Occupations: Pharmacist and sales/marketting
Incomes: $77,000 and $90,000, including superannuation
Assets: Family home worth $300,000; Investment property worth $300,000; shares worth $30,000.
Expenses per month: About $3500 (to service living and debts)
Savings: none
Debt: $200,000 on investment property, $20,000 on shares.
Goals: To drop one day of work a week, then two, three and so on. To start having children over the next two years. To increase their income by 10 percent per annum without increasing expenses.
*Not their real names
Hans and Ingrid want to be financially independent by the time they are age 35 to 40. They are keen to establish an investment strategy for the long and short term.
"Our investments are basically paying the debt for the property and shares," Hans says. "All our extra income is used to pay down the shares. Should we continue to buy more shares or pay down more on the investment property? What managed funds can we invest in to cover the cost of interest, inflation and tax? I have yet to find any."
Hans has a company structure sitting dormant. "Is there any reason why I can't buy in the company name to attract a tax rate of 30 per cent?" he asks. "I understand that when I move money out of the company it will be taxed at the nominal rate, but while it is in the structure it is compounding away."
Hans and Ingrid now save, or "pay down", roughly $40,000 a year and do not want more non-tax-deductible debt.
They would like to move into a new house within the next two years. "We are happy to buy an investment property with a decent block and develop it later or wait," they say.
"We can be habitual savers with just a few splurges - we eat out a lot but usually at cheap noodle bars. We enjoy the odd overseas holiday and lots of outdoor activities."
Michael Harrison, certified financial planner and authorised representative with Heraud Harrison and member of the Financial Planning Association, replies:
Goal setting is a critical ingredient to a successful financial plan. However, these goals should be realistic.
You want to be financially independent within 10 years, which generally means accumulating sufficient capital to provide for living needs at least until normal life expectancy and probably beyond.
In simple terms, assuming you require a net cash flow of $42,000 per annum at, say, an average tax rate of 10 per cent for 60 years from age 40, and assuming your investments can generate an average return of 4 per cent above inflation, you will need to accumulate investment capital of slightly more than $1 million in today's terms. This assumes that all needs are met with the cash flow of $42,000 per annum. If cars and holidays are to be covered separately, you will need more.
With current net assets, excluding your own home of $110,000, and a savings capacity of $40,000 per annum while you are both working, achieving the goal of financial independence by 35 to 40 looks impossible.
The secret to success is to define your goals and break the journey into small steps. I suggest you structure your strategy into time periods: from now until you buy your new home, from the time you buy the new home until non-deductible debt is repaid, from the time the non-deductible debt is repaid until you both cease work and, finally, retirement.
You want to move into a new house over the next two years but at this stage your plans are not clear. Therefore, your savings capacity should be directed into a secure investment to fund the upgrade. As it would be unwise to speculate on equity markets with money required in the short term, you should put savings into a high-yield deposit account.
When you buy the new property, you should draw from this account to fund the shortfall and minimise new debt.
After your non-deductible debt has been repaid, you should build a portfolio of quality managed share funds and direct equities to diversify your property holdings. This portfolio could then be geared. These investments should not be made in the name of your company as you would not be entitled to the 50 per cent reduction on capital gains, which applies to assets owned through either a trust or individual names.
Another issue to consider is whose name in which to hold the investment property. If Ingrid stops work first, it might be advisable to have it in her name to minimise tax on rental income.
