No need to agonise over where to invest
My wife and I are 38 and 46 respectively and left having children until later in life, so we have a three-year-old and one-year-old. (Not sure how I got to 46 so quickly.)
We both travelled in our youth so our super could be better; we have a combined balance of $210,000. We owe $380,000 on our home and have $5000 in an exchange traded fund with Vanguard (ASX 300). My wife will go back to work part time soon and I work full time.
We will have a combined wage of $165,000.
So here comes my very confused question. In terms of how best to use our money, I am not sure if we should pay off our home as soon as we can or look at a more diversified approach. Do you think we should start adding more into our super or our index fund while paying off the home, or all three at the same time? Then there is a fourth option, an investment property.
Hoping you can shed some light on a pathway that has a lot of options. We don’t want to risk not getting anywhere. Michael
Not much confusion here, Michael. Your question frames your situation very well. I think this is half the battle. What to invest in and how to do it is a second-order question.
The real issue is your personal goals and objectives. These you set out quite clearly. You made a choice to travel while you were young and healthy and to defer children, super and so on until later in life.
This is a really personal issue but it was a path my wife Vicki and I followed. We were both very close to 40 when our third child was born. Increasing life expectancy made this a more attractive choice. I am now 63 and, like most in my age group, I am active, healthy and enthusiastic and our last-born is already 24.
With a lot of travel already done, it is a great stage in life to focus on your young kids and a critical stage for wealth creation. I am sure you are all over this but, first up, the key issue is surplus cash flow.
Clearly you run a surplus family budget as you have options in terms of investing in super, your ETF, topping up your mortgage or considering an investment property. This surplus can only grow when your wife goes back to part-time work.
Let’s try to set out a logical framework. I think your ETF is really there for the long term, so it is an asset that will produce income in decades to come when you want to go back to travel and want your assets to generate your income. If you agree with this, then I would really prefer you to build your share investment via super. You are on a really good salary and are no doubt getting your employer’s contribution of 9.5% (depending on your employer this may be more).
You can only have a maximum of $25,000 going from pre-tax salary into super. You should seriously think about making the most of this, in my opinion. Funds going into super from your salary are only going to be taxed at 15%. So you have much more after-tax money building up than you would by putting it into an ETF. Many super funds have very low-cost ETF-type options with incredibly low fees.
Once this is done, then we are looking at your after-tax dollars. Paying down your mortgage is your safest option. On any money you put into an offset account, you basically earn the rate of interest on your mortgage, and you earn it tax free as it simply reduces the amount of interest you pay.
Let’s say your rate is 5%. To decide to invest elsewhere means you need to believe you will earn more than 5% after tax. This is historically realistic but an investment in an ETF, shares or an investment property is more risky.
Historically the returns on property or shares are closer to 7%-8% a year, taking into account both growth and income in the form of rent or dividends.
With an investment property we also need to look at the leverage that debt in the form of a mortgage adds to potential returns.
Debt is a two-edged sword. It multiplies the gains on investments that grow in value but also multiplies the losses if your investment falls in value.
With a rapidly growing population, I am pretty relaxed about the long-term outlook for property in areas with population growth, jobs, infrastructure like public transport and lifestyle facilities such as parks and decent coffee.
It makes sense to me that more risk, at a sensible level, will give better returns over the long term. The key for you is not to agonise over how and where to invest. The real issue is to make sure you have a sustained approach to saving and investing.
Generate surplus income and apply it to super, shares, property or paying down your mortgage and you will create wealth.
Paul’s verdict: Sensible risk will give better returns over the long term This is a great time to focus on your young kids and wealth creation