How to Use Behavioural Finance to Become a Better Investor

*This post “How to use Behavioural Finance to Become a Better Investor” may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Definition

“Behavioral finance attempts to explain and increase understanding of the reasoning patterns of investors,including the emotional processes involved and thedegree to which they influence the decision-making process.”

Ricciardi, Victor & Simon, Helen. (2000). What Is Behavioral Finance?. Business, Education & Technology Journal. 2. 1-9.

I am fascinated in research around human behaviour with money and investing. Over and over we hear the same cardinal rules about finance and investing:

  • Spend less than you earn
  • Regularly and consistently invest over several decades
  • Investing in low cost passive index funds is the easiest, cheapest way to grow wealth
  • Minimize fees including brokerage, management fees etc
  • Buy assets that grow in value or provide income rather than those that produce costs (particularly at the start of your journey)
  • Ignore the noise and just stick to your written investment plan

It’s not rocket science! Over the last decades the introduction of superannuation, cheap online brokers, and micro-investment apps have made investing attainable for everyone. It has never been easier to take the simple steps to secure a strong financial future.

So why do most investors struggle to stick to the script?

During the 1990-2000s, Behavioral Finance attempted to answer these questions.

Behavioural Finance: Why do We Struggle to Spend Less than We Earn?

Clever marketing surrounds us almost constantly. Most of us like to believe we are immune to advertising. But extensive human psychology research, aimed at manipulating the audience subconsciously, informs the design of these advertisements.

  • Colour – the background of an advert or show room is purposely chosen for a particularly subconscious association. This is proven to impact consumer behaviour
  • Subliminal messaging – hidden messages within adverts and other media
  • Emotional branding – manipulating consumer emotions to create a loyal customer
  • Autonomous sensory meridioal response technology – Do you experience a shiver or tingle with certain sounds? Brands intentionally create these pleasurable auditory sensations to engage you with online platforms or make consumers more likely to like the product advertised
  • Creating artificial scarcity – Consumers desire brand name product of which there are few available, which is why brands create demand through artificial scarcity.

We are probably far more affected than we ever realize.

Humans also have a natural tendency to prioritize the short term over the long term, so have a natural resistance to delayed gratification. And we are constantly surrounded by messaging encouraging the answer to our problems is a new product.

It’s no surprise so many fail to get past the first step – Spending less than you earn.

The Efficient Market Hypothesis.

The efficient market hypothesis of the 1970s assumed that all market participants are rational and self-interested, and aiming to maximize returns.

The theory suggests all available information is priced into the market already, making it impossible to “beat the market” unless you have inside information (which is illegal) or take additional risk (eg leverage).

It is clear that the stock market as a whole is not entirely rational. There have been many speculative bubbles. Price appreciation has resulted in irrational over-enthusiasm, and further price appreciation until eventually rationality kicked in, and the bubble burst.

Lots of speculators made a fortune during the tulip mania of the 1600s, and the dot com boom of the 2000s. Late adopters (or those that didn’t get out in time) were often wiped out when prices eventually crashed.

Warren Buffet is the most famous investor in the world. He is one of a handful of investors in history to have consistently taken advantage of stock market irrationality to make above-average returns.

Thousands of professional fund managers try to replicate this market arbitrage with a dismal success rate. It turns out, although the market can be very irrational, investors (even professionals) are the cause of that irrationality.

Unless you as an investor are less irrational than the rest of the market, the efficient market hypothesis may as well be true.

Below is an infographic from SPIVA demonstrating the underperformance of funds vs the ASX 200 over 15 years. Active funds actually outperformed the Australian index in 57.76% of cases over the past year, the most positive timeframe.

SPIVA | S&P Dow Jones Indices (spglobal.com)

What chance as the average hobbyist investor got?

“People systemically depart from optimal judgment and decision making”

Barber and Odean

WHY DON’T WE CONSISTENTLY INVEST OVER THE LONG TERM ACCORDING TO THE PLAN?

The need to invest regularly, no matter what the market is doing is widely advertised. Missing a few days of market returns by sitting on the sidelines awaiting a market correction can result in dramatic damage to overall returns.

Yet market timing is a huge temptation to most investors. It seems so easy to improve returns by just timing those investments a little better. The data tells us it is unsuccessful most of the time. But many investors can’t help but think they can beat the odds. Why is that?

Prospect theory/loss aversion/Regret Theory– Are all based on the fact we hate to lose money and will adjust decisions based on the anticipation of regret.

In fact, we hate losing $100 far more than we love to win $100. This skews our risk assessment. For many, this results in failure to invest at all, due to the fear of the market going down.

Excellent explanation of loss aversion by Quikeconomics

It also explains why investors are so tempted to remove their money from the market when a crash seems imminent. Unfortunately, massive market losses are predicted almost constantly, and the market is rarely predictable.

As a result, investors who divest for fear of a market crash are at a real risk of missing out on the best days in the market.

Delaying investing because of bad market predictions for fear of loss and regret is another example of how you are likely to lose profits by trying to avoid risk.

Anchoring Bias

Holding on to a poorly performing asset (eg poorly picked property investment or individual shares) despite all indications this is a long-term underperformer is also common. Investors cannot stand the pain of selling for a loss. They often demonstrate anchoring bias, waiting for the price to return to what they paid (No matter how long that takes). It’s the tendency for the first price to become anchored in our brains.

Investors struggle to overlook the anchoring to see the opportunity cost of having money tied up in a dud investment – that cash could actually be making money elsewhere.

Fascinating experiments on Anchoring bias – Quik Economics

Hindsight bias

Ever heard someone exclaim they knew something was going to happen, when in fact you know they did not make a strong prediction?

They’re not just lying, you probably do it too. Our brains play a trick on us when new information becomes available, in updating memories, often to include the new information.

When investing results appear predictable due to hindsight bias, it is easy to become overconfident in your ability to predict the future.

WHY CAN’T WE JUST STICK TO DIVERSIFIED PASSIVE INVESTING?

For most of us plain old vanilla investing has the best chance of getting us to our goals. But there is an ever-lasting temptation to try and beat the average with a more complicated plan.

The property next door goes up for sale. You know the neighbourhood inside out. It’s a comfortable investment. You may skimp on the research due to familiarity bias, a tendency to favour assets we feel familiar with. Although you might like your neighbourhood, this house is not necessarily the best choice for your portfolio. The decision should be just as rigorously researched as any other investment decision.

When researching an investment decision (and most other decisions), we are prone to confirmation bias, the tendency to screen out any evidence contradicting our desired action and only taking notice of information that supports our case.

Why Don’t We Ruthlessly Minimise fees?

Investors have a terrible habit of flip-flopping inside their portfolio, wasting returns away in brokerage costs as they are chasing the latest must-have stock. It is well documented that lower trading results in higher performance. Much like switching lanes in heavy traffic, it’s unlikely to get you anywhere fast.

Overconfidence is a huge risk to your investing returns. Most of us tend to think we are better than average, obviously, that is impossible! So when we look at the dismal results of the average investor compared with the index and assume we will do better, most of us are deluding ourselves. Those with high skills in other areas tend to assume they will also be better than average in finance, but the skills often do not transfer.

And then to compound this problem is the issue of self-attribution bias. When an investment choice goes well, we tend to take the credit and assume the success was due to our intellectual decision-making. When there is a poor result, some other sucker tends to get the blame!

WHY DON’T WE JUST STICK TO THE PLAN?

Humans exhibit herd behaviour. It’s uncomfortable to go against the crowd.

If there are two restaurants next to each other, and restaurant A has a line up outside and restaurant B is empty we tend to assume all the people wanting to go to restaurant A know something we don’t and assume it must be better. Savvy restauranteurs offer free drinks on quiet nights to get the crowd started.

The fear of missing out is a powerful emotion. Reading about investors becoming millionaires investing Bitcoin certainly made me stop and wonder if I was doing it all wrong. It sounds so easy! And fast! I even downloaded a podcast to learn more about this. Alas, I am not convinced I can understand the case for bitcoin beyond the fact the technology has great potential, although we’re not exactly what for yet. Teaching is a great exposer of understanding. If you can’t explain something simple enough for anyone to understand I’m not convinced you understand the concepts well enough yourself.

“Don’t invest in something you don’t understand.”

Warren Buffett

Behavioural Finance Behaviour Modifications

Being aware of these biases we are all prone to is the first step in limiting their damage. The second is to build a system of behaviours that help counteract bias. Some suggestions include:

  • Direct debit your savings out automatically each pay so you have no choice but to spend less than you earn
  • Have a written investment plan that you refer back to when considering changes.
  • Have a time delay (2 weeks? A month?) before making the changes to your investment plan. Document why you changed and your new investment plan
  • Have a plan for when you are feeling nervous about market corrections (not to log into your account until you hear media reports of recovery, JLCollins stock market meditation)
J.L. Collins Stock Market Meditation!
  • Research investments thoroughly but set a time limit by which you need to take action. Accept there will always be some risk, you can only minimize it.
  • Have an investing advisor or knowledgable buddy who you can discuss your decisions with. They will be able to identify hindsight bias, familiarity and confront your confirmation bias
  • Read/listen to many sources of information, including some that don’t follow your investing philosophy. Challenge your assumptions and learn to understand the the point of view
  • Assume you are an average investor. Be realistic about your capabilities. Just because you’re an incredible neurosurgeon* (*insert own impressive profession) doesn’t mean you are also Warren Buffett.
  • Keep an investing journal. Look back to see if you really “saw it coming”.

Behavioural Investing Conclusion

“It is possible that an investors’ biggest problems and their most dangerous enemy is himself.”

Benjamin Graham.

Although traditional economists believe in the idea of rationality in individuals, financial models are oversimplified.

Emotional and cognitive biases heavily influence investor behaviour. The resulting irrational behaviours can cause huge losses.

Only by recognizing behavioral biases in our lives can an individual investor make logical decisions. Behavior-based financial research provides fascinating insights into real financial behavior.

Further Resources for Behavioural Finance Geeks:

From Efficient Markets Theory to Behavioral Finance (aeaweb.org)

Quik Economics youtube channel

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

Investing How to: Limit Order vs Market Order

*This post “Investing How to: Limit order vs Market Order” may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Limit Order vs Market Order Definition

A market order is designed to fill as quickly as possible. You agree to purchase a set number of shares (or dollar value) at the market value at the time. The order will be executed as long as there are enough shares to fill the order before the share price changes.

A limit order is when you set the price you would like to purchase shares at. The order is only executed if the share price reaches the limit order you have set.

How to Investing – Which Type of Order?

Have you recently started the plunge and started investing? Or still trying to work out the finance jargon before you take that leap? Market and limit orders are terminology you will come across when placing a trade (buying any share or ETF) on your broker’s platform.

The thing to remember is your overall investing style. Many readers will have a plan to continue dollar-cost averaging into the stock market on a regular basis, no matter what the market is doing. Remaining disciplined and following your strategy over the long term with dollar-cost averaging is a no-hassle way to get rich slow.

The biggest risk to your investment returns is your human nature. When the market drops, as it did just weeks ago, it becomes increasingly difficult to ignore the media doom spreaders and keep buying. Our brains prioritize short-term thinking.

