The path to success... watch A Current Affair

Taking in my daily dose of comedy last night (A Current Affair), I came across a story about a woman who '5 years ago was recently divorced and debt ridden, but today is the owner of 71 properties worth $6.5 million'.

The story went on to show how over the last 5 years this woman has bought up properties all over Australia (and New Zealand if I remember correctly). She spruiked about how this property 2 years ago cost her $100,000, now it's worth $250,000. She claimed she was getting that much rental income that she didn't have to work, etc, etc.

A few problems with the story:

1. How did she find all these properties with such high rental yield? From what I have seen, average rental yields are around the 4-5% mark. Interest rates for borrowing are around 7.5%.

2. How did she find a lender that would keep lending to her? This woman's debts would be growing and growing, with income not growing. How did she find a lender that would lend her $6.5 million?

3. How did she find 71 good tenants? I hear plenty of horror stories about renters. If she owns 71 properties, at a total value of $6.5m dollars, this means the average price of the properties is under $100,000 (I think it must include a lot of units!). These would be low rent properties. Not to be stereotypical, but you would assume that when you get down to this level, you're more likely to have problems with tenants.

Thats just a few of the holes to be picked in the story. Unfortunately stories like this and books like Rich Dad Poor Dad make people believe this can be done risk free. The old rule applies. If it looks too good to be true it probably is!

Super or the home?

With the changes to super coming in, allowing you to withdraw all of your super tax free at age 60, a strategy has come into play which involves paying interest only on your home mortgage, whilst using the difference between the capital repayments on your mortgage to increase your superannuation contributions.

The theory is that you gain immediate taxation benefits, with the super contributions being salary sacrificed, and when you turn 60, you withdraw what you borrowed on your mortgage and simply pay it back. The way I see this strategy, is it lets you have the lifestyle benefits of home ownership, but allows you to invest your money in assets that you may prefer to property (eg shares).

So I've run the two scenarios through my modelling software. I have taken a 30 year mortgage, with an interest rate of 8%. The super fund I have used is invested "aggressively". with projected return of around 9% pa (after tax). The loan is for $300,000.

The net benefit of the interest only loan strategy comes out to be $34,000. That is $34,000 in 30 years time. In today's dollars it's more like $15,000. Obviously, if the rate of return on the super fund is higher than 9% pa, the benefit would be greater, but I really wanted to be conservative on my projections.

There's also the added risk that interest rates will rise (or more favourable, decrease) and the legislative risk that super may be preserved beyond 60 for 30 year olds (lets hope not!).

In short, unless you can get a guaranteed return of over 10% pa over 30 years, this strategy really won't provide a huge benefit. The risks are far greater than the rewards.

The best strategy in my opinion would be to repay your mortgage asap, then once it's paid off increase your super contributions. That way you get the best of both worlds!

Metals going off!

Base metal prices are up massively. We might see record highs on the Australian sharemarket tomorrow (although if interest rates rise then who knows). So much for the bear market! See Kitco metals for current prices.

We can't afford to support the boomers... so why give more now?

I picked up a copy of The Financial Review today to be greeted with the headline "Grim future for tax cuts", with Peter Costello predicting that future generations will not be able to afford tax cuts, with forecasts that the ageing population will fuel a rise in heath spending and age pensions. This was all part of the Federal Government's Intergenerational Report.

This news shouldn't surprise. However, wasn't it Peter Costello who came out last May promising tax free retirements for Baby Boomers and almost doubling the Assets test for Centrelink entlements, effectively allowing a couple to have $800,000 in assets and still access Age Pension?

"The key point is to keep expenses controlled. We have got to be disciplined with our financial management to keep our budget in surplus. That's very important," Mr Costello told the Nine Network.

Mr Costello has provided a lifetime burden on the younger generations. These tax savings & increased Social Security benefits have to be funded some how. As much as we hate to think it, the mining boom isn't going to last forever!

Will the shine go off the gold?

I once had a theory, and when I told it to my colleagues they laughed at me. But I have found someone who shares this theory with me!

Lazy Man, guest poster at Consumerism Commentary has this theory that Gold isn't all it's cracked up to be. I tend to agree.

Here's my (some call stupid) theory.

Gold is seen as somewhere safe to park your money when things aren't looking too crash hot. For example, in times of war and high inflation, gold prices usually increase. This is due to the ancient tradition of gold being traded as a currency.

However, you need to think of what gold really is. Gold, like copper, zinc, lead, tin & silver is a metal. It is a good conductor and most females believe it looks pretty on their hands. That's it really. It's practical uses are relatively limited, and whilst its not the most abundant metal, it's certainly not the rarest. You can't build a house out if it, you can't build a road out of it.

So, I think you see where I'm getting to. Gold, at around $650US an ounce is very expensive for what you can do with it. 70% of gold is used for cosmetic use only, so it's practical demand is really not very high. In fact Wikipedia (and we know Wikipedia is ALWAYS right) says that approximately 20% of gold above ground (ie, gold that has been mined) is held in reserve within central banks. The reason for such huge reserves is firstly because back in the day most currencies were pegged to the price of gold, and secondly because I think Governments hold onto it just in case of a doomsday event, where paper currencies become worthless, they have something to exchange for goods and services.

The Indians have a fond affection of gold, so I can only imagine that as their economy grows and more people join the middle class that their demand of gold will increase, but somehow I don't think this demand is going to greatly increase price. Lazy Man has predicted that demand for gold will decrease as a jewellery item because his wife/girlfriend doesn't like it. However, with the gold I see on women in the world (and a lot of men!) I can't say I agree. The price of gold, unlike other metals does not follow trends on supply and demand, but more on the state of the world/economy.

However, this day and age, where you can click a button to buy another currency, does gold need to be used as this security blanket? If I believe that my currency is going to depreciate due to inflation I can buy another currency that I do not believe this will happen to. If i think our economy's going down the shute, I'll buy consumer staple shares. If I think we're going to war I'll buy shares in metal producers (who knows, we might see gold plated guns and grenades?). At the end of the day my gold bullion (or someone elses) isn't going to provide me with income.

In short, I believe it's time for the world to move away from its fixation on gold as a commodity and look at its real practical value. However, call me a conspiracy theorist, but with 20% of the gold in the world sitting in Government vaults, something makes me doubt the central bankers of the world aren't going to let gold fall to $10 an ounce.

For the record, this graph shows the rise in price of gold in the last few years. I wouldn't mind a few nuggets sitting under my bed. I first unveiled my theory to my colleagues in January 2006. Gold prices have since risen about 30%. Shares in Lihir Gold (who they were trying to talk me into investing in) have risen around 50% over the same period. I'd love to come back to this post in a few years and gold prices are down the bottom of this chart. I doubt it though!

*Edit - I just came across this article by David Potts. He doesn't seem to agree with my theory!