Here is a dilemma financial and retirement advisers face regularly. The people seeking advice have a $700,000 house and $150,000 in investments. They want $15,000 to $20,000 annual investment income to top up their national super and have a good retirement.
But $150,000 at 3.5 per cent a year aftertax in the bank can only produce about $5000. Invested in a diversified balanced portfolio the return might rise to 6 per cent after tax; $150,000 at 6 per cent a year is $9000 - still not enough.
The problem is they have a lot of money tied up in a non-productive asset and a much smaller amount of money in income-producing assets. They have the house but they can't access that cash until they sell it.
Adviser's dilemma
The investment portfolio has a lot of work to do and it just isn't enough, so the investments erode rather too quickly.
The adviser can't get more return for the client without a lot of risk.
The client is uncomfortable watching his or her capital erode. The result is the big house has to be turned into a medium-size house at some point. Is this so bad? No, but it can be unsettling.
They do less than they could in retirement by trying to hang on to that big house.
It would be better to maintain investments, rather than running them down, then sell, and start the same cycle over again.
What is the real cost of owning your third and fourth empty bedrooms?
Before you buy that big house
Two couples aged 50 are mortgage-free and consider the idea of upgrading to a bigger, more expensive house.
Stu and Maria decide to upgrade so they borrow $200,000. The new mortgage at 7 per cent over 15 years costs $1800 a month (they repay $200,000 capital and $124,000 interest).
Jack and Bronte decide instead to divert mortgage payments, which were $1800 a month, to regular savings. Jack's and Bronte's $1800 a month invested at 6 per cent net over 15 years will grow to $532,900 or maybe a little under $500,000 if they missed a year of savings.
At age 65, both couples will have similar total assets. But Jack and Bronte are more diversified. They reach age 65 with $500,000 in liquid investments.
Stu and Maria have little savings and will soon have to downgrade the house.