Limit Order vs Market Order vs Dollar Cost Averaging

For those wanting to dollar cost average over the long-term, I am a strong advocate of automation.

Set up a direct debit into your investment of choice and avoid 90% of temptations to not carry through your plan. If you automatically invest no matter what the market is doing, you don’t need to know about market or limit orders.

Your automated investment will go through as scheduled as a market order no matter the market price at the time.

When the market is down, you will purchase more shares for your regular investment cash. There is no need to try and predict market movements (which seems impossible).

Options to automatically invest on a regular basis include using a micro-investment app (ideal if investing parcels <$1000), investing in a Vanguard diversified managed fund through Vanguard personal investor (quick start minimal research needed), or selecting your ETFs yourself and auto-investing with an online broker.

Micro-investment apps and VPI really suit beginner investors who just want to get started and are not interested/not ready to choose their own investments.

I have accounts with Pearler and Commsec so am in a position to step by step through market or limit orders with either.

Market Orders

As mentioned above, a market order is filled almost instantly (as long as there are enough shares available for sale at the market price at the time).

This is the traditional way to invest in the stock market before auto-investing was a thing. Many investors will still use market orders to invest at preset intervals, according to their investment plan.

It also may be how you would invest if you had come into an unexpected lump sum of cash. Statistically, you will be better off putting the entire lump sum into the market at once, rather than dollar-cost averaging. You do have to be able to stomach the volatility though, and admittedly this is much harder shortly after investing a large sum.

Market Orders with Pearler

Pearler specializes in auto-investing, but you can easily perform a one-off market order as well. Below is a screenshot of my Pearler platform.

You can type the ticker code into the search button at the top, or navigate to the “Invest” tab to choose from a selection of popular investments.

After selecting your chosen investment, the next screen displays the current market price and a graph of historical performance. The “buy” button is pretty obvious.

After selecting “buy” you are taken to the order screen.

Here you are again prompted with the market price and can enter how much you would like to buy.

Auto-deposit automatically debits the money from your linked bank account if there is not enough left in your money market account, but Pay ID allows immediate (particularly if not the 1st transaction) movement of money.

Brokerage is $6.50 with Pearler (unlimited amount) although this is planned to reduce shortly. Pearler brokerage can also be discounted down to $5.50 by paying for credits in advance. Feel free to check out my full Pearler review.

Market Orders with Commsec

Commsec remains the most commonly used online broker in Australia. It is more expensive than Pearler and other modern online brokerage platforms. But many investors stick with what they know and trust, and the longstanding reputation of Commsec keeps some investors loyal.

Again, the platform is pretty easy to navigate. There is a search button at the top of the site where you can enter your ticker code for the relevant investment.

Next, you are taken to a page displaying investment data and an obvious “buy” or “sell” option.

After pressing “buy” you are taken to an order page where you can enter how much you would like to invest today. If you want to purchase at the current price (market order) tick the “At market” box.

Once you have submitted this form, you get to confirm all the details on the next page before finalizing the order. On my first orders, I was worried about making a mistake but it’s all pretty simple as long as you check and double-check each detail.

Commsec brokerage is $10 for up to $1000, $19.95 for $1-10,000 and $29.95 for $10,000-$25,000 as long as you settle using their CDIA account.

Commsec offers T+2 trades, meaning you can purchase shares at the moment, and just have to have the funds cleared in your CDIA account (set up when you open a trading account with Commsec) 48 hours later.

Limit Orders vs Market Orders – Limit Orders

Limit orders mean you do not buy the investment immediately. Instead, you set the price at which you would like to buy and if the share price drops to that limit while your limit order is active, the order is confirmed and investments purchased.

There is a good chance that your limit order will never be fulfilled. If the share price goes up, or dips but not quite as low as your limit order the order will not go through. When there are inadequate shares for sale when the price dips to your limit, it will be partially fulfilled.

If you were relying on limit orders as your normal mode of buying, it is likely that you won’t end up investing as much. The stock market, after all, tends to go up over the long term. If you wait for market dips to invest, you are likely to end up worse off overall than dollar-cost averaging as you will have less time invested in the market.

Limit orders can be useful if you are interested in buying at a discount when the market dips, on top of your regular dollar cost investments. The argument still stands though that if you were going to invest this money, you should have done so as soon as possible to attain the highest profit.

However, I still “buy the dip” when the opportunity arises.

  • I dollar cost average every fortnight into Pearler, and superannuation
  • More savings are aimed at paying off my PPOR mortgage. At 2.6% this is likely to be inferior to stock market returns but provides more freedom (and I am so close I want the debt gone!)
  • When the market corrects 10+% I know eventually it will rebound, it is likely I will make outsized returns when this occurs.
  • The opportunity cost of paying down our mortgage instead of investing in the stock market becomes far greater.
  • I also feel more in control of the situation when the market is dropping by “doing something” that feels useful, I am less likely to panic and sell.

As a result, I have a very simple strategy of investing a set amount at set percentage drops from the high. I don’t monitor the market closely but find I can’t avoid hearing that the market is “crashing” so then set up limit orders to be fulfilled at my predetermined drops in value.

Limit Orders with Pearler

Pearler does offer limit orders. On the purchase page, you simply press “more options to find the limit order option. Pearler limit orders remain active until they are executed, or you cancel them (unlike Commsec below).

I tried this during a recent downturn. I simply used auto-deposit, but of course, by the time the money had cleared into my Pearler trust account, the price had rebounded.

Then the cash was stuck in my trust account earning next to no interest, instead of my offset earning a still unimpressive 2.6%.

Given I would prefer to work on fully offsetting my mortgage unless the market does a significant enough dip, this didn’t really suit me.

I made my 1st withdrawal from Pearler as a result. For those interested in Pearler, I had to provide a little further identification before making the 1st withdrawal and this took a couple of days to process. The money landed bank in my offset as expected after that.

Limit Order with Commsec

This is why I still have my account with Commsec. I can set up a limit order and the money only moves if the trade goes through, allowing my cash to keep saving me the interest in the meantime.

To make a limit order with Commsec, you go through exactly the same process but type the price you would like to purchase at in the “Price limit” box instead of ticking “at market”.

You are then taken to the confirmation page where you can check all the details and submit the order. With Pearler the limit order is active for 1 month, so you will need to keep resetting it if you want to.

When the trade is activated, you will receive an email with this information. You then have 48 hours to get money transferred to your settlement account or risk a fine.

Obviously, you will need to monitor your emails if you have limit orders set up and be ready to transfer the cash quickly. You must be confident your cash will clear in time before the settlement date.

Limit order vs Market order

Market orders are the traditional way to buy stocks. You simply log in and buy at the current price when it suits. But wealth is not often built through one-off or Adhoc investments. Most of us need consistent, regular investing over the long term to build significant wealth. Auto-investing makes this easier to stick to.

Limit orders won’t appeal to many new investors. If you have money that you want to put in the market, most of the time you will profit more by putting in as a lump sum immediately. But if, like me, you have a competing use for your investment, setting up a limit order may suit you.

A limit order means if you want to buy at a specific price you don’t have to spend your days obsessing over market prices (trying to catch the dip).

If you’re happy to watch the market and purchase opportunistically, a market order through a low-cost broker will be more cost-efficient.

Let me know which strategy you prefer – Autoinvest, market, or limit orders. Comment below to learn from each others perspectives.

Your wealth accumulation journey starts as soon as you make the first step. Subscribe to Aussie doc for a weekly email to keep you up to date on track to your goals.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

What is Depreciation?

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Depreciation has slightly different meanings in personal finance, accounting and taxation. Regardless of the context, depreciation refers to the decreasing value of a good over time. It applies to cars, to home appliances and even to clothing.

Personal Finance Depreciation.

Depreciation in personal finance refers to the amount of money you lose through the decline in value of a personal asset. Assets purchased for personal reasons (not investment or business) attract no tax advantages.

The rate at which each good depreciates varies. Some items depreciate more quickly than others. The commonest example of a depreciating personal asset is your car.

In fact, cars are known to lose so much wealth through depreciation, they are often referred to liabilities. If they come with a car repayment plan, even more so.

We have all heard how a new vehicle is worthless as soon as you have driven it out of the showroom. Cars literally destroy wealth if a consumer buys too much, too new and too early.

A $30,000 car that depreciates to 70% of it’s original value over 5 years will have cost you $30,000 x70% = $21,500 over the five years.

That’s on top of fuel, insurance and registration.

Losing $21,500 every 5 years just to car depreciation is not going to help you get ahead.

There is no silver lining to depreciation in personal finance. Depreciation cannot be deducted if the item is for personal use. It is simply a fact of life that your car will be worthless and less each year until it is virtually worthless.

A key strategy to build financial security and wealth is to spend the minimum possible on vehicles until you have acquired assets that will achieve your goals in the desired timeframe.

Property Depreciation

We are more used to hearing that houses go up in value over time. But the building itself, just like cars, depreciates.

A brand new house is worth less if you try and sell it a year on than when you purchased it. Nothing has that shiny new feel to it anymore. The expected lifespan of the roof, air conditioning units, carpets and boiler has been eaten into. All these things will eventually need replacing at a cost.

What often saves your home from falling in value is the appreciation of the land it sits on. This doesn’t depreciate. There are no deteriorating parts of the land (unless you’re on a cliff!) Nothing needs replacing. Over time, as populations expand in an area that is attractive to a large number of people, the price for the land increases.

The other factor that saves your home from falling in value is any renovations and replacements you put in. Depreciation of the home is still occurring, but you are paying to replace things as they go along, helping to maintain value.

Small Goods Depreciation

Most consumer purchases you make depreciate in value significantly after purchase. If you look into selling your Nick Scali lounge second hand, even after a short period of ownership, it is unlikely you will get much of the original value back.

Some items should theoretically depreciate but don’t. Highly desirable collectables can increase in value over the years as they become more scarce. Watches, cards and pokemon cards come to mind.

To be a successful collectables investor, you need to pick collectables that will increase in scarcity and popularity over time. You are best at keeping it in its original packaging and not using it (or barely). Collectables in mint condition tend to be worth a lot more than those that have been used (and loved).

If you have an area in which you are an expert, then it is possible to succeed with collectables.

Appreciating vs Depreciating Purchases as a Predictor of Long term Wealth

There is nothing wrong with buying a depreciating asset you love. That sports car, fancy watch or brand new home are not out of bounds.

But your timing of these purchases will make or break your financial life. Given your finances dictate the options you have to choose from when life throws a curveball.

Money can allow part-time work, unpaid absences, the ability to help family members in crisis and retirement when you want or need to.

Or your finances can require you to keep working completely dependant on a monthly paycheck to pay the bills. No matter what else is going on.

The earlier in life you can money sorted, the earlier you can afford to largely ignore it.

Big financial decisions, such as the home you purchase and the cars you drive will define your future financial life.

How to Minimise the Effect of Depreciation on your Finances

Let’s start with the most powerful strategy. Home buying can create wealth, or prevent you from building any.

Is the house you will buy on appreciating land, in which case your home is an investment as well as a place to live? Be as objective in this decision as you can. What are the long term capital growth stats for the area?

If you do not buy land that is appreciating at an above-average rate, minimizing your spend on a home is a wise financial decision.

