Before we consider investing, lets look at our options.
Most regular Australians have 3 choices, the share market with all its vaguries: property made up of residential, commercial and industrial: and cash in the bank.
The first response i hear when people talk of investing is “I have no spare money. At the end of each month, i have more month than money”. Consider using your superannuation with no change to your cash flow. Investing is about making your money work smarter…
There are three critical concepts to fully understand when we look to invest.
Equity: If i was to give you a suitcase containing $300,000.00 would you bury it in your backyard and dig it up on retirement? Or would you invest it, make it work for you? A lot of Aussies have that suitcase within their own home, we call it Equity. The difference, between the current value of your home, and what you owe the bank. For example, say your home is worth $700,000.00 and you owe the bank $300,000.00, your Equity is $400,000.00. In the same way that you would be cautious with investing the suitcase full of money, you should be equally cautious with your home Equity.
Leverage and Gearing: To explain these concepts, it’s easier if we recall the rule we learnt at school The rule of 10/72, which is, if we invest $100 at 10% for 7.2 years or $100 at 7.2% for 10 years you will have $200 at maturity. You double your investment. So using this formula let’s look at an average Aussie family’s Wealth creation plans. They have Equity of $300,000.00, the ability to save approximately $80.00 per week and enjoy a combined income of $160,000.00. Let’s say they invest their $80 each week in a bank term deposit for 10 years.
This equates to $4,160.00 per year, $41,600.00 after 10 years (interest and tax on their investment would alter this figure).
Now consider, they use their Equity to borrow (Gearing) $380,000.00 and buy a $350,000.00 investment property. They hold it for 10 years, and with inflation the property averages 7.2% capital growth. They earn $15,000.00 per year rent, and receive a tax refund each year (negative gearing) of $10,000.00 and they pay interest only and costs on the property of $30,000.00 per year. At the end of 10 years they sell the property and pay the bank back the $380,000.00.
After selling the property and paying the bank back, they are left with $380,000.00 (less CGT). By Leveraging their $80 pw savings they have generated $380,000 as opposed to $41,600.