This week we’re speaking about franking. Franking credits, building income and investing in property effectively, and how you can start now!
What’s covered today?
- If buying a house is going to be the worst thing for your cash flow.
- Theories about increasing assets and cash flow.
- Building income and practical ways to do that.
- A practical example of showing you head to head, if you bought a property and moved in – what it looks like in terms of cash flow?
- Make it rain $150K per year.
When you buy a personal place of residence (property):
- Asset goes up
- Liability goes up
- Cashflow goes down
A passive income is something that you don’t really have to work for, something you can start right now. When it comes to building a passive income, time is your best asset. When you buy a property, a lot of people think I’m adding an asset to my portfolio, yet this isn’t the case. In order for it to be an asset, there should be a self-feeding system where any assets you have, generate additional income.
When you buy in your own personal place of residence, it’s not really an asset, it becomes a liability. Buying your own home is great to have somewhere to live but you’re generating a negative income with mortgage repayments, which aren’t deductible.
How can you make a passive income?
If you view every dollar that you have as an employee, for example, $1,000 so 1,000 employees and invest that. Each one of those should bring you an income. Each year when they pay you an income, you then buy more employees. This will lead to capital growth. The compounding effects are really slow for the first five or six years, but after a certain point, it then begins to snowball.
See the example of our spreadsheet – Goal Sheet Here
Rule of thumb: Instead of aiming to save, think about it as investing 10 to 20% of your income.
You can invest in:
Australian shares get franking credits which are a tax rebate. If you’re earning $30k – $80k per year and you buy Commonwealth Bank shares, the after-tax yield will be 6 – 7%. A yield is for every $1 you have, you’ll get 6% back, so 6c back. With a $10k portfolio, you’ll get $600 after tax back.
If you were to put 10 on a home deposit, we ran some numbers and even if it’s a positively geared property, your yield after tax will be less than around 4%.
Lesson: Income in shares VS. property working off the same numbers – shares from an income point of view after tax can be very beneficial.
Example: Sydney shares
- Average property is $1Mil
If you have a $200k deposit for the deposit (20%) from there, assuming average market interest rates for 30 years you’ll have to make $5,300 per month. So now you have an $800k loan on your property.
Or you can rent an equivalent place for $3,000 a month.
So you either make a repayment to the bank and pay your loan off or rent somewhere for $3,000/month. Off that, you have $2,000 in renting (compared to buying) to play with that you can invest elsewhere, along with $200k deposit that you didn’t put on the mortgage.
Mortgage repayments ($5,300) – Rental ($3,000) = Surplus money ($2,000)
If you put that into the share market, after tax return the ASX over the past 30 years has given an annualised return of about 11% but let’s go lower and assume it’s 5% and you’re putting each month about $2,000 into that portfolio. At the end of 30 years, that portfolio will be worth about $3M, which is about the same as what your home should be worth too. This is a low estimate.
Compare and contrast
Buy: $1M property. $200k deposit and $5,300 per week. After 30 years worth $3Mil
Rent: Invest initial $200k and invest difference between rent and mortgage repayments of $2000month. After 30 years will be worth around $3Mil
Here’s the kicker, at the end of 30 years you’ll own your home outright, which is great but it’s a liability. It will still cost you money in maintenance and insurance. If you had of invested, you would have a $3.5M portfolio. The income would be $250k – $300k per year. Not only would you have a liquid investment you’ll be earning money off it. The negative is that you won’t own a home, but you can live in a rental and replace your income with passive income.
The end game:
Getting an asset base that will feed your cash flow and generate more income.
- Increase asset
- Decrease liability
- Increase cash flow
Look at positive gear property or shares that make you a good yield after tax. The end game is having an asset in 10 – 20 – 30 years time that will make you an income.
The Rentvesting Podcast, available on iTunes, was created by Red & Co’s Jayden Vecchio and expert financial planner Louis Strange. Together, Jayden and Louis unpack the facts behind the property market, explain what’s really going on & where the market is heading. They believe in challenging the status quo and want to get out there to educate absolutely anyone looking to enter the property market.