Should parents assist adult children to buy their first home?

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Our Prime Minister and RBA Governor suggest parental support is required

In November 2014, we published a Blog article titled “How do you give financial help to your adult children?”. Its focus was to match any assistance provided with the objective of developing children’s financial maturity. The views expressed were not influenced by what was actually happening at the time i.e. they were meant to be as timeless as possible.

However, since then, housing prices have continued to rise, particularly in Sydney. Young adults are finding it increasingly difficult to purchase a first home to meet their current living requirements. For most, housing that is also consistent with raising a future desired family is out of the question.

This has prompted a number of commentators, including both the Prime Minister, Malcolm Turnbull, and the retiring Governor of the Reserve Bank, Glenn Stevens, to suggest that the only way many young adults will be able to purchase their first home is with significant parental support i.e. the “Bank of Mum and Dad”. There is often an inference that “good parents” should provide such support.

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The power of compounding and deferred gratification

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“Compound interest is the eighth wonder of the world”

The following quotation is often, most likely incorrectly, attributed to Albert Einstein:

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t …pays it.”

“Compound interest” refers to the practice of continually reinvesting earnings received on investments over long periods of time (e.g. 40 years), as a mechanism to accumulate wealth. Regardless of who was responsible for the hyperbolic statement above, it’s a reality that the considerable power of compounding is not well understood by most and, even if understood, requires an ability to defer gratification that seems to be beyond many.

Like the achievement of a lot of generally desired things in life (e.g. becoming physically fit, losing weight, competence at a selected sport, hobby or musical instrument), accumulating wealth through compounding takes long term commitment and discipline. Early in the process, there may be little apparent reward for considerable sacrifice, making it difficult to resist the temptation to spend now rather than save and/or to think that there are few consequences for deferral of saving to later in life.

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Is superannuation’s wealth accumulation role in jeopardy

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The 2016-17 Budget proposed major changes to superannuation

We have previously discussed our “Personal Financial Dashboard” that graphically captures where a client is on the road to their version of financial independence. A key dashboard measure is the so-called Tax Effectiveness Ratio (“TER”), calculated as the ratio of superannuation holdings to total Projected Lifetime Investment Wealth.

Because of the tax effectiveness of the superannuation environment, we encourage clients to target a TER of at least 75% to be achieved by retirement. For some high income/high net worth clients or for clients who have delayed maximising super contributions, increasingly restrictive contribution caps may make this an impossibility.

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The Reverse Mortgage in action

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Two specific applications of the reverse mortgage are examined …

In last month’s article, “The Reverse Mortgage: an underutilised retirement planning tool?” we explained that a reverse mortgage is a potential solution for retirees who both wish to stay in the family home indefinitely and continue to enjoy a lifestyle beyond what their investment wealth is able to support.

Without access to a reverse mortgage, such retirees would be forced to either downsize to free up capital to live on and/or revise their lifestyle expectations downwards. Neither option may be particularly palatable.

In this article, we examine how a reverse mortgage would work in such a situation. We refer to it as the “Maintain lifestyle” scenario. We also discuss a scenario called “Bring forward inheritance” in which a reverse mortgage is utilised to provide assistance to adult children while retired/near retired parents are alive, rather than delay the children’s access to proceeds of the family home until the parents’ death.

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The Reverse Mortgage: an underutilised retirement planning tool?

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Australians’ wealth concentrated in the family home …

We have long been of the view that Australians, in general, have too much wealth tied up in the family home. For those at or near retirement, a corollary is that they often have insufficient investment assets to support their desired lifestyle for an extended period without needing to downsize or being prepared to survive beyond some unknown future time on the age pension.

This unsatisfactory situation is revealed by a measure of financial independence that we call the “Investment Wealth Ratio” (“IWR”). As a “rule of thumb”, we suggest that at retirement at least 55% of total wealth should be held in investment assets and, correspondingly, less than 45% in the family home and other lifestyle assets. But most Australian households either approaching or in retirement have an IWR significantly less than 55%.

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Housing: both unaffordable and expensive?

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Spending on housing has risen almost unabated since 1960 …

We have written previously about current housing affordability for young adult Australians (see “Are Australian house prices too high?” and “Housing and home loan affordability … again”). Our focus was the perceived inconsistency for those in their mid twenties to mid thirties of meeting both the current cost of housing (for purchase or rent) and accumulating sufficient investment wealth for financial independence by their mid-sixties.

It is sometimes suggested that a potential resolution to this “inconsistency” is a reduction in spending on other goods and services. The chart below shows how Australian households have allocated their disposable income over the period from June 1960 to June 2015:

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Diversification v Concentration: A tortoise and hare story

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Concentrate your investments to make and lose a lot of money

The following recent Twitter exchange was the catalyst for this article:
 

 
The initial tweet above is a quote from Jim Rogers, a well known US investment commentator, who believes he can reliably pick investment winners and time investment markets, despite robust academic research suggesting such skills are both incredibly rare and difficult to identify. However, his view that if you want to make a lot of money you should avoid diversification (i.e. spreading your investments as broadly as you cost effectively can) is undoubtedly correct.

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Confessions of a frustrated financial planner

Confessions of a frustrated financial planner
Responding to what I consider “dumb” money decisions

The recent Christmas/New Year period again provided time to meet less regularly seen family, friends and acquaintances and catch-up on what they have been doing. Inevitably, given what I do, the subject of personal finance often arose in some shape or form.

And it’s not usually raised by me. Invariably, the initiator is looking for my endorsement of whatever financial action/decision they have already taken or are committed to taking. They really aren’t particularly interested in hearing the almost inevitable reservations I may have.

Sheltering behind my ongoing obligation to “know the client”, I avoid getting involved in what experience has told me is likely to be a frustrating and fruitless conversation by simply saying I don’t have enough information to provide a worthwhile opinion.

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Do current interest rates justify chasing yield?

Do current interest rates justify chasing yield?

Interest rates are historically low …

With bank term deposit and other short term interest rates at historically low levels, many of those who rely on fixed interest to fund their lifestyles (retirees, in particular) feel under increasing pressure to examine higher yield alternatives. These usually come with significant additional, and often underappreciated, risk.

In a previous article, “Are you suffering from money illusion?”, published in October 2013, we warned against making investment decisions based purely on actual or nominal interest rates. We argued that it is critical to also consider both inflation and tax. Despite further falls in nominal interest rates since October 2013, after-inflation short term interest rates remain positive and are not significantly different from average levels experienced over the past 15 years.

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Re-thinking retirement (Part 2)

Re thinking retirement (Part 2)

The “New retirement” is not defined by age

In our previous article, “Re-thinking retirement (Part 1)”, we introduced the view shared by Mitch Anthony, author of “The New Retirementality”, and a growing chorus of ageing experts that the traditional concept of retirement is outdated. It is considered too focused on “money” issues, rather than the potentially more important “life” concerns i.e. what does a happy, fulfilling retirement mean to you.

Anthony argues that the “New Retirement”, unlike the “Old Retirement”, should not be age related and necessarily associated with stopping work. Rather, it should be the time when you have put yourself in a position to be able to only do what you want to do. The “money” is a facilitator for a new retirement, rather than an end in itself. As Anthony puts it:

“…it’s not about the money. It’s about doing what you love, doing what you want. It’s about balancing vocation and vacation. It’s about balancing enrichment and relationships.”

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