Ideally, spend more on the appreciating land than the depreciating house on it.

With cars (ignoring the rare collectable) you can avoid the sharpest dip in value from depreciation by buying a car 3-5 years old. Keep your cars as long as they are reliable.

I suspect what you may make in appreciating value or a collectible car you will likely put back into repairs and maintenance. Collectible cars seem more of a passion project than a profit-making exercise. And you definitely need to know your stuff!

Again, you shouldn’t necessarily sacrifice having that “dream car”. Especially if this is something you value. But your finances will be more supportive in the future if you can delay the purchase until you have accumulated appreciating assets.

With collectables, my impression is that many people use the idea that something is “collectable” as an excuse to buy a luxury item they can’t really afford but very much want.

Be honest with yourself, if the purchase is for your use, make sure you can afford it and accept it will depreciate with use.

Investment, Work Related and Business Depreciation.

These are all less damaging than personal finance depreciation. In fact, these depreciating purposes are likely to be necessary to earn money. They are a cost of doing business. And the good news is, they often come with a tax advantage, unlike with personal finance depreciation.

Tax Depreciation

The most important concept to understand is that depreciation in your tax return is not just a tax benefit. It is partially compensating you for the loss of value that is occurring in real life.

If you purchase an asset in order to make money, you are entitled to claim the depreciation as a tax deduction. You are still losing value through real-life depreciation, but the ability to claim this on tax lessens the blow significantly.

Tax and real-life depreciation aren’t always equal.

If, for example, you had purchased a new vehicle in early 2020 for your business. Your accountant will use a method of calculating depreciation on this vehicle, and claim this depreciation against your income, lowering your tax burden. But with the vehicle shortage brought about by COVID-19, you may actually be able to sell the vehicle for more than you brought it for!

Property Tax Depreciation

The purpose of depreciation is to estimate the difference between what something is worth and how much it’s being sold for.

When purchasing an investment property, the cost of construction or renovating a property can usually be deducted over 25-40 years at 2.5-4%.

This encourages many to purchase new properties, in order to maximise the deductions. But new houses will depreciate quickly in the first few years because buying new means paying the builders margin. Remember to invest for a return first, with any tax advantages kept to an incidental bonus.

Get A Quantity Surveyor Report

When you purchase an investment property, it is important to contact a quantity surveyor and arrange a report. You need to know the costs of capital works to pass on to your accountant in order for them to claim depreciation. This costs a few hundred dollars (I paid ~$600 in Brisbane).

In an older building that hasn’t had significant renovations, there may not be enough depreciation to compensate for the cost of the report.

Capital costs of a building you purchase with a plan to demolish may be able to claim, discuss with a quantity surveyor before calling the bulldozer in!

Home Renovations

If there is any chance you may use your current home as a rental in the future, it is important to keep records of any improvements you have made. It’s hard to predict the future, and circumstances can change quickly. Keep your records just in case.

In the event of renting the home out, talk to your accountant to find out if you can claim any of the costs you have sunk into the home.

Claiming Depreciation for Employee Work Tools

For those of us that are employees, there are limited things you can claim as a tax deduction. Equipment and books that are purchased for work for less than $300 can be claimed as an immediate deduction.

Most of you will have noticed, this is not the case with your laptop. If the item costs more than $300, it is depreciated over the accepted “effective life”. In the case of your laptop, this is two years. There are a few different methods you can use to claim this.

If you use the laptop for personal as well as work purposes, you can only claim a proportionate percentage of the cost.

Work related courses, seminars and conferences, in contrast, including travel and accommodation, can be claimed as an immediate deduction.

Working from Home Depreciation

With the rise in working from home over the past two years, you can claim office equipment, electricity and cleaning costs. You can work these out individually or use the shortcut method. Keep your bills and receipts as well as a record of your hours worked from home.

Small Business Depreciation

Depreciation of business assets is treated as a business expense that spreads the cost of a fixed asset over its useful life. Depreciation is used to account for the decline in value of an asset, and it is considered an expense. This means that depreciation expense can be deducted from revenue when calculating taxable income.

A straight line depreciation method is easy to calculate because it represents the actual loss of value. But there are also accelerated methods to reduce the accounting burden for small businesses.

Conclusion

Depreciation is the term used in Australia for the deduction of the cost of certain assets over their useful life. Depreciation is applied to assets that are used for business, investment or employment purposes, but can also be applied to assets used for personal reasons.

Personal assets that depreciate can cause a lot of damage to your finances. Luckily, there are some steps you can take to avoid depreciation. Buying used items or investing your earnings instead of spending as well as delaying personal spending on luxury items until you have accumulated appreciating assets will help.

Employment, investment and business depreciating assets are usually a cost of doing business, necessary to make money and attract a tax benefit.

What do YOU think? Have any other thoughts about the effects of depreciation on our lives? Let us know in the comments below!

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

Stick with Your Investment Strategy!

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Have you worked out your investment strategy? I generally recommend dreaming big, setting goals and working out how to achieve them with acceptable risk.

Set up your plan, automate everything you can and try to ignore it! Get busy living the rest of your life.

The White Coat Investor repeatedly tells us to make a written investment policy statement. Passive investing Australia suggests a 3-month cool-off period when the urge to change your investment strategy occurs.

Boom, Boom, Crash

The investing world is currently going a little nuts. Heading online is like walking into a Las Vegas casino. So much grabs your attention it’s kind of hard to think straight.

Every few minutes there seems to be another “once in a lifetime” opportunity to get rich quick. We all logically know the casino is a business, designed to financially outplay us. Yet people go back over and over, often feeding any winnings straight back into the casino business.

Online many investors claim to have struck gold with speculative investments that have multiplied in weeks. All the investing groups have frequent discussions about cryptocurrency and tesla. A few smart ones who got in early have made a killing. It’s hard not to feel you are missing out.

Previously stable, boring investors are abandoning their financial plan for a punt on these kinds of bets. Many end up self-sabotaging their financial future.

Even the property market is getting in on the action, with valuers unable to keep pace with the frothy enthusiasm of property purchasers abandoning all caution to secure that property before the champagne runs dry. With APRA threatening to shut the party down, I feel it’s time for a little caution to return!

History Repeats Itself

This all sounds pretty similar to the stories of warning I read over and over again in investment books. Tulips. Tech. Dot.com and mortgage-backed securities in the GFC. An absolute frenzy of money-making and euphoria preceded a devastating market crash. Widely diversified investors got through it if they clenched their muscles and held despite the doom. Those that had speculated in the hyped stocks often lost it all.

No-one wants to be the last idiot to press buy.

The Boring Middle

If you are a long term property and/or index fund investor, this is not where your excitement in life comes from! You have a solid plan, and are executing it. But it takes a long time. Meanwhile you are hearing about speculators doubling or tripling their bets in a few months.

The grass can start to look greener on the other side.

“Of the 35 analysts following the stock,

13 have a “strong buy” or “buy” recommendation,

another 11 have a neutral or hold recommendation.

Of the rest, seven have a sell recommendation, and only four a “strong sell.””

CNN Business on Tesla in January of this year.

This is the risk time for abandoning your investment plan. WCI and Passive Investing recommendations of having a written investment plan and a 3 month cool off period are excellent. Both of these will help prevent impulsive changes due to FOMO. I would add those in a couple to have to run any changes past their partner.

A study found that investment accounts accessed by two people had the best returns, in comparison to a single male or female investor. Men and women are quite different in their approach to investing. Working together tends to reduce their weaknesses and compound strengths. Same sex couples may not be so extreme in their different investment behaviours. It is, however, still likely there will be a more cautious and more aggressive investor.

Cautious investors need encouragement to get in the market in the first place, instead of hoarding cash (being constantly devalued by inflation). Aggressive investors need a reminder that trading fees eat into return, and to minimize speculation.

Choose your Investment Strategy

The main strategies include:

Property

  • Capital growth buy and hold (pay down debt, rental income increases gradually)
  • Capital growth buy, hold and sell to realise cash
  • Active investment strategy – Buy, renovate and hold or sell (forcing increase in equity to allow further borrowing)
  • Yield buy and hold (brought based on income provided by the investment) residential or commercial
  • Principle place of residence buy for capital growth (and a wonderful home, with a big mortgage). Sell capital gains tax free to downsize in retirement

Share Market Portfolio

Passive investing

Index ETFs or managed funds buy and hold (easiest option and proven generally most successful!)

Buy and hold capital growth focussed shares (expect growth over time in price)

Buy and hold high dividend yielding stocks (focus on income + franking credits)

Active investing

– Buying individual stocks or other assets (eg crypto) based on an anticipated capital gain and selling once the price has risen. This can be very short-term i.e. “trading” or holding for months to years, but actively reviewing whether the asset should still be held.

Times to Review Your Investment Strategiies

There are times you need to review your investment strategy and perhaps adjust them. These are

  • When the market is boring and you are calm and unemotional
  • When you reach a pre-determined age (eg 50) and plan to adjust your asset allocation accordingly
  • After a pre-determined number years of investing to review returns, decide whether you are happy to continue with the same strategy
  • At planned rebalancing times (plan in advance to rebalance every 1-2 years, or if there is a significant difference between planned and actual allocation percentages).

Avoid Investing

  • Without research, you need to understand the fundamentals of the asset. You need to find the data and form your theory
  • Following the herd – Family, friends, colleagues, online friends and investing newsletters all get the blame when investor lose a lot of money.
  • In the next sexy investment everyone is overexcited about (unless you absolutely understand it, hopefully you would have already got in before the general public hears about it)
  • More than you can afford to lose (particularly if speculating)
  • That feels like gambling.

Avoid Succumbing to FOMO

  • Have a written investment plan
  • Have a 3 month cool off before changing investing strategies
  • Run all changes past your partner in life
  • Ask yourself the tricky questions – work out what price you would consider the investment as “fully valued” before taking the plunge. You obviously only want to invest at a price below this value
  • Practice patience by distraction. Don’t watch the stock market, make your life more exciting

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

How much House Can I Afford?

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Are you considering purchasing a home and wondering how much house you can afford?

For many of us, homeownership is a lifestyle aspiration as well as a huge financial decision.

It feels great to be free of the landlord. To know your home is your own, and you can stay put as long as your like. The larger payments that normally come with a mortgage and inflexibility are the downsides.

I’ve written before about reasons not to buy a home, and how to save your deposit if and when you buy. I think it’s becoming more common knowledge that buying a home is not always the best financial move.

So How Much House?

One of the first questions first home buyers tend to ask when they have decided they want to buy a home is how much house to buy.

The easy temptation is to start by working out how much you could qualify to borrow. But this is not the best way to go about this life-changing decision.

Your overarching financial strategy should be front of mind when deciding how much house to buy. Instead of buying a house consistent with the amount lenders will lend you at the time, there are two valuable strategies in approaching home purchasing:

  • Buy less than you can afford to keep cashflow free for investing, travel, freedom
  • Buy as much as you can possibly stretch to maximise capital tax free growth

Of course, there is plenty of room in between for intermediate strategies, but I think deciding which extreme your own property strategy falls closest to is a good start.

Strategy 1. Buy as Much home as You Can Possibly Stretch to.

