Hypothetical run towards financial freedom.

[Alpine Dragon]

The following is not my situation unfortunately (sob) but is Very loosely based on a friend's situation, modified. I Would be interested in what you would do if you were in the following situation and wanted to gradually progress to financial freedom.

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Hypothetical Scenario:
You are the father (60 years old) of a working class household of 4 members. Including 2 Adult sons. (20's).
You work for the public service earning 50k a year.
Your wife is a home maker.
One of your adult children (early 20's) having just graduated from Studies (computing) is currently working for 30k P.A whiles your other son is currently still studying (finance).
Both you and your working son, are saving a combined total of 30k. P.A after tax

You all live in a near new 5 bedroom home on Auckland's Eastern Suburbs, Mortgage free. Estimated fair Market value is 700k. (Your next door neighbor's house with similar specs sold for low 800k's)
In addition to that, between the all of you, you have 350k in total sitting in bank terms deposits.
You have a further 20k in AUS and NZ shares and 10k in a Managed Forex fund.
The value of your other assets are negligible, Your house has very little valuable furniture and both the family cars are just 10 year old Japanese imports.

Your current un-finalized plans include downsizing to a smaller, less lavish, weather board, 3/4 bedroom home for $300,000 in Manurewa (which also happens to be much closer to both working family member's work places), by drawing on 350k currently on term deposit and renting out your current Eastern Suburb home out to earn an additional $600 a week income and using the 50k left over to invest in other things.
(This is not finalized, and can be changed)

Assume the family will be comfortable with living on 50,000k P.A for total living expenses, with enough additional growth / gain to allow total value of investments to appreciate at a rate above inflation.

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Based on your own real life experiences and knowledge and Taking in the account of the current economic conditions and anticipated economic conditions, If you were in this situation and you decided you want to become financially free, what would *you* personally do to in order to achieve this goal? How will you apportion your funds and equity and what would be your reason for doing so?

Assume you are willing to draw on the equity of your home if necessary.

[duncan macgregor]

ALPINE DRAGON, I take it that you are an Asian person, or the person you refer to is an asian. I point this out because of the fact of different strokes for different folks. Different nationalities have different view points about life, and what financial freedom means.
Some nationalities feel obligated to the extended family concept, where the poor ones hold the rich ones back, similar to dragging a ball and chain. Others like the asians, look after the family business, and are expected to look after their old people then pass the business on bigger and better to the following generation. Most NZanders think that if they have enough to pay the bills in their old age then that is good enough. Financial freedom we can never acheive because we rely on not being caught out in things beyond our control like wars, or other unforseen disasters. If you asked a person in Calcutta how much it would take them to be financially free you might feel filthy rich. macdunk

[rocket science fiction]

if the dude in the egg-sample has those assets and stuff and doesnt feel financially free than pirhaps he never will.
tell him to take a trip to vietnam and hell come back feeling like a billion-air

[wns]

Rocket-Science-Fiction has a good point which is why…

The first thing I would do in that situation would be to invest in my own financial education because the more financially astute you are, the higher the return you can earn on your money and you lower the “risk”. Learn about different investments such as shares and real estate then find approaches that make sense and you feel comfortable with. Make a plan, follow the plan, keep learning, invest in what you know and understand, get familiar with calculating the returns you can get on your money from different potential investments. For me, the education is an ongoing process.

Before any more major investments are made, I would set up legal structures (such as trusts etc) to control and protect the assets and legally minimize tax. They will need to engage some professionals such as accountants and solicitors to do this, but it is a worthwhile expense. Make sure these people are wisely chosen though.

John Burley has written a book with a title something like: Money Secrets of the Rich. It’s a bit of a corny title but it is an excellent book with lots of practical advice.
The first third of the book is about knowing and managing your own finances and setting up an automatic investment plan. The second part is about reducing your expenses and being astute with your decisions. The third part is about some investing principles and some profitable real estate investment strategies.

If the Eastern Suburbs home is worth $700k, then the $600pw rent represents only a 4.46% return on this money.
And I’m guessing the $600pw is before expenses (such as mgmt fees, rates, insurance, maintenance etc), which makes the net return even lower – probably something more like 3.6%. ie. The $700k would not be working very hard for them at all if they just rented the house out. Its just sitting there doing nothing.

The idea of moving to a house that can be purchased for $300k is probably a good idea. In addition to being closer to work, it also frees up an additional $400k that can be invested for an income. That will leave them with: $20k + $10k + $350k + $400k = $780k to invest with.

