Welcome to the second case study in the series!
These case studies are where we take a look at a reader’s situation and flesh out some ideas on how they can reach financial independence sooner. As always, I’m not saying this plan is the ‘best’ way, just how I might approach the situation.
Without further delay, let’s get stuck in…
Our Reader’s Situation
This time we have a family of 4 from Sydney. Shaun and Linda*, who are 39, two little toddlers…and a dog.
Historically, the couple has focused on net worth goals and paying off their mortgage. But now they’re looking to put a clear FI plan in place as well.
Shaun shared how their focus was scattered and they were torn on what to do. Being on a large income, he was adding to his wife’s super, as she’s not earning any wages. He was also directing a small amount to shares each month, while repaying extra on their mortgage.
All good stuff, but they weren’t sure if it was optimal for their goals. Ideally, Shaun wanted to be able to choose whether to work or not, by age 55.
Let’s look at the numbers…
Annual Work Income (after-tax): $147,500
…Including typical bonuses and share awards: $212,000
General Living Expenses: $75,000
Yearly Mortgage Repayments: $72,000 (includes extra principal repayments of $31,000)
Home Value: $1,000,000
Debt remaining: $350,000
Investments: Shares – $100,000 (mostly individual stocks)
Other: Shaun’s Super – $75,000. Linda’s Super – $115,000
So we can see that this family has a huge take-home income, especially with those bonuses!
And those mortgage repayments are very high. But this is because of the couple’s hatred of debt and wanting to be mortgage-free.
Overall, their net worth position is extremely healthy. In fact, it’s over $1 million!
Unfortunately, because that wealth is locked up in their home and super, it creates absolutely no freedom at the moment.
Shaun expressed some worry that they have very little in super, and he’s conflicted between where to direct their surplus cash. Also, he’s extremely attracted to dividend investing and keen to get started down that path.
This family is understandably torn between different paths to take. So it really comes down to their priorities.
After a little poking, they revealed that being debt free and choosing whether to work or not, is most important to them.
So with this in mind, I suggested that I wouldn’t be putting a single dollar extra into super. Here’s why…
The couple has 21 years before they can access it at 60. And with Shaun’s income and their current balances, they’ll likely end up with a fair bit anyway.
Today, their combined super balance is $190,000. Plus around $14,000 is added each year from Shaun’s work (increasing with inflation).
Assuming a return of 5% per annum after inflation, in 21 years, the couple will have around $1,030,000 in super. And that’s in today’s dollars!
So it looks to me like they don’t need to worry about being light on super.
Shares vs Mortgage
Normally, I’d say to pay minimal mortgage repayments while investing in shares for a likely higher return.
But given the couple’s hatred of debt, I think paying this off should be the focus.
So instead of directing money to shares, super and the mortgage, I would go into ‘murder-the-mortgage mode’ and be laser focused on that.
I’m kind of an all-or-nothing guy. The best results are usually obtained by focusing hard on one specific goal or area. Nowhere is this more important, than achieving early retirement.
For FI purposes, I’m not a fan of the ‘buckets’ approach. Directing a bit of money here and a bit of money there. You’ll end up a wealthy old person that way, which is great. But it simply doesn’t work if you want to create freedom at a younger age.
Shaun thought focusing on the mortgage made sense. And he even decided to sell their individual shares to bring the mortgage payoff date way forward. He said most of the companies appeared overvalued anyway.
The bonuses he receives are quite regular, but not guaranteed of course. So we agreed that it made sense to count 50% of the yearly bonuses going forward when making projections, which is $33k per annum.
Based on this, and going into murder-the-mortgage mode, Shaun says the home loan will be fully paid off in about 4 years. Even sooner if the bonuses stay on their current trend.
Once that mortgage is gone, Shaun and Linda will have total expenses of $75k per year, and income of $181k per year. Put another way, that’s a savings rate of 58%.
For those playing the FI game at home, you’ll likely agree that $75k per year is a huge amount to spend outside a mortgage or rent. And this is the pared-down figure after Shaun agreed to look at his spending.
The previous level was quite a bit higher, but we’ll give them the benefit of the doubt, since they’re making a good effort!
Perhaps they missed my article – The Real Cost of Living: An Inconvenient Truth.
Being debt-free at this point will be a huge mental boost for them. But it doesn’t mean taking the foot off the gas. No way!