This is the traditional strategy. The idea is to max out your borrowing capacity to buy the best house (or the worst house on the best street). The strategy often involves upgrading your property every few years, to take advantage of your growing salary and to leverage any equity you have gained in market movements. Over the years, you able to purchase houses in better and better streets.

Many of our parents followed this strategy, and it worked out well for many. The idea goes that property is a great investment, and will grow in value over the years. At the end of your career, you can sell your (hopefully) massively appreciated house without any taxes and downsize to free up cash for retirement.

Any gains are currently tax-free as long as you live in the home as soon as practicable after your purchase. There is even a 6-year rule. This means you can leave the property and live elsewhere and continue to treat it as your principal place of residence. Despite being absent from the home for up to 6 years, you can protect your capital gains tax exemption on sale. As long as you check with your accountant and make sure everything is done and documented properly.

-Strategy 1: If you Pick a Property Poorly, the Strategy Fails

This strategy works incredibly well if you purchase a property(s) that ends up delivering fantastic capital growth. The dangerous “rule of thumb” that property doubles every 7-10 years imply this growth occurs to all properties. Some properties grow in excess of this, some don’t grow at all.


Sydney and Melbourne property prices have historically performed far stronger than the rest of Australia, which is why these cities are so unaffordable. The rest of Australia has not done so well. Up until this latest property boom, our property value in a regional town has just about matched inflation since we purchased.

If you pick the right property, in the right suburb and in the right city. But if this home is your single retirement plan (as it was for my parents), there is a whole lot riding on your choice! This is an example of concentration risk – all your eggs in 1 expensive basket.

Even if you choose a location that has historically provided great capital growth, there is no guarantee this will continue. If you maximise your leverage into a home in Sydney, what if Sydney lies dormant for the next 20 years whilst Melbourne booms?

– Strategy 1: You Get to Live in that Dream House

If you aspire to live in a prestigious area, and you get the investment part right, you are fulfilling an investment and lifestyle goal in one. You get to live (eventually) in your ideal home, and then it pays for your retirement. Sounds like a dream!


Inevitably though, few people can afford their actual ideal and still have to make some compromises. But you should definitely get an absolutely lovely home with this strategy

Strategy 1: Tax

The fact that this strategy means all your gains remain capital gains tax-free is attractive. You need to move into the property as soon as that is possible or you lose your capital gains tax exemption altogether. So no renting it out for the first few months, or delaying moving in after settlement.

Unfortunately, interest paid on own home is non-deductible. This means you are footing the entire interest bill for the duration you own your home. We currently have record low-interest rates, which makes this considerably less painful. But assuming interests rates eventually rise, your capital growth needs to increase faster than your annual interest rate.

Strategy 1: Reducing Options & Financial Stress

Having a mortgage repayment eating up half of your take-home salary drastically reduces your options in life. You cannot take a pay cut by changing jobs or reducing hours. You will probably not be able to invest money elsewhere for several years.

The reason I personally don’t like the idea of this strategy is from watching my own parents struggle for years. My father worked 7 days a week for decades! I wanted a different sort of lifestyle for our growing family.

If buyers can get through the first few years (the first 2 are the highest risk), financial stress tends to reduce. Those expecting a large pay rise in the near future may be tempted to push the borrowing in the short-term reassured that income will soon increase.

Those that don’t have 100% secure income or plan a reduction in income in the next few years (parental leave) need to take this into account when working out how much house they can afford.

Strategy 1: How Much House – Remember Interest Rates Do Go Up!

Mortgage repayments don’t look so bad with today’s low-interest rates. But they won’t stay low forever. Borrowers have the option of fixing rates, which can reduce risk significantly for tight budgets over the first 2-3 years. But once your fixed rate expires, you are at a mercy of interest rates at the time.

Our household purchased our family home in 2008, paying an interest rate of around 8%. Since then, interest rates have gradually dropped making our (less than we could afford anyway) mortgage less expensive over time. I buying a home and then experiencing interest rates inch all the way back to 8% over the next 10 years would be stressful.

-Strategy 1: The Downsizing Plan

Many who have followed this strategy have then struggled to downsize when the time came.

After many years living on the best street, it can be hard to downsize or move to a less prestigious suburb.

My parents brought the biggest and best house they could possibly afford. They were under financial stress for many years trying to pay the debt down. By the time they were ready for retirement, they were used to (and very proud of) owning a big, lovely home on a good street. The thought of downsizing to anything less prestigious was unappealing!

Strategy 2. Buying Far Less Home than You can Afford

This strategy works far better for those buying in a town not likely to see above-average returns. It also works well for those that want to have money left over for holidays, time off for kids and retirement. In lower house values areas, you also get a lot more house for your money so it doesn’t necessarily mean living in a suboptimal home.

There has been recent news about tightening lending conditions again. A borrowing maximum of six-time gross income has been suggested.

On a $150,000 gross salary, 6 x borrowing would be $900,000.

Repayments on $900,000 over 30 years at 2.99% would be $3790, or ~40% of net income assuming the income was earned by a single worker. That seems like enough of a mortgage to me!

Yet according to this financial review article, recent average loans in Sydney are written based on 8x salary! Even a tiny movement in interest rates makes these loans impossible to pay (hopefully they’ve fixed rates).

With Sydney and Melbourne prices, borrowers have been pushing these limits just to get into the market. If they have selected a great property, fingers crossed it will pay off.

In a regional city you may be able to get away with only borrowing half your potential borrowings.

– Strategy 2: Missing out on Capital Gains

The big opportunity cost here is if you plan to live and work in an area that will benefit from a significant capital gain over the next few years. It is important that if you choose the smaller mortgage, you use the extra cash flow consciously on something that will give you long-term value.

– Strategy 2: Missing out on Living in the Dream Suburb

If the prestige of living in THE suburb to be in is something that appeals to you, this is something to weigh up. Perhaps you won’t live as close to cafes and restaurants, or have your colleagues on your street. The benefit of living in a more average suburb includes less pressure to “keep up with the Joneses”. If you purchase on the street of your dreams, you may find you NEED to upgrade your car, and dress in more upmarket identifiable labels.

– Strategy 2: Spare Cash Flow Potential

Your extra cashflow freed up by buying less house than you can afford can be put towards investing or lifestyle goals (or both). Options include:

– Paying the mortgage down

A worthy and low-risk goal. Increasing your equity will allow you to borrow off this if you want to invest in property in a few years time (which feels like hitting two birds, one stone).

If you invested this money in the stock market, you would need to pay tax at your marginal rate on any dividends or withdrawals. So your returns need to be good enough to beat your mortgage interest saved after tax. That shouldn’t be too hard over the long-term at current rates, but as interest rates increase, paying down your mortgage becomes even more attractive.

When “paying off” your mortgage you may like to fill an offset account rather than actually pay down the loan. It has the same effect on the interest paid (less and less as you fill your offset) but the money still legally belongs to you, not the bank. This means you can withdraw it if in financial distress when the bank could prevent you from redrawing. It also provides flexibility if circumstances change (a new job offer in a new city?) and you decide to convert your home into a rental property. The offset cash can be withdrawn and used as a deposit on a new PPOR (or for whatever reason) and interest on the remaining loan balance remains tax-deductible.

– Purchasing an Investment Property

You are probably not going to be able to immediately purchase an investment property after buying a home, but with an aggressive pay down strategy and a booming market like currently, you could be ready to go pretty soon.

Interest on investment properties, as opposed to your principal place of residence, is tax-deductible.

Between renters and tax incentives, this makes owning a 500K home and 500K investment property potentially more profitable than owning a 1M home. The renters are helping significantly (particularly at current interest rates) and any shortfall is further softened with a tax deduction.

Owners of a 1M home pay every bit of the mortgage themselves, with no help from the Australian Tax office.

Interest rates are often slightly higher on investment properties (mine are 0.6% higher) than homes. And you lose out on the capital gains tax exemption you would get on the 1M home (although you would still receive it on your more humble 500K home). You would receive a capital gains tax discount of 50% on your investment property if you kept it for a year or more. And you pay no capital gains tax on an asset you never sell.

Automated investing into your superannuation or index fund ETFs outside super

This is easy and ideal for busy professionals who don’t have the time or interest to do significant research. Your super will allow you to direct debit extra payments directly into the fund, brokerage fee. Keep in mind that you will not be able to withdraw until your preservation age, so don’t invest so aggressively in super you are left short.

Those wanting to retire earlier than their preservation age (keeping in mind that may change) or those with a long term non-working (on the 0% tax bracket) adult at home may want to invest outside super. This will take a little research but is pretty easy to organise and automate through Pearler*.

– Holidays and travel

You may be purposely avoiding over-commitment to a huge mortgage to include more fun in your life. This may be more eating out, buying nice things or going on awesome holidays. Spend on what you value and brings you joy. Just put a little aside to do the grown-up thing and save a bit too.

How Much House Can I Afford?

How much house you can afford depends on your:

Current gap between income and spending plus rent paid –

Find out your net income, and work out what you actually spend, not a budget based on a hypothetical idea. Use expense tracking to work out what your actual expenses are. Your bank is going to examine (with a fine-tooth comb) your real-life spending using bank statements so you might as well get to grips with reality.

How Much House: Income security and anticipated income changes

Do you have a permanent contract? Doctors are often on temporary contracts for many years, but banks do seem to accept this as a norm. You could negotiate a longer contract with your employer to provide yourself and the bank extra reassurance.

If you are hoping to start a family or reduce income in some other way in the next few years, make sure you take this into account. Make sure you aren’t committing yourself to financial stress during anticipated times of reduced income.

Do you have income protection insurance, or will you qualify for a policy large enough to cover your intended mortgage? Unfortunately those with significant “pre-existing conditions” will often struggle to get cover. If you or your partner suffer an illness or injury that prevents them from earning an income for a significant period of time, there needs to be a backup plan.

It is a good idea to have some cash sitting in the bank in case of emergencies on settlement day. The last thing you need after spending every dollar on that dream house is for the car to need a major repair, or the hot water system to blow up and need replacement.

Priorities for the future

This involves a bit of daydreaming. Set audacious goals and design your ideal life. What is most important to you? Incredible house or incredible holidays? Intended retirement age (do you need to invest extra)? Is getting mortgage-free important to you?

Almost no one can have everything. You have to prioritise what you really want to make sure you get it!

Area you want to live in

How confident are you of its capital growth potential? Are you happy to bet the (literal) house on it? Is it in a major capital city within the commuter belt? Is it an established house (new homes and high rise units seem to perform poorly)?

How Much House Can I Qualify For?

Only after answering the above questions should you work out whether the bank will lend this money to you. Your ability to borrow depends on;

– Income

What is your gross income, easy to find on the ATO website. Banks will want at least 6 months of payslips or two years if self-employed.

– Security of income

Permanent employee > temporary employee > self-employed.

I was questioned about my income protection, total permanent disability and life insurance by the bank during the latest property purchase. If anything terrible happens to you, the bank wants to know you will still be able to repay your loan.

-Gap between Income and Spending

If my recent experiences applying for a mortgage are anything to go by, they are not going to take your word for it. They will ask for every bank statement you have ever received. One at a time. A couple of times each.

