There’s a lot of ways to become rich in life.
You can be entrepreneurial - creating a Unicorn business that is worth billions.
You could marry rich, receive an inheritance, or get lucky on the stock market.
But few wealth creation strategies have the likelihood of success as does investing consistently over the course of one’s life.
Even though there are more exciting ways to become rich, why not use the long and time-tested approach of investing modest amounts consistently as your back up plan?
The outcome of Plan B is, you still end up a millionaire and very wealthy.
It’s doesn’t have to be complicated.
For the every day individual, that earns an average salary and lives a normal life, I believe there are three main actions you can take to build a strong financial future for you and your family:
Pay your house off before retirement (preferably much sooner)
Invest any spare savings first in superannuation, and then personally.
Have adequate insurances in case of an emergency.
Why this strategy?
The importance of home ownership:
Having a home is the cornerstone of your financial security.
Everyone needs shelter, a place to live.
In retirement, having your house paid off is so important as it minimises your living costs significantly.
Say you retired without owning your home, and were paying $450 a week in rent.
That’s $23,400 a year that you need before you even start doing anything else.
If your investments were earning 4% per year, you would need $585,000 invested just to cover your rent.
When you own your own home, you don’t need to fund ongoing repayments to repay the mortgage, you’re just responsible for general upkeep, maintenance and utilities.
Secondly, I believe it is important to own a home as every year you are out of the housing market, you risk inflation, making it more difficult for you to ever own a home.
When you aren’t in the market, every price increase makes it harder to get back in.
In its own way, owning your own home is a protection against inflation and price increases, helping the value of your assets keep up with inflation.
The long-term benefits of superannuation:
There is a reason I suggest that most people would be better investing via super instead of personally. And it comes down to one reason…tax benefits.
Although tax should never be the main driver for an investment decision, the benefits of investing in super are significant.
If you are an average Australian earning $80k per year, you’re paying tax at 34.5%. When you contribute to super, the tax on that contribution is only 15%.
So for every dollar you put into super (currently up to $27,500 per year less the super you receive from your employer, noting there are age based restrictions in place as well), you are receiving an automatic return on investment of 19.5%. That’s an epic return for simply taking money out of your own name and putting it into super.
As we have discussed in the past, fees and tax paid have a significant impact on your long-term investment returns. Therefore, it makes sense to minimise fees and tax on investments.
When you invest via super, your investment returns at only taxed at 15%, which means that your investment returns are being reinvested in a lower taxed environment, helping your investments to compound faster.
One of the best ways to invest in super is by salary sacrificing.
For me, there is a simplicity in investing in super. It is easy, you have a fund manager taking care of investment decisions for you, the tax savings are immense and you have the ability to access your super tax free in retirement, helping your investment earnings go further.
Insurance:
Insurance is one of those expenses that if you don’t use it, you regret paying so much for it, and if you do need it, you wish you had have been insured for more.
Insurance is important because for most people, their ability to earn income is their greatest asset.
Take away that ability, and things start to get scary pretty quickly.
Most people will be able to obtain insurance through their superfund - TPD and Life, Income Protection Insurance.
These policies will typically be cheaper than holding these policies individually. You can also make a contribution to super to cover the cost of these policies so that you receive a deduction for this contribution. The additional benefit of this is that your super earnings won’t be eroded by insurance costs.
In life, you need to protect against the unexpected. If you can’t work, you can’t create wealth or care for your family. Yes, insurance is expensive, it may not be used, but if you can’t afford to lose it, insure it.
What are the key risks of this strategy?
No strategy is risk free.
Murphy is always standing around, waiting to apply his law. Things go wrong at the worst possible times. When it rains it pours.
For me, the key risks with this strategy are:
Selecting a poor performing super fund
Market crash just before retirement
Underinsured when needed
Government changes to super
Unfortunately, most of these factors are outside your control.
So work with what you can control.
Be vigilant with your superfund, make sure you monitor the returns and make changes if you need to.
When you are ready to retire, hold 2-3 years of expenses in cash, so that the market has time to recover.
Better yet, invest enough to live off dividends, instead of needing to draw down on capital.
Constantly review your insurances, and stay on top of tax changes.
As the super pot becomes larger and larger, it will be more tempting for the government to make changes, though if the changes affect more people negatively, this will also make it harder to get across the line at an election.
Dedicate spare time to increasing your financial education - because if you aren’t educated about how the market works, you’ll freak out the first time the market crashes and change your investments to cash, at the worst possible time, before your investments have recovered.
The longer you invest, the more you get to experience how the market works. So when you retire and the market isn’t in your favour, you have been there before, and have confidence it will continue to perform.
While no strategy is risk free, the proof is in the maths.
Consistently investing over the long term, in tax effective ways, while living below your means and having savings and insurance for emergencies is the closest thing to a guaranteed way to become very wealthy.
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