It means switching from murder-the-mortgage mode, into invest-like-an-animal mode!
The couple has a whopping $106k per year to invest at this point. If they aren’t careful, they could easily slack off and waste much of this cashflow.
The Investing Plan
Since Shaun wants to invest for a growing stream of dividends, I’m assuming he’s investing in either an Aussie index fund like VAS, or a couple of old LICs like Argo or AFIC. Both options have similar dividend and growth profiles, so each suit this purpose.
As Linda isn’t working, it makes sense to do most of the investing in her name initially. Once the portfolio gets bigger, Shaun can start buying shares so they’re both receiving a decent stream of tax-effective income, after reaching FI.
I’ll assume that investment returns are 7% per annum (5% after inflation). That return is comprised of 4% dividend yield, plus 3% growth. And to be extra conservative, I’ll also assume Linda gets no franking credit refunds along the way. (In reality, from day 1 she’s likely receiving 5.7% dividend yield after-tax, rather than 4%)
As a side note, if franking refunds do get abolished, they can continue to invest in Linda’s name the whole way through, as this will still yield the highest after-tax return.
This part is relatively easy to figure out. Just a couple of simple numbers are needed to forecast their journey to FI.
Investing $106k per year, with a return of 5% per year, gives a balance of just under $1.9m after 13 years.
But that’s not the important part. The critical point is, at this level the portfolio will be producing annual dividend income of around $76k, plus franking credits.
In retirement, franking will cover the tax entirely, so their after-tax investment income will be a minimum of $76k. The portfolio balance and income will be even higher, if franking refunds remain as is!
That’s all in today’s dollars, and 17 years from now. Shaun and Linda will be 56 and comfortably FI. Not to mention their super still compounding in the background and rapidly approaching seven-figures.
They can live off dividends at this point, and do as much or as little work as they like. And in only a couple of years, they’ll have access to that large super balance.
These are clearly just rough numbers by the way. They’ll obviously need to keep a bit of cash on hand, or be more flexible in spending, in case dividends fall when we (eventually) have a recession.
As they’ll be investing heavily into Aussie shares in their personal portfolio, it’s probably a good idea if they look at allocating their super towards international shares.
This gives the best of both worlds, in my view. A strong level of dividend income as soon as possible for FI. While also investing internationally for likely higher growth and extra diversification, as part of their overall plan.
Their super is effectively a very meaty backup plan.
It’s also possible the kids have left the nest at that point and the couple could look to downsize their house to free up even more cash to add to their portfolio.
Either way, Shaun and Linda’s overall net worth will likely be over $2.5 million, though only $1.9m is accessible.
That’s a pretty damn fine position to be in!
And although this stuff isn’t my forte, if they wanted to, they could possibly retire a bit earlier by selling a few shares to boost their income.
At age 54, their portfolio would be worth $1.5m and spitting out $60k per year of dividends, plus franking. Probably not quite enough to cover their $76k of spending.
They could sell around 1% of their portfolio ($16k) per year to to top up that cashflow. Doing this means they’re reliant on market prices, which makes me feel uneasy just typing out this idea!
Obviously this entails more risk than the initial plan. But because they actually end up with more than they need, it’s something to consider. And it’s only for a few years until they hit 60, when they can access their super.
If they work on killing their bills, Shaun and Linda can likely bring forward their FI date even closer. Or if they’re interested in some part-time work or income-earning hobby after retirement.
So to simplify, here’s what I’d do…
Work on reducing spending further. Murder that mortgage. Then invest every spare dollar into dividend-paying Aussie shares like LICs or an index fund.
That’s it. They should be comfortably FI by 56. Or earlier, with any of the additional options or tweaks we’ve discussed.
It probably looks too simple. But I think that’s a good thing. Creating a simple plan that’s easy to follow is far more powerful than a complex one. Don’t forget, perfection is our enemy.
And as I said, I think the best results come from the power of focus. Directing all efforts towards one thing means you’ll make progress faster, which boosts motivation to do more, and the results start compounding!
Anyway, this is how I would approach Shaun and Linda’s situation.
What would you do differently? Let me know in the comments.
Or if you have some helpful tips for this family on their journey to financial independence, please share…
*Names changed to protect the innocent. Keep in mind I’m just a blogger, not a financial advisor. Investment examples are for informational purposes only. Please do your own research 🙂