OK, maybe I’m exaggerating a bit. But your pie in the sky budget (that never foresees the emergency car repair, dental treatment…) is not going to cut it.

If there is a reason to keep your banking simple, this is it. Being asked for statements on 9 accounts repeatedly is really annoying. Sorry Barefooters!

– Other borrowings

These make a big impact on your borrowing capacity. Credit card limits are treated as if you have maxed out your card and need to make minimum repayments. Even if you pay them off every month religiously. If you’re anywhere near your borrowing capacity reducing card limits or closing unused cards and accounts may be worthwhile. Check with a mortgage broker.

– Credit score

You can apply for your credit report from Experian and monitor it monthly on Creditsavvy. I did have one random application appear on my file, which was erroneous. I managed to get it removed but had to be pretty persistent with the company involved.

– Profession

Certain professions are considered ultra low-risk borrowers because as a group they rarely default on loans. These include doctors, accountants, lawyers, dentists. Many banks will allow high borrowing (up to 90%LVR) without charging lenders mortgage insurance which is a big bonus.

– Deposit

How much deposit have you saved? You will generally need at least 5-10% of the purchase price plus ~6% buying costs.

– Age

Banks have become much less keen to lend to those they don’t see having enough working life to pay off the mortgage. A colleague was questioned (and offended!) by the bank about her plans to pay off the debt despite her advanced age (45!).

How Much House to Buy?

This is a very personal question, which depends on your capability of paying back over the next 30 years as well as your priorities. Do yourself a favour and spend some time reflecting on these questions (with your partner if you’re buying as a couple). Make the right decision for yourselves.

Your wealth accumulation journey starts as soon as you make the first step. Subscribe to Aussie doc for a weekly email to keep you up to date on track to your goals.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

Too Busy to Research an Investment? A Quick Start Guide

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Basic Step by Step of Getting Your Investments Started

  • Work out some goals or choose to invest 20% of your net income
  • Save an emergency fund whilst researching options
  • Consider opening a microinvestment account if you have less than $200 to invest at a time, perform risk tolerance assessment and set up a direct debit into the investment account. Lookinto Commsec pocket instead if you already bank with CBA
  • Do your research on a Vanguard Personal investor account if you are keen to invest in (particularly diversified) managed funds. Pretty much like a micro-investment account on a bigger scale. Now offering auto-invest, brokerage and account fee free! From $200 investments
  • Look into a Pearler account if you have more than $2000 to invest at a time. Vanguard diversified funds offer an easy option to get started and can be brought with any broker. Set up a direct debit to invest your chosen sum regularly.
  • Stay invested. Keep direct debiting. Review in 2 years and consider optimizing further. Avoid frequent fiddling! It does take time, and a watched investment account doesn’t grow very fast (yes I’m still working on this!)

The Detail of Building your Investment

You’re a busy professional. There is so much to do, and so little time. You think you’re “bad with money”. You may have had one or two hurried attempts to invest that didn’t go well. It’s easier to stick with your area of expertise. There you know exactly what’s going on. And you earn plenty of money, surely everything will work out, right?

Maybe. Maybe not. One thing I do know is that you deserve better.

Looking after your personal finances is a form of self-care.

How many thousands of hours have you put into becoming the best you can be at work? How many unpaid work hours do you put in? You take on a lot of risks and stress. You probably made significant sacrifices in your 20s and 30s to get where you are today, perhaps these are ongoing.

Why shouldn’t reward yourself with the peace of financial security?

We may even be fooled into thinking we have it by a big paycheque each month. It’s nice to be paid well, but unless you are building income-producing assets of your own, you remain vulnerable to external events (COVID-19) and with limited choices should circumstances change.

Your Why of Investment

Hopefully, you love your job, but what happens if you get sick or injured? Do you have the insurance you need set up? Will the insurance company even pay up when you make a claim?

Do you want the option of more “Income flexibility” in a few years? The ability to cut work hours or take a break to meet family obligations or want to take on a new adventure?

Would you feel upset if when you are finally ready to retire, your financial situation means you need to keep working for a few more years?

These are the strong reasons for not ignoring your finances. But I know, it’s hard. You’re busy, and even knowing where to start investing can be overwhelming.

The good news is, you’re smart.

Investing can be as simple or as complex as you like it. Some (like me) enjoy learning about finance as a side hobby, greedily consuming every investing book I can get my hands on. Many others think the topic is brain numbingly boring and would rather do anything else than sort out their finances.

Both types can do well investing.

In fact, those not that interested may be less tempted to fiddle with investments. Leaving them alone is usually for the best anyway.

Do you Need a Financial Advisor?

You may benefit from a financial advisor if your situation is complex. But I see many of my colleagues trying to outsource their financial life completely to an advisor. The complexity of the fee structures involved has meant that many people don’t realise how much they were paying for often lacklustre advice or financial management.

If you want to use a financial advisor, you still need to educate and protect yourself.

Ideally, a financial advisor is used when you have a specific strategic question you need help with- eg Should I invest in property vs shares? Paying for a financial advisor before working out goals you want to work towards is an inefficient use of time and money.

If you do choose to employ a financial advisor, make sure they are qualified (do I need to mention Melissa Caddick?), and are paid by you, not by commission. Most “financial advisors” are really just salespeople trained to sell insurance and investment products.

Find an independent, fee-only advisor and use this checklist to screen them.

Investments: Where Do I Start?

Ideally, you want some goals. Set some time aside, with your partner if you have one to dream about your ideal life. From there, narrow them down to specific goals with time frames. Common goals include:

Next, you need to find out where you are financially already. Make a record of your current salary, house debt and equity, savings, superannuation and any investments you have. You can use a super calculator to work out if you are heading in the right direction for your desired retirement age. You can use a savings calculator to work out whether you are on track for other goals.

Then you can play with the calculators to work out how much you need to save and what you need to earn on your savings to meet your goals.

That Sounds too Hard, I just want to Start my Investment

Setting a retirement age and life goals seems pretty overwhelming in your 20s and early 30s. There are so many variables, it is impossible to project long term results with any accuracy anyway.

An alternative method is to save and invest 20% of your income. This method is suggested by Dev Raga our own medical finance podcaster, as well as the Whitecoat investor.

Taking 20% of your take-home pay (excluding super) and investing this sensibly for the long-term will get you closer to any goals that form over the years, and provide you with lots of options in life.

Save that Emergency Fund before Investing

Any consumer debt needs to go. This means anything apart from your mortgage, student loans and investment debt should be paid off. Particularly if the interest rate is over 4%. There is no point in paying guaranteed interest with no guarantee that investment returns will match them.

Traditionally a 3-6 month emergency fund is recommended. This is very individual. If you own your own home, your mortgage offset is the sensible place to leave this unless you will be tempted to dip into it for “fake emergencies”.

As your responsibilities increase, your emergency fund probably needs to. Unfortunately, those still on lower incomes have a greater need for the emergency fund.

It really doesn’t make sense to start an investment until you have funds to cover at least basic, common emergencies such as a car repair. You do not want to be withdrawing from your investments for a long time.

Check out your Current Investments

You should have a list of any investments you have collected from the earlier steps. It’s time to look at your current asset allocation.

For many of you, your only investment will be super. The good news is your superannuation is an excellent investment.

I wouldn’t start fiddling with your super asset allocation at this early stage. Most people overestimate their risk tolerance (particularly during good times). Being invested more aggressively than you can tolerate during the bad times risks you selling out and changing your investments during a market crash, locking in losses.

But you do need to make sure you are being ripped off with fees. These make a massive difference to long term performance, and are the only factor guaranteed to affect your returns.

Choose a fund with a low expense ratio (<0.6%) that suits your risk tolerance.

There is no ideal fund. Opening an account with one that’s just won an award for best performance is a bad idea. Many supers get their turn in the limelight of being the best performing super for a year. You don’t want to to pick a fund that has just had it’s best year. Another fund will win next year.

No-one can tell you which fund will outperform the others over the next decade. But you can control the fees. Minimise them.


Choose an Investment – Property or Shares.

Yes, there are other options, gold, collectibles, bonds. You will have exposure to some of these in your super. But the bulk of your investments will likely be in the stock market and/or shares for long-term growth.

I wrote an article on my approach to the property vs shares debate. Hang out in any investing forum online for a short period and you will notice a fight breaking out over which is superior. Whenever something is so hotly contested as this, there are certainly merits to both sides.

I am a big property fan for the use of leverage and diversification of income away from the volatility of the stock market. But the property market’s complexity is frequently underestimated by investors.

I have known so many people that regretted investing in dud (often off the plan) properties and swear of property investing for life. The issue with property is massive concentration risk and the risk (as well as the potential reward) of leverage.

If you are putting hundreds of thousands of dollars into one asset, you had better be sure it’s a good’un. And many aren’t. If you don’t have significant time to invest in education and research and don’t want to pay for professional advice, I wouldn’t invest in property.

But Sharemarket Investments are Volatile

The share market is often portrayed as some sort of risky casino. Yet we are all invested in the share market already, through our superannuation accounts. Everyone needs a basic understanding so they can ensure their super is invested appropriately.

Making an investment in the share market can also be surprisingly easy. It can be as simple or as complex as you like. Conveniently, research suggests simple “boring” investing* outperforms the sexier, time consuming and complicated version the vast majority of the time.

Risk is Not the Same as Volatility

The terms risk and volatility are often used interchangeably in personal finance books. I see them very differently. The stock market is extremely volatile. If you make your first investment in a broad-based index fund ETF, your money will grow exponentially over time but could also halve in value overnight.

This sounds terrifying! But over a long enough time period, the value of the stock market as a whole always goes up.

An investment in a single stock could take off like a rocket, or collapse to zero, taking your savings with it. But an investment in the entire stock market is not going to zero.

Your success in the stock market depends on your ability to withstand volatility.

It’s tougher than you expect to see your investments plummet, as they did last year by 30%. The protracted GFC in 2008 was even more challenging. But in all cases, those that held were rewarded with a mighty rebound and record-breaking growth eventually. The same cannot be said for individual stock pickers, who depending on their skill and luck may have lost everything or made a tidy profit.

For these reasons, it’s probably best to dip your toe into the stock market before diving right in. Starting investing before you can afford to is ideal.

You Can Get Started Very Quickly

It has never been easier to start investing in the stock market. Investments can start from just $5! It is also cheaper than it has ever been, which is great. The minimising of fees is a major factor in maximising returns.

For those wanting to dip their toes in the market, a micro-investment app is an ideal way to start. Start a regular investment of $50 per pay. The fees will be relatively expensive, but it’s a pretty cheap education in investing. I used one starting out and remain a fan. RAIZ even offer a rewards website, through which you can shop to offset your fee (and more).

Open a Micro-Investment Account if You Don’t have Much Money to Invest

There are several other options including Stockspot, Sharesies or Commsec pocket (ideal for those already banking with CBA) and spaceship.

RAIZ (and several of the others) offer Robo-advice. This is not individualized, and cannot take into account complex situations or questions. It assumes you want to invest in the stock market, and suggests a portfolio based on your risk tolerance (which it will help you assess). Most people overestimate their risk tolerance. You then set up a direct debit, and the money is transferred into your investments. Most of these platforms charge a fee per month but no brokerage, but Commsec pocket charges brokerage and no monthly fee (if you have a CBA account).

