Courtney C. Lipsey 1. Build a solid foundation
Three things are fundamental to me in order to build wealth and financial independence.
You need first to understand your cash flow. How much does it cost to live? What is your income, and what are the costs of living?
If you don’t have surplus cash flow, there is nothing to invest or build wealth. You can find help with this in chapter 2 of my book. I give you several cash flow management techniques and a tool that will help you choose the one best suited to you.
A fund for emergencies is the next essential element in building wealth. The lack of an emergency fund is what leads to credit card debt and a downward spiral. You can use the redraw capability in your home loan or money you set aside at the start of the mortgage to create an emergency fund. It’s important to have money available when you need it, whether you need to repair your car, replace the fridge, or are in between jobs.
The final piece of the foundation is to have your debts in check. Mortgages, if the payments are affordable, can be a great way to achieve wealth and financial stability. It is not a good idea to accumulate debts for holidays or cars. It would be best if you first focused on clearing these debts before investing or building wealth.
2. Investing for long-term growth
Now that the basics are covered, let’s move on to investing and saving.
Divide investment assets into those that have growth characteristics and those that are more defensive and stable. Shares and property are the most common growth assets. Cash and bonds are considered defensive assets.
It would be best if you decided how you want to divide your savings between defensive and growth assets when developing your investment plan. Your investment timeframe will be the primary factor, but you should also consider your comfort level with volatility. A strategy that makes you nervous at night will not work because you can’t stay on track over the long term.
For someone who has a time horizon of at least seven years, you can invest with confidence in 100% growth assets. If you have a timeframe of less than three years, then only 50% of your balance should be in growth assets due to their volatility. You can use a sliding scale between three and seven years, depending on your comfort level. If your investment period is five years, you may choose to invest in 80% growth assets while 20% are defensive.
Your best option is to keep your money in cash if your investment period is less than two years. Consider a term loan to get a better rate of interest. With this timeframe, any investment with some volatility carries too much risk of a loss when you redeem it.
In Step 1, I discussed how to get a clear picture of your cash flow in order to know what you have available to invest and save. If you are investing for long-term growth, it is important to add to your investment regularly. If you are investing in a mutual fund, this could be done as a monthly contribution. If you are investing in property, this could be done by repaying a loan.
3. Enjoy one of Australia’s most generous tax breaks
The financial and tax system in the United States is heavily skewed towards home ownership. Capital gains are not taxed on the increase in value of your principal residence. The growth of an investment in a home can be substantial due to the leveraged nature and the tendency of people to keep their homes for many, many years. This growth is tax-free, which is the biggest tax break in Australia.
Add to that the lowest interest rate that you have ever seen on a home loan. Mortgage rates today are higher than 18 months ago or even two years prior. The interest rate for your home loan will still be lower than that of a credit card or car loan. This is likely to be lower than any other business loan.
The cost of home financing is low, so you can buy a house and benefit from a tax-free growth asset. It is, therefore, a no-brainer to include a home as part of your wealth-building plan.
Rent-vest strategies are also not something I endorse. The interest on the loan is tax-deductible. However, the rental income will be fully taxable. This effectively cancels out the benefit. You’ll also have to pay capital gain tax on any increase in the value of your property. Interest rates on the loan are also higher.
4. Take advantage of Australia’s Superannuation System
Our superannuation is a close second. If our capital gains tax-free primary residence in Australia is the top tax break, then our superannuation would be a close third. The tax rate on superannuation wealth is only 15%. Then, when you retire, you will receive all your income tax-free. This is a generous system.
To make the most out of your superannuation, you need to be careful not to be over-conservative with the investments you choose. If your time frame exceeds seven years, as I mentioned in Step 2, you can afford to invest in 100 percent growth assets. You could do the same thing with super for shorter periods, given that you will not be able to access all of the capital upon retirement. Only a portion of it is sufficient to cover a year’s living expenses.
Remember that volatility is a risk. Risk and reward are, of course, inextricably related. You want to ensure that your superannuation grows as much as possible. It makes little sense to hold cash and bonds when retirement is a long time away. Your balance may be less volatile, but it doesn’t matter. You are locking in a low return, which will ultimately mean less retirement income or an increased chance that your money will run out during your life.
You can top up your employer’s contributions to super funds, provided you don’t exceed the caps. This is usually done through salary sacrifice. It is especially attractive for those with incomes between $180,000 and $250,000. This sweet spot is where you get the most tax savings.
5. Protect yourself
To build wealth and create financial security, the final step is to put in place a financial safety net. The emergency fund you mentioned in the first step is one piece of this puzzle, but on top of it all, you also need insurance.
Your first step should be to purchase income protection insurance. You’ve put in a lot to achieve your level of success. Your annual income is the result of all that effort. It makes sense to protect that income.
You should also consider life insurance if you have kids. Rule of thumb: Leave your spouse a home free from debt and enough money to support their children until they reach adulthood.
Total and permanent disability insurance is usually linked to life insurance. It is important to consider how this will work with income protection and ensure financial security.
