It’s too easy for people to miss the signal that they are able to become ‘wealth builders’ and are in prime position to ensure a healthy financial future if they make the right choices.
Unfortunately, if they miss the signal it can make a significant difference to their financial position when they retire, says Mr Jonathan Philpot, wealth management partner at accountants and advisers HLB Mann Judd Sydney.
“Missing out on a couple of years of savings and its compounding effects over ten to twenty years can make a huge difference to the amount they have saved.
“Different people will reach this ‘wealth builder’ stage at different times, so it’s difficult to say precisely what age this is, but for most people it will be some time in their 40s, when their income reaches a peak, their mortgage is down to 50 percent or less of the home’s value, and retirement planning strategies become a focus.
“Generally, one of the first signs is that there is more disposable income available in the family and it’s important to recognise this so that a decision can be made to put some of the extra funds into savings rather than spending it all on the family’s lifestyle.
“It’s the first time in our lives when we are in control of our financial situation and can make big decisions about how to manage wealth, and the choices made now can have a significant impact on our financial future.
“For younger people, much of their financial situation is ‘automated’ and inflexible – a set amount goes into superannuation, another set amount goes to pay off the mortgage each month, and there is little opportunity to vary this or put aside enough money to do anything else.
“For those in retirement, there is a good level of flexibility; however there are still rules and regulations governing, for instance, how much you are able to contribute to super, when you are allowed to commence drawing a pension; and a minimum amount that must be drawn down. There is also the limitation that people in this phase of their life can’t afford to be too aggressive in their investments, and must therefore keep to fairly balanced or simple strategies.
“However in the pre-retiree years there are a number of tax-advantaged strategies that can be adopted – but how these can be applied will depend on how successful wealth accumulation strategies have been.
“It is therefore critical that people who have the opportunity to change gears and focus on building wealth ten to twenty years before retirement, start doing more than just repaying the mortgage and making superannuation guaranteed contributions.
“As it also coincides with the peak income-earning years, there should be additional money available that can be put towards building wealth,” he said.
Mr Philpot added that there are three main strategies that people should focus on when they become wealth builders.
They are: reducing the mortgage; increasing super contributions; and looking at appropriate gearing to diversify their wealth.
Mr Philpot says that people should plan to be mortgage-free by the time they enter retirement.
“Therefore any wealth accumulation strategy should include reducing home mortgages as a priority, especially as the interest on mortgages is not tax-deductible.
“This strategy should start as soon as possible with mortgage holders looking at ways of always paying more than the minimum amount or making mortgage payments more frequently than required.
“Given that we are in a rising interest rate environment, this approach also builds in a buffer against future interest rate hikes.
“However, it should be only part of an overall strategy as your home is a “lifestyle” asset but doesn’t help build your investment wealth, which is what provides future income,” he said.
The simple fact is that people don’t start thinking about their superannuation early enough, according to Mr Philpot.
“It used to be at age 50 that people started worrying about building their super balance, but now, in light of the restrictive superannuation contribution limits, they need to start thinking about it much earlier, when they are still in their 40s.
“A desired retirement income of $50,000 is not extravagant; however it requires around $1 million in superannuation savings, which most people will not be able to achieve without making significant contributions above the superannuation guarantee levels during their 40s and 50s,” he said.
Mr Philpot says that gearing can be a useful strategy, as long as it is not just into another residential property, and is not overly aggressive.
“Many people’s wealth is tied up in the value of their home, therefore residential property market moves have a large influence on their future wealth. If the residential property market has a flat period for five years, it follows that most people will see no change in their net wealth.
“Simply buying another residential property for capital gain is therefore a flawed strategy unless there is other diversification.
“Most people have some exposure to the sharemarket through superannuation, but given how low most superannuation balances are, it is relatively small.
“There can be real benefit in borrowing to invest in shares as you will diversify wealth and increase access to more assets. These are key ingredients to building wealth over the long term,” he said.
However, Mr Philpot cautioned against excessive use of gearing and borrowing against the home to purchase shares.
“Gearing is not for everyone and should be considered very carefully. It means taking on a much greater level of risk with leverage into shares.
“The borrowing should be interest only, as most of the spare cash flow should be directed towards the mortgage.
“On the positive side, with the dividend yield at close to 5% on Australian shares and interest rates between 7-8%, there is not a large cash shortfall in the cost of holding the shares. Also, with the Australian equity market still subdued, it is a good time to be buying for long term gain.
“Borrowing against the house to purchase shares has benefits over taking on a margin loan, as borrowers are not subject to margin calls when shares fall in value.
“In addition, the cost of the loan is about two percent cheaper than a margin loan,” Mr Philpot said.
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and part of the HLB Mann Judd Australasian Association.
For more information please contact:
Jonathan Philpot – 02 9020 4196