The people seeking advice have a $700,000 house and $150,000 and investments.
They want $15,000 to $20,000 pa. investment income to top up their national super and have a good retirement.
But $150,000 at 3.5% pa. after tax in the bank can only produce about $5,000 pa.
$150,000 x 6% pa is $9,000 pa – still not enough.
The problem is they have a large amount of money tied up in a non-productive asset and a (relatively) much smaller amount of money in income producing assets.
Of course they have the house and will hopefully get some capital gain over time, but they can’t access that cash until they sell their house.
The investment portfolio has a lot of work to do and it just isn’t enough, so the investments erodes rather too quickly.
The adviser can’t win – he/she can’t get more return for the client without taking a lot of risk, which usually is NOT the solution.
The client is uncomfortable watching his/her capital erode.
The end result is that the big house has to be turned into a medium-size house at some point in time.
Is this so bad?
No, but it can have undesirable consequences, along with being uncomfortable and unsettling.
Human nature being what it is, people want to keep the big house as long as possible and tend to spend less than they could because they are watching their investments erode too quickly.
They do less than they could in retirement, by trying to hang on to that big house.
What’s the point in hanging on ? We don’t live forever.
It would be better to maintain investments, rather than running them down, then selling, and then starting the same cycle over again.
Nb. What is the real cost of owning your 3rd and 4th empty bedrooms ?
Before you buy that big house ?
Two couples age 50 are mortgage free and consider the idea of upgrading to a bigger more expensive house.
Stu and Maria decide to upgrade so they borrow $200,000 to do so. The new mortgage at 7% over 15 years costs $1800 per month (they repay $200,000 capital and $124,000 interest).
Jack & Bronte decide not to, and instead divert their mortgage payments which were $1800 per month to regular savings.
Jack & Bronte’s $1800 per month invested at 6% net over 15 years will grow to $532,900 or maybe a little under $500,000 if they missed a year of savings, and had a big trip.
Stu and Maria’s flash house will grow in value, so at age 65 both couples will probably have similar total assets. (but Jack & Bronte were more diversified).
Jack and Bronte arrive at age 65 with $500,000 in liquid investments.
Stu and Maria get to 65 with a nicer home, but have very little in savings. Before too long, they will have to downgrade the big house to release some cash for retirement income.
But who has had the better quality of life from age 50 to 65?
Was it Jack & Bronte with no mortgage?
Or Stu and Maria with mortgage debt pressure but with a nicer home?
And who is better set up going forward into retirement?
Supplied by Alan Clarke who is a financial and retirement adviser.
He is the author of a book entitled “Retire Richer” which is a practical guide for everyone age 25 to 85, and also writes regular articles on www.acfs.co.nz
Alan is an independent authorised financial adviser (AFA) and his disclosure statement is available on request and free of charge.