Say What Wednesday

Should you reduce debt or use surplus cash to build wealth? Negotiating with future-you

Welcome to Finance and Fury, “Say what Wednesday”

  • Where we answer questions about the world of personal finance.
  • This week, the question isn’t from a listener but a common one recently from people I have been meeting with.
  • Best strategy for surplus cash: to reduce debt or use it to build wealth?

Why is it important to ask this first?

  1. Finite resources – economic problem
    • Wants and Needs – We have a lot of them
      • Physical things
      • Experiences like travel or going out
    • Resources – A lot of things cost money – Which is typically more limited than our imagination
    • Balancing act – Use what you have to get where you want to be
  2. Budget and Cashflow – What is left after everything is paid for?
    • Things that reduce your cashflow
      • Taxes – Decreases what you have left
      • Lifestyle costs
      • Debt – Mortgage

What is spent on each, versus what is important 

  • Now versus future needs – Your now needs will seem more important

Uses of disposable income – A hard decision

  1. Factors that should help to determine:
    • Stage of life and the timeline
    • Priority
  2. The options of cashflow
    • Reduce debt – More defensive
    • Build wealth – More expansive

Breaking down the options for each

  1. Types of debt
    • Bad – Something against a non-investment asset which doesn’t generate an income
    • Good – Is it against something increasing in value, and can I claim the expenses?
    • Yes to both = Good debt which is a form of building wealth
  2. Build wealth – Investments
    • Monthly investments
    • Salary sacrifice – Super
    • Using leverage = More debt

What to focus your cash flow on

  1. Goals
    • How long until debt has to be paid off
    • Savings
  2. Good – Pay down in time to retire, but wait until the last minute to start
  3. Bad – Pay down ASAP, but not at the expense of investments
  4. Investment – What are the income needs in retirement?
    • Hard to work out: Rough guideline – Rule of 20:
      • $X amount of passive income multiplied by 20
      • Multiply this number by 1 plus the inflation rate to the power of the number of years until retirement
    • How long do you have? Great to start early.

 

Answering the question: Should I pay down debt or invest it?

  • Ask yourself if it is debt or investment as the priority to reach your financial goals?
  • Am I on track to retire with enough invested?
    • Yes – Means you have enough to cover what you will need
    • No – You may need to focus on investments more
      • Look at the timeframes you have to work within
    • Do you have bad debt? Yes, will it be paid off before retirement?
      • Do you need to pay this off quicker?
      • How much, and by when?
    • If it is good debt, will the investment be able to pay for itself before retirement?
      • Or, will the income be needed to provide a passive income? i.e. used to live
  • Putting it all together: Rules of thumb. Remember, this is not advice, but just some guidelines:
    • Bad debt is always bad.
    • Good debt declines in value the closer you are to retirement.
    • But if used correctly, can decrease the time until retirement.

Example: Person with $520,000 mortgage, just bought first place so they have a 30 year time horizon

  1. Long term rates of 7%, repayments of $3,462 p.m
  2. Option 1: Pay $20,000 onto a loan, or invest the money – 30 years
    • Loan – rate of 7% long term rate and P&I, versus lower rate
      • 7%: 30 years would save you $123,301 in interest and 3 years – If you kept your repayments the same
      • 5%: 30 years would save you $63,787 in interest and same 3 years – If you kept your repayments the same
  3. Option 2: Investment – Put $20,000 into portfolio, getting 8% p.a. for 30 years
    • 30 years would be around $186k to $200k invested.
    • Taxes on investment income – Return: 4% Income + 4% growth, income will be taxed.
      • Either fund through cash flow
      • Or use investment income to pay for
  4. What’s even better? Pay down the loan and redraw the funds as separate investment loan.
    • Convert debt to good debt. – Debt recycling that we have covered
    • Have best of both situations – Have investment, and while paying interest it is deductible.
    • You would have the $200,000 in investments and pay the loan with $123,301 of deductible interest along the way. Depending on MTR: lowest marginal tax rate: $25,893 to $57,950 at the top.

 

Summary – Remember this isn’t advice, just things to think about:

  1. Should you pay debt or invest your cash?
  2. Long time – Invest but not at expense of Bad debt costing too much
  3. Short time – Bad debt, then invest or pay down good debt, or both.

Current Australian Share Market

Episode 39 Current Australian Share Market Welcome to Finance and Fury Shares are at almost the same price as 2 years ago in Australia – What is happening? Mid Dec 2016 – 5,580 and last week the 3rd of December – 5,667 Today – is it a great time to buy some shares or...

Agenda 2030 – A global conspiracy theory, or something to actually worry about?

Welcome to Finance and Fury, The furious Friday edition Intro ep to a new FF series – probably going to be the biggest Today – episode to give the bird's eye view of the overall topic - massive topic - ranges from education, energy, transportation, medicine prices,...

Don’t forget about Inflation! How it can either be your best friend if you have debt, or your worst enemy if you are building wealth

Welcome to Finance and Fury,  Inflation and interest rate – real rates RBA update – Inflation and interest rates RBA - cash rate unchanged at 1% - following two consecutive rate cuts – past ep, talked about loans and property pieces Today – Look at the hidden wealth...

Say What Wednesday: The ups and downs of Bitcoin – currency, investment opportunity, both… or neither?

Say What Wednesday The ups and downs of Bitcoin - currency, investment opportunity, both... or neither? Today’s question comes from Richie, who asks, “Have you been following the Bitcoin ETF at all? If so, are you able to do an episode on this and if it is worth...

Furious Fridays: Wolves in Sheep’s Clothing: How socialism is threatening our amazing country

Furious Friday Wolves in Sheep's Clothing: How socialism is threatening our amazing country Welcome to Finance & Fury, the Furious Friday edition. To start this episode, I want to say just how incredibly lucky we are to be born in Australia during this time, even...

Where to invest in a post election world?

Welcome to Finance and Fury There is a saying that goes hoping for the best but planning for the worst. With the election around the corner, for those wanting to make it for themselves and create financial security may be in for a bit of a shake up Today I want to...

Say What Wednesday: Welcome to the Wild West

Say What Wednesdays Welcome to the Wild West Welcome to Say What Wednesday This week we’re going to answer some of the burning questions that have been on a lot of peoples’ minds around the banking royal commission…and rather than repeat everything you’ve been hearing...

Furious Friday: Is social media at a tipping point?

Furious Friday Is social media at a tipping point? Today we’re looking at the market environment for Facebook, Google, Twitter, YouTube etc… their costs are going to far outpace what their revenues will be. Are they on their way up, or on their way down? EU copyright...

Wars and the original purpose of Central Banks

Welcome to Finance and Fury, The Furious Friday Edition.  Today is an interesting episode - Central Banks and Wars – Often wouldn’t think of these two together – What is the purpose of a central bank? Financial stability, a lender of last resort, to smooth out the...

Beggar thy neighbour – How devaluation of currency can make or break economic growth domestically, or for trading partners

Welcome to Finance and Fury, the Say What Wednesday edition  Today's question comes from Jessica. Jessica – Hey Louis, You mentioned something about a Yuan devaluation in the Tech Share episode. I’m just wondering what this is and why a country would do this? Thanks...

Pin It on Pinterest

Share This