I’d probably have something more like $25k in a term deposit earning 5.4%, instead of the $350k. Not much would need to be there because they are earning a net surplus of $30k per year anyway. If they do what I mention in my first paragraph, they will be able to find more profitable places to invest this $30k per year surplus as time goes on.

I would then invest the rest of the money in both real estate and a select few companies that are financially strong and meet my investment criteria. I would include borrowing in this strategy to leverage my returns.

[duncan macgregor]

WNS, You give an example of an eastern suburbs home worth $700000 rented out at $6oo pw giving a return on money of only 4.46pc on money quoting your figures. What you forget is if you take the figures over the last thirty years and assume that this will continue for the next thirty years you might come to a different conclusion. House prices have increased in value 10 pc per annum. That being the case your rent will go up roughly by the same figure.
The landlord will have a much better bargain than the tenant over time. With your figures the landlord isnt to bright, and the tenant is the smart one, but in ten years time the house price has doubled, and so has the rent. Never rent if you can afford to buy, unless you are on the move. macdunk

[Halebop]

What MacDunk forgets is that house prices do not increase at 10% per annum. The gross value of housing stock does not even increase at this rate and it includes incremental new housing stock, maintainance and improvements. Nor have rents kept up with capital values - meaning houses have become relatively more expensive compared to their cashflows. Rental increases have kept closer to the rate of inflation. Capital values increasing at a faster rate than cashflows is a hallmark of confidence. Confidence is an emotion and not a fundamental. Emotions have mercurial characteristics.

The more recent surge in house prices since the 90s is in response to cyclical factors: Lower Interest Rates, Baby Boomers hitting their peak earning capacity, Boomers inheriting from their parents, a friendlier economic/GDP/Low Inflation environment. Even if you assumed this is a 30 year housing super cycle (it's not - housing underperformed inflation for a big chunk of the last 30 years as well), it's a cycle that will end with some currently unforseen event that will be blindingly obvious in hindsight.

No investment category is an island. There is no magic formula. Housing doesn't just increase in value every year by magic. It's impacted by all the factors that every other hard asset enjoys and endures. Do we think record employment, strong economic growth and low inflation had nothing to do with the current round of housing price rises?

[duncan macgregor]

Haletop, The price of compliance to build a new house is going through the roof which in turn will force house prices up faster than ever. macdunk

[wns]

quote:Originally posted by duncan macgregor

WNS, You give an example of an eastern suburbs home worth $700000 rented out at $6oo pw giving a return on money of only 4.46pc on money quoting your figures.

Not my figures macdunk. I was responding to Alpine Dragon who started the topic and asked for some ideas. The $700k and $600pw were given by Alpine Dragon.

What I was suggesting is that they search for higher yield investments because the 3.5% net yield they would get by renting out the $700k house is not a very good return.

It is cash flow that will enable them to have financial freedom and that is what they asked about. The value of the house might go up in the future but it is investments that produce an income today that enables them to cover their living expenses.

They can't even buy $10 worth of groceries based on "possible" future appreciation can they?

[duncan macgregor]

WNS, I understand where you are coming from, so let us both look at the figures we were given for this house rented out. Let us presume that the return on the investment is only a paltry 4pc plus the capital gain, less the expences for the first year. A good investment is double that, but this is the figures we were given so lets see how bad it really is. According to figures that i have for the last thirty years, the house price rises have averaged up at 10pc per year. This bad investment will double in price over ten years, along with the rent. The return on this bad investment will rise on average 10pc per annum, the house can be borrowed against at the drop of a hat. We will get all sorts of crappy people that have never rented anything out themselves saying its rubbish. House prices will rise at a higher rate in the short term, the costs are rising faster than inflation, with fewer people being able to afford to buy, pushing demand for rental accomodation higher. The person with that crappy investment is much better off than if they got an eight pc return from a bank. macdunk

[Mick100]

"According to figures that i have for the last thirty years, the house price rises have averaged up at 10pc per year."

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now I'v seen this statement made by macdunk so many times I thought I'd do some quick calculations and see weather, as I suspect it doesn't, stack up.

Don't know exactly what price the average house was selling for in the 70's but lets pick a figure of $20,000 (I know a new car was valued between $3500 and 4000 in the early 70's)

$20,000 at a compounded 10% rate of interest over a term of 30 yrs comes to $348,988

If prices double every 10 yrs
ie $20,000 (1975)
$160,000 (2005)
equals compound rate of 7.18%

My Guess is it's closer to 7% than 10%




PS edited calculation


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