Investing and wealth creation are both subjects with lots to learn along the way.
To help simplify tricky questions and clear away confusion, we’re running an ongoing Q&A series.
We hope these little discussions and case studies provide you with insights to further your thinking as you progress towards your goals :)
Just so you know, in many cases there’s often not a “right” answer, so be sure to think carefully how to adapt any information to your own circumstances.
If you have a question you’d like answered, feel free to leave it in the comments below, or post it on the
Pearler Exchange
.
In this Q&A session, we’re tackling:
– “My loan is fully offset. Now what?”
– “Does selling hurt compounding?”
– “Am I saving enough for my kid’s education?”
– Building wealth on an unpredictable income
– “How much of my income should I spend on housing?”
– Debt recycling + keeping debt in retirement
“I have a rental property that is fully offset. What are the implications if I invest that money into ETFs?”
Firstly, for those unsure, this means you’ve been able to save enough money that the offset account has the same amount of cash as the value of the loan. For example, this could be a $400k loan with $400k cash sitting in an offset account. Very impressive!
Currently, this investment property will now have interest expenses of $0 per year. If you pull the money out to invest in shares, the loan will be charged interest again. This interest is tax deductible though, so it’s not all bad. Plus, you would only do this if you expect to earn greater long-term returns through ETFs than you are paying in interest (after tax benefits).
While you have to pay interest, you’ll also start earning
dividend income
from your shares and may achieve capital growth over time. Keep in mind that you are saving money by keeping your money in an offset, as you won't have to pay tax on any of your savings. Whereas, you will have to pay tax on any dividend income you receive. As for whether this is a good idea, it depends on your goals, your mortgage interest rate, and what your expected return is on investments.
You might want to have a paid off rental as an income stream to live on. If so, then either paying the loan off or keeping the cash where it is will make more sense. If, however, you were wanting to be more aggressive, you could easily invest this cash – either
at once
, or over time – into an ETF portfolio.
Investing the money offers more diversification and a possiblity of greater wealth over the long run. However, be mindful of market movements. If you’re just starting out, take it slowly and dollar-cost average until you get used to the fluctuations.
Does selling shares ruin compounding?
Here’s the scenario…
“When I first started investing in shares, like many newbies, I became allured by thematic ETFs and penny stocks. This was prior to becoming fully aware of the fees associated with thematic ETFs or the extreme volatility of penny stocks. I have since thankfully invested in low-fee index funds, however am now left with the decision of selling off to consolidate.
“I realise there’s no right or wrong answer without being able to predict the future, but I was wondering if you could talk through the pros and cons of consolidating investments. For context, I am looking to invest over a long timespan, however am not sure whether selling my ETFs/paying CGT goes against the adage of 'never sell/never interrupt compounding'.”
Great question. Deciding whether to sell and consolidate our money into less holdings is something most of us deal with at some point.
Let’s talk through the main concern first: interrupting compounding. In short, 'never interrupt compounding' basically means don't sell unless it truly makes sense.
One of the cases where it
does
make sense is when you've decided to consolidate and sell off some not-so-good investments. The reason this passes the test is because the money is being put into better quality investments for the long term.
It doesn't count as 'taking money out' because the money is being reinvested basically straight away. Simplifying and/or switching investments makes sense in a lot of cases and I've never heard of someone who hasn't done it at some point!
That being said, if there’s
capital gains tax (CGT)
to pay, you’ll want to weigh that up. If it’s a significant sum, it could make sense to keep it until you're in a lower tax bracket. But if you expect the investment to underperform your alternate option, then taking the once-off hit could actually be more profitable.
So that’s the long-term decision. In the short term, the right answer is unknowable. The shares you want to sell may well outperform over the next 12 months. They could also perform much better than your index funds. We simply can’t know.
In reality, if that happens, I would just smile and chalk it down to luck. That’s happened to me before, and I did just that – smiled as if to say, “That’d be right!” and then forgot about it.
Whatever you do, don’t sell and then keep checking those other shares! You’ll drive yourself mad over what you ‘should’ have done, which is delusional at best and confidence-damaging at worst.
For those who’d like to read a bit more about this topic, I wrote the following articles:
"Am I saving enough for my kid’s education?"
“I'm struggling with how to be sure that I have locked the right amount of savings for my children’s higher education and whether I am using the right tool for it. They are 5 and 2 years old right now. I have a set amount going towards VDHG every month, likely working out to be around $110,000 by the time I would need to use it.”
Disclaimer: I have no kids, nor do I plan on having any.
I think this reader is doing an excellent job in this area. They’re worried about not having the ‘right’ amount set aside for this future date – say, 15 years into the future.
But I actually don’t think they have anything to worry about. I say this for the following reasons…
-- They’ve got a good plan underway already, a very healthy amount planned for, and a long timeframe to work with.
-- Any amount you don't 'include' in the kids education fund can/will be invested separately and you can always tap into this later if needed.
-- The exact amount is unknowable since we don't know for sure what investment returns will be, nor the growth of education costs.
In short, I think this person is nailing it already! Given the timeframe involved, I’d be doing basically the same thing. One thing to be aware of though, is the tax implication of needing to sell your shares in order to fund your kids' education. It may be worth talking to a tax accountant about the best way to access this money when it comes time to do so.
