plan to making a difference in a young person’s life.
The number one secret to raising financially fit kids is …
… to be a good money manager yourself.
You’ll do that by following the Barefoot Steps. Even better, you won’t be stressed about money, so you’ll have more time to be present with your kids.
As kids get older they may not listen to you — but they never fail to imitate you, so:
be a good provider: show them the joy of hard work, and the respect you gain by doing a good job
be thrifty: show them that lights need to be switched off, and that money is to be saved for a rainy day
be an investor: this is the fun part — unlike most kids, who stare blankly at a compound interest chart in high-school maths — you can show them first hand.
Let’s get stuck into it.
The Grow Bucket: compound interest for kids
This investment will form part of your Grow Bucket.
And grow it will: a once-off investment of, say, $2000, plus $50 a week, could be worth more than $140 000 in 21 years’ time.
That’ll come in handy because for some time private school fees have been growing at twice the rate of inflation. Australian parents spend, on average, $50 000 on their kids’ education, according to a report by the National Centre for Social and Economic Modelling.
And many can’t afford it.
The Australian Financial Review reported that a quarter of parents borrow for their kids’ private school education, and one in seven run up a credit card debt to pay for school fees.
So it’s not surprising that each year I get hundreds of emails and letters from well-meaning people who want to put some money aside for the kids in their lives.
The problem is, too many of these people screw it up, and then they write to me.
So let me show you how to do it right.
(And if you decide to send your kids to the local state school, you’ll be able to give them a bloody big cheque that they’ll be able to use as a deposit on a home, or that will give them the freedom to follow their passion and start their own business.)
Straight up, under no circumstances should you invest for your kids’ future in a bank account. This especially applies to the accounts designed for kids (which often come with a cute plastic piggybank). They’re generally awful, with terms and conditions that give your kids their first lesson on banks being bastards.
Avoid them like broccoli.
Instead, we’re going to invest in good-quality Aussie shares.
But it’s here that things get a little difficult.
See, the government wants to deter you from using your kids as a tax dodge, so they smack minors who declare ‘unearned income’.
The first $416 of their unearned income is tax-free, but after that the penalty tax kicks in and can go as high as 66 per cent (no, that’s not a typo).
Thankfully, there are two (perfectly legal) ways to get around paying penalty tax on kids’ investments: you can invest in your own name (perfect for lower income earners) or via an investment bond (perfect for higher income earners).
Let’s talk about each of these.
Lower income earners
If you or your partner is earning below $37 001 per annum, you should buy shares in a low-cost listed investment company (LIC) like AFIC (ASX: AFI) or Argo (ASX: ARG) on behalf of the kid.
Put it in the lower earning spouse’s name.
We’ve covered share investing in Step 5 already, but let me give you the 30-second recap here:
A LIC is basically a share fund that trades on the sharemarket. The oldest LICs, like AFIC and Argo, have been around for decades (and in the case of AFIC since the 1920s) and have been wonderful investments for long-term investors who don’t want the hassle of picking individual shares or paying high management fees.
Bottom line? I have a large amount of my own money in LICs. So do my parents, and my mates and my children (under my name — see below).
You buy the shares in a LIC by opening a share trading account. And if you don’t have an account, in most cases your bank will have one. Buying is as simple as doing internet banking. Just make sure you set up your share trading account with the following designation:
Adult Minor
Alan John Wilson Penny Wilson A/C
This means you’re the legal owner of the shares — and therefore you’ll need to declare any income from the shares in your tax return. Still, it’s simple and clear (from a records perspective) that you’re administering the account on behalf of your child.
For a stay-at-home mum or dad this is a cracker of a strategy because you can earn $18 200 in total income each year before you have to pay any tax on earnings.
You’d have to have more than $300 000 invested before you even had to think about paying tax.
In a few weeks’ time you’ll get a dividend reinvestment plan (DRP) letter in the mail (like this).
Tick ‘full participation’.
This will allow you to automatically reinvest any dividends into buying more shares. When you do this, you won’t need to pay brokerage (the fee for buying or selling shares), and often you’ll get a slight discount on the current share price.
Higher income earners
What about if each of you is earning over $37 000 per annum?
Then the name is Bond … Investment Bond.
Bad jokes aside, I’m a huge fan of investment bonds.
They allow you to invest in managed share funds, and they’re awesome for kids.
Let me give you three reasons why I had a picture of an investment bond next to my poster of Michael Jordan in my bedroom growing up:
There is no additional capital gains tax (CGT) after 10 years when you sell.
You can open an investment bond, start up a regular savings plan into a managed share fund, compound your returns and then pull your money out capital gains tax free after 10 years.
You can kiss your accountant goodbye (you don’t have to declare the income).
The investment bond pays tax within the bond (at the corporate tax rate of 30 per cent — which is why it makes sense for higher income earners), so there’s no need to declare this on your yearly tax return. And there’s no tax at the end of the 10-year period. Dead simple.
You can compound your yearly contributions.
A major benefit of investment bonds is you can increase your yearly contributions by 25 per cent each year and still pull your money out free of CGT after 10 years.
Which investment bond?
There are a number of investment bond providers — like Australian Unity’s 10Invest bonds, Generation Life’s LifeBuilder bonds and AMP’s Growth Bond. To choose one, the same rules you used for choosing a super fund apply: you want to invest in shares (not all of them do) and the lower the fees you can pay the better.
In the past I’ve warned people that the only mob they should definitely stay away from was my old nemesis … Australian Scholarships Group, or ASG as it was known (they’ve since rebranded to ‘Futurity’).
However, I found out in 2019 that a mate of mine had taken over as ASG’s new CEO.
It was like finding out your mate has a tattoo of Justin Bieber on his rump … or when he turns to you and says, ‘Actually, Pauline Hanson does make some decent points, you know’ … or that he’s the new head of a company that you’ve despised for over a decade.
Yet I have to give him credit: so far he’s turned things around somewhat, closing down most of the old, crappy products.
(Though they’re only closed to new members … the people still stuck in them are out of luck.)
One more thing: all bonds have a number of rules, so check the fine print before you invest.
How not to raise a spoilt brat
I’m passionate about financial education. So passionate I’ve written a whole book about this: The Barefoot Investor for Families: The Only Kids’ Money Guide You’ll Ever Need.
I even bought a farm for my kids. Each one will get a paddock, a ram and a ewe — financial education and sex education rolled into one.
The trouble parents get into is not understanding that pocket money is really a tool for financial education.
So if you don’t want your kids to grow up entitled, don’t give them an allowance. Make them pitch in on ordinary things around the house (washing up, taking out the bins), but pay them for working hard (like in the real world).
Now I’ve already introduced you to the Serviette Strategy with its ‘three bucket’ approach. For your kids, the three buckets turn into three jam jars.
Grab three jars (without the jam!) and label them ‘Splurge’, ‘Smile’ and ‘Give’.
Kids learn by seeing and touching (which is why student banking sucks), so you want to make it as visual as possible. Keep the jars in your kid’s room so they can see the money piling up.