I am always raving about micro-investing accounts. I found it a great way to get started, as a cautious first-time investor. It allowed me to risk very little, but to start to experience volatility, get nervous and think about withdrawing my cash to then see it rebound.

Over time, confidence grows. Upgrade to a Brokerage Account

Most of the platforms offer some financial literacy education, which is variably useful. Once you have outgrown your micro-investment account (the fees get too expensive eventually), you could replicate the same portfolio or choose your own with your choice of broker, or choose a similarly diversified portfolio with Vanguard personal investor.

Unfortunately, Vanguard personal investors don’t yet offer the ability to automatically direct debit your investment from your bank regularly. You have to organise the transfer manually each time. Although this doesn’t sound like a big deal, it dramatically reduces the likelihood you actually follow through with your plan to make the investment each time.

Vanguard has just announced its new auto-invest feature. It is available with managed funds only but is brokerage and account keeping fee-free. If you are happy to invest in Vanguard managed funds, Vanguard personal investor is designed for you. With their range of diversified managed funds, it comes down to a choice of 4.

I have written an article about asset allocation if you wish to know more. I feel you could learn everything you need to start your own portfolio from scratch in a weekend from reading through each article at Passive investing Australia. But it is probably far easier to start with an easy diversified option such as a micro-investment account or a diversified Vanguard product. You have the choice of buying the latter brokerage free through Vanguard personal investor, or with brokerage charges but the ability to automate with Pearler. This article explains limit orders vs market orders vs auto -investing.

How to Get Started Investing Summary

  • Work out some goals or choose to invest 20% of your net income
  • Save an emergency fund whilst researching options
  • Open a microinvestment account if you have less than $1000 to invest at a time, perform risk tolerance assessment and set up a direct debit into the investment account. Consider Commsec pocket instead if you already bank with CBA<
  • Open a brokerage account if you have more than $2000 to invest at a time. Choose a vanguard diversified fund that matches your risk tolerance. Set up a direct debit to invest your chosen sum regularly.
  • Stay invested. Keep direct debiting. Review in 2 years and consider optimizing further. Avoid frequent fiddling! It does take time, and a watched investment account doesn’t grow very fast (yes I’m still working on this!)

Time is of the essence with investing, so you really need to make a decision and get started. Depending on your interest levels, you can dive into investing books, or spend a weekend reading the fabulous site Passive investing Australia to learn more. If you want to grow knowledge gradually over time, subscrib to this blog, money magazine or a podcast that you will listen to or read once a week to grow your financial literacy over time.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

How To Choose Your Investment: Opportunity Cost

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

What is Opportunity cost?

Opportunity cost is the analysis of the trade-off between one choice and another. Every choice you make in life involves an opportunity cost.

Opportunity cost usually refers to economic consequences, but there are also non-financial factors to consider when making investment decisions.

If you choose to invest in Apple shares, rather than CSL, the opportunity cost is the CSL returns you miss out on.

What Opportunity Cost is Not: Sunk Cost

A common error in assessing options is falling for the Sunk Cost fallacy. This is the tendency for people to irrationally consider the non-refundable time, money or resources already sunk into one choice when deciding whether to continue with that choice or change to another option.

Going forward, if being logical, time, money or effort already spent on one choice is irrelevant to which choice will provide a better financial outcome.

Cost Changes Over Time

Opportunity costs change over time as different options arise, and the cost of each option changes. For example, a change in interest rates would alter your opportunity cost of investing in property vs shares.

What’s more, costs and returns are, by necessity, based on assumptions. These may turn out to be inaccurate. If you assume that every property in Australia doubles every 10 years, and your investment property actually goes down in value, your opportunity cost calculation will be wrong.

Can Opportunity Cost be Avoided?

There are always alternative uses for your money. Some may be extremely high risk but provide well above average returns, or not, depending on what happens.

Sometimes you will choose to sacrifice the opportunity cost of more aggressive investing (eg highly leveraged shares) for a lower risk situation. You may prefer a very likely chance of a good return over a more uncertain chance of a high return (and some risk of capital loss).

How Opportunity Cost is Calculated

The expected returns from the two investments are compared. The opportunity cost is the difference between the higher and lower return.

My very first post in 2019 outlined my attempts to work out the opportunity cost of invest in property vs shares. Dare I look back and see how I did in retrospect?

My opportunity cost calculation at the time lifted from the original article.

I had $2,200 per month spare to invest.

ReturnsINVEST IN PROPERTY
Long term returns ~7% but are extremely variable
Buy and sell costs
5-6% purchase cost & 2% selling cost
INVEST IN THE STOCK MARKET
Long term returns ~9% but extremely variable
Can be $10 / $10,000 (0.1%)
Power of leverageCan leverage up to 90% turning 7% returns to potentially 90% (minus interest)Can leverage up to ~70% turning 9% returns to potentially 63% (minus interest)
The full table including other costs is the original article.

So I assumed a 7% return for a $600k property leveraged at 100%. My $2200 monthly surplus cover costs exceeding rental income.

I didn’t take into account rental income increasing over the years and the property becoming less negatively geared. I also considered the tax benefits of negative gearing separately. The maths gets a bit complex, and it’s probably best to be conservative with all assumptions.

I assumed 9% total returns for shares, a bit less than the S&P 500 accumulation index historic return of 10%.

Leveraged Property vs Leveraged Shares Opportunity Cost

Of course, the property won hands down. It’s not really a fair comparison.

The shares in this example are completely unleveraged because the thought of leveraging into the share market was too risky for me.

If we compare the effect of property leveraged at 100% (with equity from own home) and typical maximum share market leverage of 70%.

Here we can see the aggressively leveraged shares overtake the property after around 8 years. Because of the volatility of shares, leveraging is far more aggressive. A drop in values can lead to a margin call, where the bank is not happy with the level of risk when an investor drops below their acceptable loan to value ratio.

The bank can demand with a margin call that you invest the extra cash within days.

Leverage into property is not without risk, but the bank doesn’t demand you pay up immediately. Investors of dud properties can choose to bite the bullet and sell in order or hold until (hopefully) the value improves.

If you want to know how the property did in reality check out my 2-year update.

How Opportunity Cost Affects Decision Making

The above calculations are made on many assumptions. Opportunity cost can only be accurately calculated after the investment period has proven the actual returns offered.

As we need to choose investments before we invest, it’s important to attempt to make an opportunity cost calculation as accurate as possible. Try and avoid introducing too much bias into the equation.

At some point, you have to accept that you’ve made the best decision based on the information available at the time and take the leap.

Look back in a few years to assess the accuracy of your opportunity cost calculation if you dare!

Rent or Buy Example

Should you purchase a home in your current city or just rent?

There are many variables to consider, check out my article on rentvesting and my my opportunity cost from purchasing a home in a regional area.

To assess the opportunity cost of choosing to purchase your home, you need to know

  • Rent you will be paying
  • Anticipated returns from investments you could make if you continue renting
  • Mortgage repayments
  • Anticipated returns from investments you could make if you buy (if any)
  • Anticipated capital growth returns from your purchased home
  • Time frame

If you are staying put for 10 years, rents will increase. Interest rates are currently extremely low, but will eventually increase. The expected capital growth of your intended purchase and the number of years living in the property make or break the deal for renting or buying.

Dud Investment Example

Let’s catch up with Bob, our rural specialist doctor who purchased a house and land package in a regional town on 2014 for $240,000.

We first met Bob (who really lives in my head) in 2019. After 5 years of paying the mortgage, he was in the disappointing position to be $45,00 in negative equity. The property valuation came in at only $195,000 after a bad economic turn for the town. The rent was covering the mortgage repayments so there was no emergent need to sell. He certainly wasn’t going to sell at a loss!

But Bob is making a common error in his thinking. This is the sunk cost fallacy. The fact that he has lost money on this investment does not affect the opportunity cost of the decision to stay with this property, or cut his losses and invest elsewhere.

If we were logical investors, the decision of whether to sell and reinvest or hold and hope would be based on:

Anticipated property returns for the original property going forward

VS

Anticipated returns if Bob sold up and invested elsewhere (another property of shares)

Transaction costs involved in selling the property and reinvesting

Property is particularly expensive to get in and out of, with purchasing costs of around 6% of the property value and selling fees around 2%. Over the long term, or if there is a large difference in potential returns between the investment choices, it becomes more logical to sell.

Dud Investment in Shares.

Earlier, you chose to buy Apple shares and accept the opportunity cost of the potential profits from buying CSL instead.

Now imagine the general public get fed up with Apple and it’s annoying charging port that has to be different. No-one is buying apple anymore, and it doesn’t seem likely the company is going to make a come back.

You decide to sell and buy CSL shares.

The sunk cost is the transaction fees (brokerage) you spend buying Apple shares, plus any losses. It is common for investors to hang on to shares in the hope they recover to the buy price. This makes no sense. Even if Apple manage to stage a comeback over the next 3 years, if CSL are expected to significantly outperform, it may be the more sensible investment going forwards.

When assessing the opportunity cost you would assess

Anticipated return of Apple shares going forward

VS

Anticipated return of CSL shares going forward

PLUS transaction fees to sell apple, buy CSL and capital gains tax to be paid.

It’s tempting for investors who have purchased a “dud” to stick their heads in the sand. Or illogically wait for the price to return to their purchase price.

It’s hard to face up to the loss, but there is an opportunity cost to doing this.

A capital loss is when you sell an asset for less than what you brought for it plus costs of ownership. The silver lining is that if you make a capital loss, this can be used to offset capital gains.

So if you lost $10,000 on Apple shares, but made a $10,000 gain on another investment, you could offset the gain and pay no tax.

Why Opportunity Cost is Important

Investors are prone to all sorts of biases in investing. Trying to make decisions logically based on the best available information at the time is a good start. Spend the time to calculate as best you can the opportunity cost of your next significant financial decision. Don’t be fooled into the Sunk cost fallacy.

I use limit orders to invest in my chosen ETFs when the market drop instead of paying extra into the mortgage offset, because as the market drops, the opportunity cost of paying off the mortgage grows large enough to overcome my desire to get rid of the debt.

Your wealth accumulation journey starts as soon as you make the first step. Subscribe to Aussie doc for a weekly email to keep you up to date on track with your goals.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

How to Use a Super Calculator properly

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Everyone needs a financial (including retirement) plan.

It’s very easy to put retirement planning into the too-hard basket, particularly if you are under 40. But these years are when you can make the maximum benefit to your outcome with minimal effort. Due to the amount of time available for compounding of returns, total returns are higher the longer you invest.

It means investing a small amount regularly from a young age can make a surprising difference to the outcome over the long term.

The compounding really starts to take off after around 30 years, but most people don’t even think about retirement planning at that stage.

Most of us, however, don’t want to defer gratification forever.

There needs to be a balance between saving and investing and enjoying the experiences your cash can pay for now. A danger in becoming too extreme in frugality is missing out on the important stuff, and delaying life! It is a fine balance, and very individual.

Would you like to know exactly how much you need to invest to meet your financial goals? If you know how much you need to invest, you know how much you can really afford to spend. This allows savers to enjoy more experiences along the way.

