Using property to cover your cash flow shortfall in retirement
I wish more Australians knew their retirement shortfall amount and I wish they knew it a lot earlier in life than when most actually start thinking about retirement.
Most people don't start taking their retirement planning seriously until they are in their 50s, yet for many this is too late to make a real difference to their nest eggs.
I think it's because people get overwhelmed by the detail, thinking that calculating such a number is really complex.
Sure, if you want to get down to the dollars and cents, then the calculations do get more complex when you factor in indexation, taxation, compounding interest and time frames. However, there is a simple way you can calculate your retirement shortfall so you can take action.
First of all, what is your desired annual income?
When answering this question, be realistic. A great starting point is to try to replace 70% of your current household income.
Why 70%? Because most people are living with a mortgage and are using about 30% off their income to pay it down. So if you can live comfortably now while also paying off a mortgage, then that might be a good starting point.
In the example I am using, I'm targeting $100,000 a year for a couple to keep the numbers simple.
The next thing you need to do is decide on an income return you are looking for from your nest egg. Often financial professionals refer to this as the yield return.
Put simply, if you are going to build up an investment asset base, what income are you expecting to receive?
For my example I'm going to work on a 5% annual income stream. You will note when you do the final calculations that the higher the investment yield the lower the nest egg you need to build, and the lower the yield the bigger the next egg needs to be. There is no greater example of this than for the current retirees who have money in bank term deposits - interest rates in general are at historical lows.
So my tip is to be conservative but not too conservative, and since there are investments in the market today yielding 5%-7% I'm going to stick with the 5% to keep the maths simple.
Once you have decided on your desired income and the yield return it's time to crunch the numbers. In my example I have an income target of $100,000 so I need to divide this figure by 5% to obtain my investment nest egg target: the result is $2 million.
It' a challenging number on paper, and it really highlights the importance of thinking about your retirement early.
There's one last step to take: what is the value of your current nest egg?
This would include your superannuation, shares, savings, managed funds or any other income and growth investments.
We don't include the family home, as this is not income producing. For our example let's say this couple already have $400,000 in super and investments, so their retirement shortfall is $1.6 million.
How can property play a role?
While we are still working, our super should continue to grow and it's important to get an idea of what this figure might look like come your targeted retirement date. Investing in property can play a huge role in getting this shortfall down.
For example, a couple who are 45 years old and plan to retire at 65 have a further 20 years of working income.
They could buy two or possibly three $400,000 to $500,000 investment properties over the next 10 years and focus on paying off the mortgage by retirement, or certainly by this time they would be cash flow positive and generating some of the important income they have been planning for.
The old saying is still so important today: plan to become what you plan to become.
You can crunch the numbers yourself in terms of what investment properties would suit your situation or you can get advice from a qualified property investment adviser, who should be able to drill further into the numbers to develop a strategy that will see you having no retirement shortfall at all.