Wealth With Purpose

The most common investment mistake retirees make

 

When most people retire the natural reaction is to invest your money more conservatively, after all you no longer have a job that can help you make up for any lost income due to poor investing.

The financial industry tends to classify shares and real estate as ‘growth assets’ and cash, term deposits and bonds as ‘income assets’. The problem with this is it can be horribly misleading to an investor.

The table below uses Woolworths once again but compares them to an investment in term deposits (a fixed term bank deposit). Both assume a starting value of $100,000 in each investment.

Due to interest rates at the time and the dividends paid by Woolworths the income in the first year was as follows:

Investment                                    Year 1
Term Deposit:                                $5,250 per annum
Woolworths Shares:                      $3,420 per annum

However over the course of that particular 10-year period interest rates fell reducing the income from the term deposit and at the same time profits from Woolworths rose allowing the company to pay higher dividends. Here was the income in year 10.

Investment                                   Year 10 Income
Term Deposit:                               $2,750 per annum
Woolworths Shares:                     $10,108 per annum

As you can see the income from the term deposit declined by $2,500 per annum or fell 48%. The dividends however increased by $6,688 per annum or increased 295%!

It is important to look at this in the reality of day-to-day life. By owning the perceived more conservative investment the income has dramatically decreased whilst owning the more growth orientated investment income has nearly tripled. The standard of living between the two is very different.

The table below illustrates an additional reality and that is the difference in the capital value. As a term deposit has no capital growth, the starting and finishing value are exactly the same meaning on an inflation adjusted-basis the term deposit actually lost money. There has been a significant decline in the purchasing power of that $100,000 over that 10-year period due to inflation.

On the other hand the Woolworths shares have risen in value by $165,696 over that 10-year period representing an almost tripling in their value.

10 Years Starting Value Income Received Finishing Value
Woolworths Shares $100,000 $69,768 $265,696
Term Deposit $100,000 $48,500 $100,000

CAPITAL MOVEMENT

One of the fears that people have with share investments and growth investments is their potential to make losses as well. The table below and the line graph show the Woolworth’s share price movement over the same 10 period. Unlike the year after year rise in dividends there were two negative years where the value of the investment went down.

Had you purchased $100,000 of Woolworth shares at the beginning of 2011, by the end of the year your holding would be worth $85,000 having lost 15% of its value. This is not unusual in the share market, and should be considered a relatively ‘normal year’. You have good years and bad years.

Year Share Price

Growth

2004

$13.16

20%

2005

$15.77

25%

2006

$19.73

51%

2007

$29.82

-7%

2008

$27.78

4%

2009

$29.00

1%

2010 $29.23

-15%

2011 $24.79

16%

2012

$28.88

21%

2013 $34.96

13%

Interestingly enough the share price gains over the 10-year period averaged out at 13% per annum growth, which incidentally was the same as the dividend growth rate which makes logical sense given the value of any asset is based on its future cash flow. In other words as the profits of a company increase, and the subsequent dividends, the share price should follow a similar pattern.

 

Picture1

 

Had you bought Woolworths shares at the beginning of 2007, you lost value initially and did not make that value back up until in 2013 when the share price broke through the $30 level.

The point I am trying to illustrate is that when investing in growth assets it is far more important to focus on the income stream than it is on the capital value.

INVESTMENT PROPERTY

You should apply the same principle to investing in real estate, which is you should invest in property where the rents are likely to rise each year. If the rents are not rising, then the price is unlikely to rise either. There are times, potentially even long periods where the price may rise faster than the underlying income, but inevitably this must correct itself and usually happens through falling prices rather than rising rents.

The example I have given below of a residential investment property assumes that you as the landlord increase the rent each year and I would certainly encourage you to do so at least at the rate of inflation.

Year

Rent

Rental Growth

2004

$15,000

2005

$15,450

3%

2006 $15,914

3%

2007 $16,391

3%

2008 $16,883

3%

2009 $17,389

3%

2010 $17,911

3%

2011 $18,448

3%

2012 $19,002

3%

2013 $19,572

3%

As I’ve demonstrated one of the key ways to create wealth over the long-term is to invest in assets where not only will the value grow but more importantly the underlying income stream from the asset will grow.

Enjoyed this article? For more like it, sign up to receive our newsletter.

  • This field is for validation purposes and should be left unchanged.

Leave a Reply

Your email address will not be published. Required fields are marked *