It’s hard to believe that people with investment portfolios of several million dollars could be struggling financially but we are seeing this more and more with people who have large portions of their portfolios in property and/or fixed-interest investments.
Government ten-year bond rates are now at 0.89 per cent, so a portfolio of $5 million invested in ten-year bonds will generate annual income of less than $50,000.
I recently met a new client who appeared, at first glance, to have few financial worries. Aged 50, he has $7 million in total assets, including a family home with no mortgage. He requires, he says, $120,000 a year to live on.
My first inclination was that he had nothing to worry about, but a closer inspection showed this wasn’t the case.
His principal residence in Sydney is unencumbered and valued at $2 million. His investment portfolio totals $5 million, of which $3 million is tied up in residential investment properties which, although they have appreciated in value in recent years, deliver little in the way of income. Most of the rent goes towards repairs and maintenance.
His remaining $2 million is spread across equities and fixed interest, which produce an average yield of around 3 per cent per annum, or $60,000. While a $7 million investment portfolio seems huge, the mix of investments – including a heavy exposure to residential property – means his income requirements are not being met.
If he draws on his invested capital to take his annual income to $120,000, his capital will disappear within 30 years. He could conceivably live another 50 years. And as he eats into his capital, his income from investments will fall commensurately.
My client is a casualty of the dramatic reduction in interest rates in recent years, and represents a good case study of how people must adapt to meet changing circumstances. Lower interest rates are fine for borrowers but no good for investors.
Where once $1.5 million on term deposit would generate a reasonable income ($75,000 a year at 5 per cent), today that same amount, at 1 per cent, generates $15,000 a year.
Dramatically lower interest rates are only one of several key issues affecting older Australians. More and more Australians wish to retire earlier and most are living longer. People who don’t prepare for these things could end up in genteel poverty.
Two generations ago, people retired at 60 and many died at three score and ten (70), so their savings needed to support them for only ten years. Today many people are living into their 90s, so their savings must last three or four times as long. Meanwhile younger Australians are watching this in horror; it is they who will have to fund social security for the burgeoning number of retirees.
So, what should investors do in these days of dramatically lower interest rates?
1. Reassess spending. Until interest rates recover, investors need to reassess what they really need, and temper spending accordingly.
2. Delay retirement. Investors must take stock of their investments and savings and do the maths on possible length-of-life scenarios. Will your savings last you and your spouse 40 or 50 years? Can your lifestyle be maintained at current income levels? What happens if there is a downturn in the stock market? Do you have the resources to enter aged care later in life?
3. Reduce passive assets. Passive assets like investment properties have been a bonanza for many people, but land tax on investment properties (which increases exponentially as the value of a property’s land is revalued), increasingly lower returns, higher outgoings and more demanding tenants mean they can be a drain on finances.
4. Reassess your portfolio, but always align it with your risk profile. Blue-chip companies paying dividends that yield greater than 4 per cent, ideally fully franked, make up the bulk of many share portfolios. Be wary of changing your risk profile in the search for greater returns; there must always be a balance between risk and reward.
5. Beware of being too generous to children or grandchildren. Several generations of Australians have assisted their children financially, principally by helping them enter the property market and by paying school fees. Today, this needs to be reassessed.
IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial situation, objectives or needs. That means it’s not financial product advice and shouldn’t be relied upon as if it is. Before making a financial decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services advice.
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