As we touched on last week, personally I believe it’s important for Generation Xer’s to be building wealth and reducing debt in tandem – rather than focus on one at the exclusion of the other. Whilst debt reduction on your home feels good and builds equity, as we covered in Wealth Creation for Gen X – How much is enough…really? in order for you to achieve Financial Freedom and get to the point where you don’t have to work for the money anymore…you are likely to require significant investment assets in order to cover your future desired lifestyle. Plus, remember “If it’s to be, it’s up to me (you)”. No one else is going to do this for you…and the government will not be in a position to help you financially like they do current retirees. And keeping in mind that the age in which we can access super is likely to keep increasing (and could be age 70 for younger Gen Xer’s)…it’s crucial that you build multiple income streams both outside of superannuation as well as inside of superannuation.
So where should you invest your money? Well it depends mainly on your goals for the future as well as your current position. Beginning with the end in mind, in order to give you the best shot at future financial freedom, at a minimum I believe that most Gen X & Gen Y’s should be striving towards the following;
- Buy your own home and pay this down over time (pay off by “retirement”).
- Build a diversified liquid investment account via a regular investment plan.
- Buy an investment property and pay this down over time.
- Build a significant amount inside of superannuation (to cover most of your desired lifestyle for life after 70).
- Build and hold a cash buffer to cover a minimum 3 months worth of expenses.
I don’t believe that anyone should focus on only one avenue in order to achieve their financial goals. What if that one option turns out to be the worst option out of all the options available? Over time focusing on most – and ideally all – of the options above will set you up towards building multiple streams of income, and will go close to bullet proofing your financial strategy while reducing the risk of any one option turning out to be the worst one.
Future blog posts will dive into the detail and provide specific and tangible ideas on each point above to help you build assets to fuel your family’s future, however an important concept to keep in mind along your wealth creation journey is what is known as “3 bucket asset allocation”.
Combined with your future goals and current position, how you invest money should also be driven by the time frame that your money can be invested for before you need access to it. As the above picture highlights, you should only invest in growth assets like shares and property if you are able and willing to hold on to these investments for the long term in order to ride out the inevitable volatility and still achieve strong long term returns. Whilst plenty of people would disagree with me I believe any shares should be bought with a minimum 5-7 year time frame in mind. Some allocation to shares could be the “medium term bucket” but most should be held in the “long term bucket”. With an investment property, given the extra costs of stamp duty, holding costs, and selling costs – you should only buy an investment property if you are willing and able to hold the property for a minimum of 10-15 years (ideally much longer).
Whilst a small percentage of people might have a talent for share trading or renovating and flipping properties for a short term profit, for 95% + of Gen X & Gen Y, the above 3 Bucket Asset Allocation should drive most of your investment decisions. Based on this, with any funds you need access to in the short term (less than 2 years)…the only place to hold this money is in cash and/or offsetting your mortgage. With few exceptions any attempt to make a short term profit from growth assets is gambling…not investing. I never want any clients to be in a position where they have to sell growth assets in a falling market in order to cover their cost of living. The 3 Bucket Asset Allocation concept is a key to protecting yourself while allowing growth assets to stay invested for the longer term.
Warren Buffet has been quoted as saying his favourite holding period is “forever”. I agree – ideally it would be brilliant to build enough assets to be able to live off the income from investments and hold the investments for the long term to pass on a legacy to the next generation/s (as we’ll cover in future blogs around creating generational wealth). However the reality is that most Gen Xer’s will never quite have the wealth of the “Oracle of Omaha” and instead will need to draw down on assets over time to cover their cost of living. So therefore it’s crucial to know how long investments can be held for to ensure you have the best chance of using the powers of compound growth, and in my mind the above minimum time frames are a must.
Whilst the above 5 points are the minimum long term asset position I believe all Gen Xer’s should be working towards…where should you start?
Personally I believe that the foundation of most people’s financial strategy should be property – in particular to buy your own home and then eventually an investment property. Whilst it may make sense to rent for a while and instead focus on investment properties and other investments (“rent-vesting”), the draw back with this is that the expense of rent will increase forever. Whereas over time as your income grows mortgage payments become less of a % of income…and eventually not be there at all upon paying off the mortgage. A mortgage on your own home is good forced savings and the growing asset will be a foundation to your wealth creation strategy.
If you don’t yet own a property…then, I believe, saving a deposit to get on the property ladder should be your focus. Whether it’s best to buy an investment property or home as your first property depends upon individual circumstances….but at least strive to do whatever it takes to get on the property ladder. This may mean making plenty of short term sacrifices…but your future self will thank yourself.
Importantly aim to build up enough cash so that after settling on the property you have at least 3 months worth or expenses in a cash buffer – just in case you lose your job or become sick and injured and not able to work for a few months. See also Wealth Creation for Gen X – Protect your greatest Asset (part 1) and protect yourself before taking on property debt.
Assuming you already own your home and are starting to build some equity, you should then give serious consideration to focusing on building the other income streams including allocating a monthly amount to a regular investment plan, contributing extra into superannuation, and eventually using equity in your home to buy an investment property. Combine this with a debt reduction strategy to create equity regardless of property market conditions and you are well on the way towards creating future financial freedom.
I like to call the investment account & regular investment plan under point 2 above your “pre-retirement superannuation”. What if you are currently 40 and would like to be in a position to choose to stop work at say age 60-65 and cover your desired cost of living? But what if you couldn’t access your superannuation until you are 70? Even if you had an investment property, it’s pretty hard to sell a kitchen, lounge room or half a house to free up some cash. You’d need to sell the whole thing and lose this income stream. A liquid investment account built up over the years via a regular investment plan, provides a liquid bucket of money to draw on for life after work. This delays any need to sell the investment property and hopefully sees you through to being able to access your superannuation…delaying once again the need to sell the investment property – allowing this to continue to grow and compound over time.
I know that carrying out the above 5 points together is easier said than done – especially when 81% of people spend everything that they earn…and a further 9% spend more than they earn. However it is possible with the right strategy. To make this possible it may require a bit of “Bottom Up Budgeting” and some delayed gratification. Either way it’s crucial to develop and implement a wealth creation strategy to provide you with clarity and direction as you strive to build multiple streams of income.
Matthew Morrison is the Director of Wealth Advisory at The Practice, a Personal Wealth Advisory & Business Advisory firm based in Parkville, Melbourne. Matt along with The Practice team are committed to and passionate about developing & implementing wealth creation strategies for clients to enable them to Fuel their Family’s Future (while protecting them along the journey).
Matt and The Practice team can be contacted via http://thepractice.com.au or (03) 8888 4000.
Disclaimer – the above views are general advice only and are purely the opinions of the author. It’s important that you seek personal advice & guidance based on your individual circumstances.