I love investing. Why do I love investing? Because from personal experience I can see it works. The source of our wealth is investing. Yes, the incomes we received from our jobs enabled us to invest, but we would not have become wealthy because of our jobs. Why? Because we always spend what we earn. Let me explain using one property as an example.
I purchased a property in 1997 for $165,000. By the end of 2007, the property was re-valued at $410,000. That is a capital increase of $245,000. In ten years, I would have found it impossible to save that amount: over $20,000 per year. Over those ten years, I was on an average salary of approximately $50,000 per annum. It would have been impossible to save an average of $20,000 per year.
To me, investing has been a form of forced savings.
As much as capital appreciation on an investment is very exciting, it also brings with it a level of risk.
The risk is the access you have to the capital appreciation. Loan products are available that allow you to re-finance your property to the current market value and you can access a portion of the capital growth for your purposes.
This access to the capital growth can either be a risk or an opportunity.
Let’s look firstly at the risk. Let’s say your Mortgage Broker tells you you can gain access to $100,000 on your property. You get very excited and buy a new car and a boat for your family. Let’s look at some of the downsides of this decision:
– Increased expenses: you now have to pay interest on the $100,000 loan. This is a personal expense you did not have before you purchased the car and boat.
– You purchased items that will decrease in value over time (depreciating items). The depreciation rate on a new car can be as high as 25% per annum. On the $50,000 car alone, without even considering the boat, you could lose $12,500 in the first year on depreciation.
– You purchased items that are unlikely to generate income for you. It is more likely they are going to increase your expenses. For example registration, petrol, insurance, mooring fees.
Going into debt to purchase depreciating items that do not generate income is not a strategy for financial independence. Cash flow and wealth are going backwards.
Let’s now look at the opportunity. Once again, your Mortgage Broker tells you you can gain access to $100,0000 on your property. Again you are excited but this time you use the $100,000 as a deposit on an investment property. Let’s look at the positives of this decision:
– You purchased an item that will increase in value over time (appreciating items).
– You purchased an item that will generate income for you in the form of rent. Property will also incur expenses in the form of interest on the loan, property management fees, rates, depreciation, insurance, etc. However your Accountant will be able to advise you on the expenses that you can claim as a tax deduction.
Going into debt to purchase appreciating items that generate income is a strategy for financial independence.
Now you might say that you also want to enjoy life and buy some lifestyle items for example a newer car or a boat. Yes, I agree with you. Life is for living. I believe it’s all about balance.
Financial independence is when your passive income covers your living expenses. If your goal is to become financially independent, you need to work on increasing your passive income, not your expenses. If your living expenses are going up but your passive income is not, you are on the path of working for a living rather than financial independence. My philosophy is to buy luxury lifestyle items when passive income covers expenses. Until then, we live within our means.
Our property investment strategy is to build a property portfolio and then just basically hold it for the rest of our lives. You can never say never, so along the journey some properties may be sold, however they are sold with the intention of buying another property that better fits with our strategy.
Given we are passive investors, it is important that we buy property in an area with high potential for capital growth and manage our cash flow well so we can afford to hold a property portfolio, without the need to sell.