It’s hard to go wrong when you approach any goal with these three things: thoughtful planning, consistent action, and tweaking things as you go.
Building wealth on an unpredictable income
“I’m a music producer and I just signed a distribution deal worth $500,000, which I’ll be receiving over the next 12-24 months. I was wondering how to approach this dramatic increase in income (tax wise), and what would be some good options to do with this much money?
Fascinating situation, and congrats on the deal!
Given I don’t know this person’s age, or their personal goals, it’s hard to know what to prioritise.
None of this is personal advice, but let's run through some scenarios that may be worth considering.
Putting money into super would be very tax effective, given the tax rates involved here. However, it locks up money for multiple decades. Fortunately, there’s a number of potentially attractive options. You could do any one (or a combination) of the following…
1. Go heavily into super
. Also look into
carry-forward (catch-up) super contributions.
This saves a lot of tax but locks up a big chunk of money.
2. Build a big emergency fund if income is expected to remain lumpy
(use a high interest savings account). This offers maximum safety, but not a great long-term return.
3. Start investing into a low-cost diversified share portfolio
. This offers higher long-term returns in exchange for some risk and volatility.
4. Use it as a home deposit if ownership is desired . This one is more about life stability and future security.
If the goal is to maximise wealth, then I would go for Option 1 + 3, plus a cash buffer. But, as usual, it all depends on your particular goals and preferences. As this is a large sum of money, it may be worth talking to both a financial adviser or tax accountant to consider all possibilities when it comes to various financial options.
What’s the right amount to spend on housing?
In the personal finance space, you’ll often see experts suggest you should allocate a certain percentage of your income on housing, a certain percentage for investing, a certain amount for spending, and so on.
I’ve never been a fan of this approach. Why? Because it’s completely arbitrary and made up.
While it might seem sensible, it’s not actually useful, because everyone has such different scenarios, incomes, and priorities in their lives. Here’s what I mean…
You could spend 15% of your income on housing, and then spend a ton on cars, holidays, and entertainment, leaving you with very little left over. Or you could spend 45% on housing, while you optimise everything else and end up saving 30% of your pay.
Maybe living in a lovely house was your top priority and you simply aren’t fussed with restaurants, cars, and holidays. Who’s to say that’s wrong?
I understand where it comes from. If you spend too much on housing, you won’t have enough for other stuff, and will be left struggling to save and invest. The sentiment is fine, but the figure is arbitrary.
You essentially want enough breathing space so you can still have a good life and ideally save and invest as well. As long as you can maintain that, you’re good. Don’t worry if you’re not hitting some made-up percentage.
Of course, there may be periods where rates are higher and mortgage repayments are painful for a while. But on average, and over time, if you haven’t overdone it, then you’ll be fine. As your income goes up over time, you’ll hopefully have an improving situation, giving you more cash to invest or pay down the loan.
So don’t worry about matching some arbitrary target. Feel free to do whatever you like, as long as you can maintain a decent savings habit :)
How long into your FI journey did you discover debt recycling? And should you pay off the debt as you approach retirement?
First,
debt recycling.
I did a bit of this in the earlier property investing days when I teamed up with my partner. We paid off a big chunk of her owner occupied home loan, and then took the money back out to use as a deposit for an investment property (making the interest on that part of the loan tax deductible). So I’d been aware of how to optimise debt since pretty early on.
As for paying it off, it can often make sense to get rid of debt before retirement. But it does depend on the situation, so a blanket answer isn’t helpful.
We actually left work with a giant pile of debt given our property portfolio (several million in fact). This wasn’t a problem as long as there was always enough cash in the bank to cover the loans (which I made sure of).
Owner occupied home loans are often best eliminated before leaving work as this improves your cashflow substantially. Rental property loans are a different story, where it depends more on your strategy. If you’re wanting to use rent as an income stream, then paying off the property is ideal. But if you’re trying to maintain as many assets as you can for as long as possible, then keeping the debt as it is will be a better fit (provided you can service it, of course).
Let me zoom out and speak in general for a moment. Debt recycling and keeping debt around typically works better during the pre-retirement phase. After FI / retirement / whatever you’re doing, most folks want to get rid of debt, reduce risk, and simplify their cashflow. Not strictly for numerical reasons, but psychological reasons too.
In almost all cases, the rate of both rental income and dividends will be lower than principal and interest mortgage repayments, just on a percentage basis. So cashflow is typically improved by removing debt. But…if you can still access cash from elsewhere and are more interested in maximising wealth, then keeping debt will often prove more profitable.
It may be worth chatting with a financial professional to see how this strategy could work for you.
Final thoughts
As you can see, there are multiple angles that we need to consider when tackling these scenarios.
Hopefully you enjoyed this Q&A session, and these answers gave you food for thought.
If you have a question on a topic you’d like some more information on, feel free to post it on the
Pearler Exchange.
They’ll be answered by fellow investors in the community – like myself, someone more knowledgeable, or one of the Pearler team.
You can also post a question down in the comments selection and we’ll cover it in a future Q&A article.
Until next time, happy long-term investing!
Dave