20’s

In your twenties, there are a million fun things to spend cash on. Hundreds of dollars can disappear on a great night out. The physical and financial hangover is never as much fun! These are also great years to explore the world with lots of travel.

I implore you not to miss out on these experiences. But right now, we’re pretty limited in our ability to explore. Make sure you are saving or investing the extra cash. Perhaps you could save some for the ultimate trip once travel is a realistic option again, and invest some? You don’t need to have a lot of cash, you can start micro-investing with $5!

Priorities tend to change for many when they start a family. There are only a finite number of years when the kids are little for you to enjoy.

It’s important to fit in all your “bucket list with kids” items in that period before the opportunity is gone.

Those that have the forethought to get their finances into good shape as much as possible before having kids will be glad of a little less pressure. Sleepless nights, tantrums and balancing home and work life are plenty to keep your mind busy without the very common issue of financial pressure.

30’s

Your 30s also tend to be the most financially stretched years. Most will have to practice patience and self-forgiveness as their financial picture can get very tight. Saving for retirement can seem an unrealistic thought! Particularly for big-city folk, large mortgages can keep them very cash strapped for many years. Think very carefully before you commit yourself to becoming house poor for the next decade! Over committing to a huge mortgage limits your ability to save for other financial goals, take overseas trips and take time off work when it is needed.

Again, even saving and investing a token amount regularly provides lots of value. Prioritise an emergency fund, then work out your financial plan. Don’t be discouraged if getting on track for your goals is not yet possible, just do what you can to move in the right direction. Things get easier and opportunities will arise to increase your investments.

Salary sacrificing and optimising concessional super contributions offers you, if not a free lunch, a heavily discounted one. Your investments via these vehicles are boosted by tax savings, making out of pocket costs far less onerous.

40’s

Hopefully, your 40s will start to get a bit easier. Having recently crossed this dubious achievement, I feel I feel “over the hill” financially speaking.

Money seemed an uphill struggle for many years. The first few years of a mortgage are the toughest, parental leave meant a massive drop in income and childcare and kindergarten was expensive. During these years, our household focussed on maximising any superannuation tax benefits and paying down the mortgage as fast as we could. The principle owed inched down painfully for the first 10 years.

Things got a lot easier after that. Part of that was a step up in income. The kids starting school and reducing mortgage interest have helped to accelerate progress.

The past 4 years since returning to work have involved paying down the mortgage aggressively, purchasing two investment properties and starting regular investing into index fund ETFs. Our super balances are also starting to compound, growing more in a year than we contribute.

When the financial stresses start to ease make sure you notice and use the opportunity to increase your investments to get on track with your goals.

How Much Super is Enough?

AFSA’s Definition of a Comfortable Retirement

AFSA assure us a “comfortable retirement” will cost around $44,818 for a single person, or $63,352 for a couple as long as they own their own home. There is some description of the lifestyle these retirees could afford, including a visit to the local RSL, a domestic flight per year and flying internationally every 7 years.

Many high-income professionals would have become accustomed to a far higher cost of living, with upgraded spending in all categories.

The issue with this is that we tend to lose the skills of managing on a low budget. Once luxury purchases ($20 bottle of wine) are now considered essential. The thought of swapping back to the cask wine of your 20’s is usually incomprehensible. The wine alone may not be a big deal, but upgrading every area of a spending really makes a big difference to cost of living.

If you are in your 20s, so far from retirement it’s impossible to anticipate your required spending, I think AFSA’s “Comfortable retirement” figures are a reasonable starting point. Just remember to reassess every 5 -10 years.

For those in their 30s, 40s and beyond I think starting with your current spending is the best. Then you can make an educated guess, based on expenses that will no longer apply after retirement (mortgage repayments, kids school fees, professional expenses). Remember to add back in additional expenses in retirement (more travel, health care).

Again, don’t worry about it being accurate. More exact numbers will only be realistic in the last few years before retirement. A rough number will get you most of the way there.

Comparing Your Super Balance with Others your Age

Unless you are on an average income, I think comparing your super balance with the average balance at your age is nothing more than a feel-good exercise. The average balance is $417,900 for the top age bracket, male 65-74 years.

If you have earned an above-average income, you should be well above average by your 40s. If you are in your 20s with a delayed start to the workforce, the average may be useful in motivating you to get caught up asap.

Most people currently rely at least partially on the aged pension. High-income earners should consider the aged pension only as insurance if all else goes wrong.

Aiming for the Super Balance Transfer Cap

Another strategy is aiming for the “super balance transfer cap”. This is somewhat arbitrary and unrealistic for those without a high income. But removes a lot of complications and is also a good starting point.

The super cap is the maximum you are allowed in superannuation that can be transferred to a pension account and received as a tax-free income. This year’s cap is $1.7 million per person. If you have over $1.7 million in your super account, this means you will continue to pay 15% tax on the excess that has to be kept in accumulation phase.

We are all different, but for us $1.7M for one or $3.4M would be excessive for our spending. It is worth being aware that if you might hit the super cap, you should consider sharing your super with your partner (assuming they have a lower balance). Individuals with large amounts of super will be an easy target for future governments looking for new sources of tax revenue. I think it makes a lot of sense to have your super balance (and assets in general) as evenly spread between spouses as possible.

The super cap changes with indexation and is not immune to being fiddled with by future governments.

What is a Super Calculator

If you have ever opened the correspondence from your superannuation fund you will have come across a super calculator. Most of the super funds have calculators on their sites and will often send an individualised projection according to your super balance.

I entered a theoretical situation into several super calculators online to find out how similar they were in their projections. The situation is a 30-year-old male, earning $150,000 receiving 10% employer super contributions only with a balance of $50,000.

There is a $227, 000 difference between the highest and lowest projection. Retirement income projections varied from $29,176 to $52,119. There is so much variation it makes the projections almost meaningless.

Issues with Super Calculators

The issue with super calculators, and investment projections, is there are multiple variables you need to make assumptions on. The super calculators generally make these assumptions, although the better ones allow you to change these. Variables include:

Rate of Return

This is probably the biggest factor of all. Whether the stock market will return 5% or 10% over the next 10 years makes a huge difference to your retirement balance. No one can predict what future returns will be. There were widespread expert predictions that returns would be lower than previously when I started investing in 2017. I’m glad I ignored them.

There is also a huge variation in the asset allocation of super products. Whether you are 25% stocks or 25% cash is going to make a big difference to your long term returns.

Most super calculators assume a generic rate of return. Each one I looked at made different assumptions.

Long-term historic returns are the best we have to go on. Have a look at your super product. Make sure it is appropriate for your situation. Use the targeted return for your fund in super calculators.

Super Fees

Super fees will also make a difference over the long term. Fees are sometimes ignored by calculators, at other times a generic fee estimate is made.

Fees are the only guarantee with investing. Minimising them makes a guaranteed improvement in returns. Check your super website and see what fees you are paying. Check they are within the lower half of super products available, and certainly under 1%.

Insurance Premiums

Perhaps you are maxing out your concessional contributions. Kudos! But if you have your life, TPD and income protection insurance premiums coming out of your superannuation, not all your contributions are staying invested. Watch out for overestimating your super by ignoring insurance premiums.

Again you can easily find out the total premiums paid from your super from the website.

Tax

Super withdrawals are generally tax-free if you are retired and over your preservation (mostly 60 now). But if you are over the super cap, or younger than 60, you may have to pay some tax.

Unless you have a particularly unusual situation, I think it is reasonable to assume income will be tax free.

Retirement Age

Some super calculators assume a retirement age of 65 or 67. Most will allow you to change your retirement age to 60, but no younger. This makes super calculators of limited utility for early retirees.

Time is the other huge factor in investment returns. If you assume you will work to 67 but actually end up wanting (or needing) to retire at 60 your projections will be meaningless. Best to assume you will be a younger retiree and ensure you are prepared in case of unexpected health or life changes.

Inflation

Again, assumptions need to be made about inflation. The long term target of ~2.5% is often used. I don’t think this can be predicted with accuracy, but as long as you review your expected retirement spending every few years, along with assets accumulated, you can adjust for unexpectedly high or low inflation over time.

Change in Salary over Time

Super calculators assume you will earn your current income for the rest of your career. This is wildly inaccurate for young professionals just starting out, who may be expecting large jumps in income.

Use this to comfort yourself if (when?) you find it is impossible to currently get on track to your goals. Unless you’re close to your expected top salary, there is no need to panic. Just keep swimming in the right direction.

None of the super calculators I have tried out allow for multiple changes in salary over the years. Professional projection software I suspect could do this. But there are so many assumptions, I’m not sure its worth the expense. If your assumptions are out, the detailed and “accurate” projections will be wrong anyway. And it seems unlikely you will make all the assumptions needed accurately.

If you’re anything like me, you will find this annoying! Uncertainty is unfortunately unavoidable.

Career breaks

Some of the super calculators allow you to include career breaks for parental leave or extended travel, fellowships etc.

Withdrawal Rate

Super calculators will make an assumption about how much of your balance you will withdraw each year, and give you an estimate of when you will run out of superannuation.

There is huge controversy around the acceptable withdrawal rate, and this will likely change closer to the time depending on your health, balance and risk tolerances.

A rough rule of thumb is that a 4% withdrawal rate is very likely to last 30 years in retirement.

Information Required to Use a Super Calculator

Ideally you want to use as much information as you can to get your super projection as close as possible. This free calculator has a lot of detail, and lets you play around with the variables without starting the entire process from the start.

Super calculators can give you an idea of how much extra you should invest to reach your retirement goals. They are limited by the huge number of assumptions that need to be made. The projections get more accurate the closer you are to retirement age. I still think they have a benefit in the younger years, to get you moving roughly in the right direction. It’s important not to panic when you realise you cannot currently get on track, just keep swimming in the right direction.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

Landlord Insurance

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

As a landlord, your rental property is one of the most valuable assets you own. It’s important to protect it adequately.

Landlord insurance can help protect this asset and provides personal injury and property liability protection. Many firms have, however, reduced coverage for rental default as a result of COVID-19.

Read more about landlord insurance in this guide for new landlords!

What is Landlord Insurance?

Landlord insurance consists of two components. The first protects your rental property just as your own home buildings insurance does. This policy compensates for theft, fire or flooding and landlord liability coverage if someone is injured at the rental unit.

The other component of landlord insurance is in relation to tenants. This covers, depending on the policy, malicious damage caused by the tenant or their pet. Certain policies will also cover loss of income in case the tenant defaults on the rent, absconds or needs to be evicted. Landlord insurance policies may cover legal fees, costs of changing the locks and even tax audit fees.

Like all other insurance policies, there is a huge variation in the cover. It is wise to decide on what cover you require before comparing and read the PDS carefully.

Why Is Landlord Insurance Important?

All insurance companies aim to make a profit by paying out less in claims than it collects in premiums. This makes insurance policies a losing bet for consumers. And (hopefully) a boring waste of money!

But consumers who cannot yet afford to self insure need to protect themselves from financial catastrophes.

If your investment property burned to the ground, or a visitor suffered a serious injury on your property, the event may cause financial ruin. Changing the locks after a tenant was evicted? Annoying but hopefully not financially catastrophic if you are a property investor.

