If you suffer from a love affair with property like many Australians, then you will often ponder the above two choices when deliberating how to build wealth long-term with this asset class.
With the first option, the idea is buy a big house and spend as much as I can afford, so that when retirement comes, I can simply sell the house and downsize to a smaller property. The difference in the cash I receive from the sale is then used to fund my retirement.
The other option however, is to buy a more modest home which I can easily afford and then spend the available surplus cash to build an investment portfolio that over time will include shares and property.
The interesting thing with these two options, is that it not only involves a financial decision, but one that also involves ego and lifestyle etc…… so you need to tread carefully.
So what are the points to consider with each option?
Let’s start first by exploring the big house (or the show piece) option with the almighty price tag and top end stretch to allows you to acquire the best that you can possibly afford. The points to consider with this can be as follows:
- At retirement if you decide to downsize and the profit or the capital gain will be 100% tax free. So if your property goes from say $500,000 to $1 million the entire gain would be yours to keep. This is often pretty enticing. This money could be deployed into super or a retirement income stream to fund the next chapter.
- At retirement currently Centrelink will ask you to tally up all your assets. If you sit under the threshold you may be eligible for a Centrelink Age Pension. Currently the home is exempt. So if you did not sell the home you could be sitting on a $2 million dollar property you could still receive a full age pension from Centrelink potentially. Over time, potentially you could progressively downsize.
- An area of concern with a big house however, is that it can be quite expensive to upkeep over your lifetime as large homes can also be expensive to heat, cool, maintain etc. The mortgage will also potentially be large and all the interest costs on that mortgage is not tax deductible. That means you have to slug it out with after tax money to pay down the loan.
- The other area of concern can come with ego. The downsize to a smaller property can hurt your ego – especially if the cash out from the sale may not be as much as you had hoped thanks to high transaction costs with stamp duty, agent fees etc.
The flip side to this is to explore the modest home option where we use savings to build an investment portfolio of property and shares over time. The points to consider with this can be as follows:
- Holding a range of assets creates diversity and helps reduce risk over time. Here you don’t just own one asset or have your entire retirement future based on one sale price.
- An investment property along the way may provide tax relief when building wealth.
- Should you require capital or money in a hurry you could sell off parts of the investment property to fund new ventures or opportunities. This may reduce the need to dig into equity and take on more debt.
- The need to downsize of the home at retirement may not be so important as you will have other assets already in place to potentially fund that later stage of life.
- The one careful point to consider with this approach however, is that sometimes the spare cash flow can be directed towards silly things that don’t build wealth over time. So a level of focus and commitment is really important for following this option.
- Once also needs to consider the administration and extra headache also goes with owning more assets with tax returns, legal structures etc.
- Finally as this option takes time to build your ego may find you looking enviously at those flashy homes and over time you may be tempted to cash it in and go the “show piece” option.
Like all great investment ideas, it is important to consider the above points carefully and consult with a professional Financial Planner. At AJ Financial Planning we enjoy working with clients to craft a innovative strategic blueprint that provides you with a well thought out approach to help you move towards your desired objectives.