Ask Paul: I'm a divorced single father, can I afford a new car?

Dear Paul,

I'm a divorced, single father, age 43, with two daughters (16 and 12 years).  Shared custody is 50:50.

My current residence is in the Riverina, worth about $1,050,000 (mortgage $384,000), and I recently purchased an investment property in a nearby town, worth around $400,000 (mortgage $350,000).

I used equity in my Riverina residence to purchase the investment property (deceased estate) and rent it for $420 a week.

I work in allied health and earn about $120,000 with on-call and overtime/penalty rates. I have insurances for life/TPD/trauma etc that would cover all of my expenses and assist my children should something happen to me.

I have about $400,000 in superannuation (Aware) plus a small shareholding (commercial property with limited recourse borrowing) in a self-managed super fund with about $220,000. I hope to realise this in about four years when the value should exceed $400,000. I salary sacrificed the maximum amount of $27,500 last year, increasing to $30,000 this year.

I also hold $30,000 in an offset account against the owner-occupier property as my emergency fund. 

I have about $10,000 in direct shares and exchange traded funds as well as a Raiz micro-investing account (combined).

I have zero other debts apart from a $1000 credit card. I have a 2013 Hyundai Santa Fe that has done 175,000km. It goes like a dream and it has been one of the best purchases I've ever made. I live three blocks from my work so it doesn't do that many kilometres.

However, I do get a bit of car envy watching other people who are about my age driving around in newer models. I'd like to upgrade to an SUV such as a Kia Sorrento or Mitsubishi Outlander (secondhand) with about 20,000km. 

But my car drives perfectly fine at the moment and I think I'm just getting a bit of 'the greens'.

If I were to look at getting a newer car, what method do you think would be best for me? Use some of my offset and get a car loan for the rest? Look at a novated lease through my work (NSW Health) or reduce my salary sacrifice contributions into super and my shares/ETFs to save up and buy outright in another three or four years?

And, lastly, do you think my current savings/investments in superannuation will allow me to retire in 20 years with an annual drawdown of about $100,000?

Thanks for your advice.

Andrew

Well, Andrew, I grew up in Griffith, so it's always good to hear from people in the Riverina. I love your question as you've given me quite a lot of detail, meaning I can give you a better answer.

I also enjoyed your sense of humour regarding one of the most awful financial assets, a car.

First, I want to congratulate you on how you have articulated your financial position. It might work better if I send you my details and you can advise me!

Seriously, though, you've done a great job. I particularly like the important finetuning, such as insurance to protect your girls and yourself, as well as the smaller things such as the Raiz account.

You are all over the big stuff: maxing super contributions, a $1000 limit credit card, your home with good equity, an investment property and the older but still reliable car.

Planning for the future

Where I can probably help most is running some projections on the critical question of whether what you are doing now will give you about $100,000, with today's purchasing power, in 20 years.

As you know, saving is simply postponing consumption. This is where I like people to have a model of where the actions we take today will leave us in the future. You'll find these models online, or an adviser can do one for you.

Basically, it is a road map. If you don't know where you want to end up, you will never get there.

Let's take a look at your map. Any model needs assumptions.

We'll start with a clear fact. You are 43. It makes sense that your 'financial independence' destination is that at about age 63 with $100,000 a year you can have a good lifestyle.

I think it is fair to assume that your home will be paid off well inside 20 years, so you will have a fully owned home at 63. Sure, it may not be this home - you may buy bigger or smaller as your daughters become adults, you may move, but owning a home, I think, we can list as a certainty.

Now, we need to allow for inflation.

On property, shares or a diversified super portfolio, a historically sensible number to use is 4%pa for investment returns. Good assets have historically grown at that rate, on top of inflation.

We'll leave your house alone, as you will need somewhere to live. If you downsize you will free capital, but 
that's a decision for the future.

Super will play a big role

You have $400,000 in super. Including your employer's contributions, you are maxing out with $30,000 this year. Who knows what will happen to contribution levels into super, so we'll just use $30,000. This is conservative, as this should increase over time, but using 4%pa you should have around $1.8 million in today's purchasing power.

This alone puts you in a strong position. You could take about 5% a year from super and still have much the same balance for decades. That would give you a great start for your $100,000 - in fact, about $90,000.

Your investment property should be worth about $880,000 in today's money. The rent, also in today's money, should be about $770 a week. It probably makes sense to not pay off the mortgage, as 20 years of inflation will destroy its real value.

This is the power of debt on good assets: the asset goes up with inflation and population growth while inflation destroys the real value of the debt. Let's allow a bit for costs and that should add about another $25,000 a year to your spending pot at 63. Now you are at $115,000.

Next, we have the $400,000 in about four years. Let's assume this is invested, again earning about 4% above inflation. This would add about $760,000 to your funds at 63. If you draw down 5%, or about $38,000 a year, to add to your spending pool, you're at $153,000.

Life gets in the way

We can pause here because we have your answer. Obviously, life may get in the way - illness, accidents, a change of career, who knows. But based on the facts we have, it is a big 'yes' as to whether you will have $100,000 a year with today's buying power in 20 years.

In fact, while I hate to say this, you are technically over-saving. But as I said, life is uncertain. You may well achieve your goal a decade earlier, but my advice is to keep doing what you are doing and arrive at your financial destination early.

That will give you more choices.

Buy the cheapest car your ego can live with

Finally, the car.

I've always said 'buy the cheapest car your ego can live with'.

But given our analysis I can hardly argue against a new car. I'm not overly keen on a car loan - too expensive. So, check out the novated lease; with some tax benefits it may be the way to go.

I don't really want to encourage you to buy an asset that sinks in value like a stone and costs you to run it, but given you are above track for your goal at 63, I really don't have a logical objection. If it's cheaper than a novated lease, use your offset and, if necessary, add a bit to your mortgage.

Normally I'm banging on to people about saving more, but you are way above the required savings trajectory, so I guess a new car it is! I'll be 89 when you reach 63 and may not be around, but I do wish you and your girls all the best.

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