The two greatest secrets of growing wealth in Australia
Have you ever wondered how sometimes average people manage to create wealth on an average income? Do you sometimes feel like there is some secret club that you haven’t been given the key to? Does this sound like a really bad ad on television?
It does sound like a really bad ad, and the reason it does is because they know what will get your attention. We all have the thoughts mentioned above that rattle around our head…
“Why can’t I get ahead?”
“How did they afford that investment property?”
“Will I ever be able to retire”?
Unlike the ads, we won’t be giving you a set of steak knives but we will be telling you the two (or maybe three) most effective, and legal ways, you can build your wealth. So rather than looking at someone else and envying them you can be that person.
Is it too late to start? It’s never too late to start but the earlier you start the better off you will be. Warren Buffett (the greatest investor in the world) once said “someone is sitting in the shade today because someone else had the vision to plant a tree”. Always think of where you are and where you want to get to.
Even with the two strategies we are going to tell you, you still need some discipline. It’s not all champagne and diamonds, you have to work hard, save and invest. If your plan A is to win Powerball then you still need a sound Plan B.
Secret number 1: Compound interest
It’s silly calling this a secret as millions of people use it to their advantage and even more know about it and don’t use it, and some just don’t know about it. The first secret is the power of compound interest.
The concept is simple enough, instead of taking interest from an investment you leave it there and receive interest on the interest.
For instance, if we found a magical investment that returns 12% and invested $10,000. With interest compounded, the results would be quite outstanding.
In the table below without compounding you would receive $12,000 in interest, with compounding you would receive $21,058, an increase of nearly 75% over 10 years.
Now imagine if you applied this to an asset that was also growing in value? Imagine if you bought stocks with your initial $10,000 and received dividends, reinvested them in buying more stocks, and then they also grew in value?
Historically the U.S. Stock Market has compounded wealth (adjusting for inflation) at 6.9% a year over the long run. At this rate an investment in the stock market has historically doubled every 10.5 years.
Couple compounding to an asset that grows in value and you have a pretty good recipe for long term gains and growing wealth.
Oh and while we are there make sure you ask your financial planner to explain franking credits, it’s another bit of free money you may not have heard about.
Secret number 2: Money out of thin air
Money out of thin air you say? Yes I think I would like to know a bit more about that. Now for this secret to work you do need to have generated a few bucks with secret number 1.
For some time, all we have heard about is the housing market, low interest rates and investors that are pumping up the market. A lot of people have heard of negative gearing, most may not understand it, but that’s not the secret, in fact, if you are looking to build a property empire, you may want to consider the merits of positively geared property. The power in property investment is the leverage, otherwise known as borrowing money to invest in the property. Either way, you can make money on investment property and take advantage of this strategy.
Buying an investment property can be an excellent idea, it may, and most probably will rise in value over a period, and with luck it will also generate income, but did you know even if you are making a profit or a loss you can still get a substantial tax deduction for just owning a property? Similar to the compounding strategy discussed above, instead of going on a spending spree with your tax return, if you reinvest that into the property by paying down the principal on the loan or putting it into an offset account, you will soon be able to add another property to your portfolio.
Your new best friend the quantity surveyor
You may never have heard of these guys but they will be your new best friend if you buy an investment property. What these guys do is what it sounds like they survey your property. The objective of this is to obtain a depreciation report, this depreciation can then be used as a tax deduction.
Depreciation is claimable under 2 types of ATO allowances: Division 40 and Division 43.
Division 40 is the legislation that covers the depreciation of ‘plant and equipment’ within an Australian investment property. Each plant and equipment item has an effective life set by the Australian Taxation Office (ATO) and the depreciation deduction available on that item is calculated using this effective life.
Otherwise known as ‘Capital Works Allowance’ or ‘Building Write-Off’. Division 43 covers the deduction available to owners for the structural elements of the building and the items within the property that are deemed irremovable.
Depreciation is pretty much the ability for you to claim wear and tear on a new or old investment property. It allows you to claim internal items like carpet, ovens, kitchens (plant and equipment) and even the structure of the building, the building allowance.
Let’s say for instance you had a $600,000 investment property with a 10 year depreciation schedule prepared by a quantity surveyor, that had a year one claim of $5,000, down to $2,000 in years ten. Every year that amount comes off your taxable income.
Yes indeed there is money out there in thin air!
Avoid get rich quick schemes in all forms, in most cases the only person to make money from them is the person promoting the scheme. Compounding interest may seem like it will take too long to build wealth, but it is a tried and tested strategy that has worked for many of the worlds richest people, just look at the chart below, it wasn’t till age 30 Warren Buffet was worth one million and not until age 56 one billion, finally at age 83 his net worth is 58.5 billion.
These two strategies are simple, and very effective, but they are only two of many strategies that you could use to grow your wealth and create some shade for yourself in the future.
By speaking to a financial planner, you may realise that you could actually get started on building significant wealth a lot sooner than you thought possible. A good financial planner will be able to analyse your current financial position, understand your current goals and objective, help you build new ones, provide you quality strategic advice and most importantly keep you accountable to your goals.