You should have financial buffers and an emergency fund.

The only reason you should take on the losing bet of an insurance policy is to insure against disaster. So when looking at policy inclusions, focus on ensuring you have disaster covered. It’s easy to get distracted by bonus inclusions that you are unlikely to recieve. Don’t pay extra for insurance you don’t really need.

How Does Landlord Insurance Work?

Landlord insurance works by providing coverage for the non-owner occupied residential rental property (i.e., landlord). It also provides liability coverage for bodily injury or property damage to others that arise out of your rental activities.

The landlord pays an annual or monthly premium. Most of the time, they won’t need to claim. If a claim is required, it’s time to call the insurance company. Only then do you find out how much of a battle it’s going to be to actually get the cash!

What Is An Excess (deductible)?

An excess is a dollar amount you pay on an insurance claim before the insurer pays anything toward the loss. For example: If you have a $500 excess, you would pay the first $500 for repairs yourself.

Increasing the excess will often reduce the cost of a policy. Again, the majority of the time you (hopefully) won’t need to claim, whereas you will always need to pay the insurance premium. It is generally more cost-effective to accept a higher excess for a lower premium

How Much Coverage Is Enough?

In general, landlord insurance covers replacement cost value or actual cash value (depreciated) for your building plus any additional living expenses due to damage from an insured event such as fire or storm.

It is important to consider all risks involved with owning rental property when purchasing landlord insurance because each landlord may have different coverage needs based on their situation and the type of property they own.

Terry Scheer was recommended to me. I have never had to claim (touch wood!) They cover $2 million in liability.

Underinsurance of homes is a massive issue, revealed every time Australia has a natural disaster.

The most accurate way to estimate the rebuild cost of a home is to order a quantity surveyor’s report. If you are planning to order a depreciation report for your investment property, enquire about a replacement property valuation for insurance purposes.

Alternately, insurance companies have calculators to help you work out the insurable value of a home on their websites. Use multiple sources and take care to get the estimate as accurate as possible.

Landlord Insurance Policy Features To Consider:

  • Excess options
  • Does the insurance company cover replacement Cost or Actual Cash Value of Building and Contents?
  • What Is Covered? (i.e., what is NOT covered?)  
  • Limits Of Liability Coverage For Bodily Injury Or Damage Claims/Lawsuits
  • Malicious damage by tenant
  • Damage caused by pets (do the insurance need to know about pets prior?)
  • How Long Does Landlord Insurance Last Before It Expires / Becomes Invalid
  • Are There Any Exclusions (“acts of God exclusion” is pretty subjective!)
  • Online reviews on claim process
  • Rental cover in case of tenant default, absconsion or (hate to imagine) death*
  • Eviction costs

*Following COVID-19, many firms have cut loss of income cover. Landlord insurers stopped offering new policies for a while as their costs blew out with unexpected claims. Multiple insurers do offer rental default cover again if this is important to you.

How To Get The Lowest Price On Your Landlord Insurance?

It is important to focus on the quality of the cover before trying to find the cheapest option. Cheap insurance that doesn’t cover financially catastrophic events is a waste of money.

The cost of a policy will depend on the size, value and makeup of the building, its location, policy inclusions and excess. It is usually more expensive than your principal place of residence insurance policy.

Shop around and compare landlord insurance quotes of appropriate policies. There are many online sites that offer landlord insurance comparison shopping. Make a list of available policies from different companies with all their pricing information, policy features and exclusions.

Another option is to ask your property manager if they have a recommendation.

Can You Make A Claim On Your Landlord Insurance?

Landlords can make landlord insurance claims for covered losses resulting from an insured event.

If you have to make a landlord claim it is important to follow all instructions given to you by your agent and landlord insurer regarding filing landlord insurance claims properly.  Speak to your insurer before commencing repairs if possible.

It’s also good practice to maintain detailed records of any conversations with agents about coverage information related to making claims, sending proof of loss statements etc. Keep copies of all documents filed during the process including receipts for repairs/replacement items purchased.

Landlord insurance is an important defensive tool to limit your risk in property investing. Make sure your policy covers causes of financial catastrophe, and then minimize cost.

Your wealth accumulation journey starts as soon as you make the first step. Subscribe to Aussie doc for a weekly email to keep you up to date on track to your goals.

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

M&M – Over Leverage by The Joyful Frugalista

*This post may contain affiliate links. This means if you purchase through the link I will receive a small commission at no cost to you. It is the way sites like this are funded, but does introduce a conflict of interest.  

Everyone makes some money mistakes. But learning from others is a lot less painful than making your own! I have benefitted from listening to tales from family and friends investing disasters and have confessed my own financial errors for readers, in turn, to learn from.

It is rare people are brave enough to share their financial horror stories. The shame and embarrassment of a huge financial mistake often prevent people from reporting or warning others.  But learning from others mistakes is sometimes more valuable than stories of success.

In the M&M series, I have asked financial content producers to bravely confess their worst financial mistakes. Read these warnings carefully and learn as much as you can from them to avoid making money mistakes of your own.

Over Leverage

Hi.  My name is Serina Bird. I’m the author of The Joyful Frugalista*, and host of The Joyful Frugalista Podcast.

I turn 49 in a few weeks’ time (how did that happen!), and I am mum to two boys (9 and nearly 12).  I’m a former Commonwealth public servant, who left to pursue other goals. I didn’t have a particular FIRE goal or target, but I was close enough to being financially secure that I felt I could take the leap when I did.

Oddly enough, I’m back in my former role part-time, and I’m enjoying the intellectual rigour and connecting with others.

My Worst Money Mistake: Over Leverage

In my first marriage, we were over leveraged in our property investments.  I was the primary income earner and for several years the only income earner.  We both had a goal of having at least ten residential investment properties.

So far, so good.

But I felt like it was often up to me to be the sensible one who watched the income and expenses where things were going. As I was in a busy job working overseas on posting, this wasn’t always possible.

In the last year of our marriage, we had huge gaps in our tenancies.  One property was vacant for six months before I realised what was going on! My ex-husband didn’t want to ‘worry’ me, and he also didn’t want me to lower the price. 

At that time, he had the main role of liaising with the real estate agents and I guess I wanted him to have a clear role as he wasn’t in the workforce at that time.

After returning to Australia, and then leaving the marriage due to an escalating anger situation, I suddenly had the burden of ten investment properties, plus legal costs, plus childcare.

I guess my worst financial error here was over leverage to the extent that there was no emergency fund.

We had a maxed-out credit card and an overdraft that was also at its maximum. 

While on paper I was wealthy, it didn’t feel like it. I was essentially living payday to payday and it was stressful.

Back in 2014 when we separated, the property market in my city (Canberra) plummeted due to cutbacks in the Commonwealth public service.  It wasn’t a good time to sell, yet both of us needed cash.  We managed to reduce the carnage by coming to an agreement to sell one and to avoid a fire sale. Selling at the lowest point of a market is never a good strategy.

What this taught me was the importance of building up wealth gradually and also of having funds available for contingencies.  Marrying (again) to someone who shared similar, frugal money values has also shown me how powerful it is when two people work together to achieve shared goals.

Related to this, another big financial error was being overexposed to property.

I love property investing and always have ever since playing Monopoly as a child.  Nothing’s going to stop my love of property investing!

But I almost totally missed the big mining boom because of fear of investing in shares – despite working on China issues at the time and reading about the big need for iron ore.

I also didn’t take the time to understand how my superannuation plan worked.  My ex didn’t like shares or believe in superannuation, and I guess I also was a bit sceptical of super. It seemed such a long way away before I would ever need it!

Warning Signs (in hindsight) I wish I’d Noticed:

With the benefit of hindsight, there were many warnings that my ex-husband and I weren’t on the same page when it came to investing and finance.  He had larger visions, but I was the one who was taking the responsibility for making mortgage repayments.

On the property investing front, the family tried to tell me we were taking on too much and being too ambitious. I heard this as them being jealous or thinking we were being greedy.

To be honest, there was a lot being written about leveraging heavily to buy more investment properties.  The boom of the early 2000s had a profound impact on people seeing how residential property could explode.  But booms don’t happen every day.  The money trail of what was coming in and going out should have told me that we were financially stretched.

How I Could Have Avoided this Error:

I could have avoided this error by having a more diversified portfolio, and crucially, ensuring we had an emergency fund – or at least access to a redraw facility in one of our mortgages. 

I also should have looked more closely at what was going on with our finances.

At the time when there were tenancy gaps, it was an especially busy time with my work as I was balancing being a mum to a toddler and baby plus many work-related evening events.  That said, it’s important to always prioritise your finances.

When I realised Over Leverage was a Mistake?

I don’t’ think I realised there was a ‘mistake’ as such for many years.  We had been so proud of our property portfolio. I was adamant we had made a good decision.  Yet looking back, I was always so anxious and, I think part of it was the stress of worrying about how I would make payments. It also held me back by keeping me in the same job as I didn’t have the courage to quit to follow the entrepreneurial path I had dreamed of.

On paper, selling the properties when we did was a mistake. If I had held all of them until the big 2021 boom, I would be laughing.  But, it would have been extremely stressful to have done so and my kids and I would have had to have made extraordinary, beyond the normal frugalista sacrifices. I think the pressure of doing that would have had a defining and adverse impact on my kids. I mean, there’s frugal and then there’s just plain crazy penny-pinching.

Looking back, I think around six years or so ago, I began to start rethinking my finances and how they aligned with my values. While I still loved property, my focus was more about ensuring that I could provide for my children through any contingency. Accordingly, a heavily geared strategy (even though it could have paid off eventually in a mega-bonanza), was incredibly risky.

How I recovered financially from Over Leverage:

It has taken me several years to restructure my investments. I have now rebuilt my super (I lost a third in the property settlement) and rebalanced the investment properties.

Two of the investment properties I retained.  I retained – then sold – the former family home, and my ex retained one house.  The rest we sold. 

I now have zero mortgage debt on the apartment where I live, my husband and I drive one car (car loan free), we pay our credit card off in full each month, he makes the maximum contribution to his superannuation, we have a cash emergency fund of $10,000, and we are building up our ETF portfolio. 

We have three investment properties and plan to start selling them down in 18 months’ time (ahead of hubby’s retirement at age 55). 

Without having to devote large amounts of funds to mortgage payments or car loans, we find we have more surplus funds to direct to ETF and other investments.

And we’re both somewhat amazed at how quickly our investments are growing now that we have reduced debt and consolidated our finances.  And the most important thing is that going into COVID, we knew we were in a good financial situation and didn’t have any reason to panic.

Thanks, Serina!

Thanks so much to the generous Serina Bird for sharing her financial mistake of over leverage, and her time to warn us! This warning is so relevant in todays over heating property market.

This article also contains a powerful warning to always be fully aware of how the household finances are being managed. Never outsource this completely to your partner.

Serina has also shared her investment strategy with Aussie doc readers earlier this year. The Joyful Frugalista book* shares more details on Serina’s property over leverage experience and loads of ideas on how to save money. I can recommend picking up a copy, I’ve read it twice to pick up hints on becoming more frugal!

Aussie Doc Freedom is not a financial adviser and does not offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.