Sunday, August 26, 2012

Blueprint for getting rich – part IV


Our generic plan for getting rich is shown below. We also have discussed the main elements of the plan – owning your first home, creating an ETF portfolio in a Tax Free Savings Account, and last but not least saving through an employee savings plan.

1.      Your Belize (Vision for the future):

You want to retire 25 years from now at the age of 22 - J

That means you want to have a net worth of at least $1.5 million 25 years from now so that you can live and work independently of an employer. (In plain English you want to be able to say to your employer “scr/// you!” without losing your meals and house - J - I am having so much fun).

2.      To do so you, as a household, will have to save around $10,000 per year. You do that by living below your means. Saving will initially be difficult but over time with increased pay cheques that will get easier. Maybe you can at later age save $15,000 per year and speed up reaching your ‘financial adulthood’ also known as retirement.

3.      First you save a down payment for your first house using your TSFA

4.      You buy the house

5.      You put your annual $10,000 savings in ETFs which are tax protected in your TSFA

6.      You will work for an employer who provides you with an attractive company savings plan.

7.      That’s all folks. See you in 25 years.

So let’s discuss some of the finer points regarding these approaches. First of all let’s discuss real estate.

Owning your own home is great. It allows you to use leverage in order to maximize your ROI that results from appreciation; it is a forced savings plan and you may have lower monthly payments compared to paying rent. But what happens when you pay off your mortgage? This is the end goal in many people’s thinking when it should be just the start. Here are some points to consider:

·         Your house is paid off and all future appreciation is tax free. But from now on your ROI on all that money tied up in your house does equal its appreciation and yes, it is cheaper than renting the place. But can you do more?  Of course you can. Before your mortgage payments were not tax deductible, but now you may put a line of credit on your place and use the proceeds for further investments. The interest you pay on any outstanding balance is now tax deductible.  So not only can you borrow money on a moment’s notice, you pay 40% (tax bracket dependant) less interest than you did on your old mortgage.

·         Now, that the leverage on your house has increased, so does the ROI on the equity that remains in your house. Don’t take out more than 50% in borrowed money – after all, your home is your castle and financial foundation. The money in the LOC must now be invested at a higher ROI than the interest you pay on your loan. So where to invest? What about investing in another property? Not a property to live in but a rental property! So we can use the LOC to fund the down payment on your next rental property. The details about how to buy and manage a rental property are discussed in earlier posts and if you want even more information join REIN.

·         Sometimes, you don’t have to wait to set up the LOC on your apartment before the mortgage is completely paid off. You can do it earlier provided you don’t endanger your financial stability.

·         Next you buy your first rental property with a prudent amount of leverage and your ROI on your own home as well as on rental property increases dramatically.

·         If you are not happy in your current home, you may buy a new residence and use your previous residence as rental. There are some tax issues involved with this, so talk to your accountant.

 

Yes, that is right, by now don’t try to do everything yourself. Because your time may be better spend on your next investment opportunity than doing your tax returns. You will start to expand the staff of your investment company (because that is what your building) to include a trusted accountant that can help you with tax planning; you’ll need a lawyer for your real estate deals and for estate planning and you’ll need a realtor, stock broker or financial planner. Watch out for the latter three ‘staffers’ because many are there just to sell you stuff. They can be very charming until the day you don’t invest enough through them. There is here an inherent conflict of interest that you have to be aware of. Having said that a good realtor, financial planner or stock broker is worth the money you spend on commissions and fees (see Should I fire my stock broker? )

·         You could use you’re LOC money for stock market investing but I do advice against that until you have a significant level of net worth and a lot of experience in the stock market. If your net worth is less than $1 million and you have less than 10 years of intense stock market investment experience don’t even dream of it. But for experienced investors leverage is an extremely powerful tool that helps enhance ROI and sometimes even cash flow when used with caution.

So now you’re ready to include real estate investments as an important component of a diversified portfolio. In the next post we’ll put the dots on the ‘I’s for your employee savings plan.

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