Discussion in 'Investing Strategies' started by Simon Hampel, 19th Mar, 2006.
Use this thread to discuss the article - Living on Equity - Part 4
OK - I'll start. One of the "magic" things about a margin loan, not fully drawn, is that the investor has total control. With one internet transaction - available funds can be simply transferred into a personal bank account. And these available funds automatically reflect current market prices and any equity growth.
Even with recently aggressive and friendly banks and other mortgage lenders - the process for drawing down property equity is not as simple. It is also subject to various rules, moods and risk management strategies of the financial institutions.
With the living off equity strategy, I do wonder about how easy it will be to access property equity at various stages of an investor's life cycle, eg moving into retirement, in early or later retirement.
I think a discussion around these elements of the LOE strategy - accessing the equity - would be useful. Maybe there is an argument for more margined shares and less property, over time, to mitigate this risk.
Maybe there is also scope for an innovative mortgage lender to develop a new product that adjusts the loan limit to the current value of the property, using some reference index, like a margin loan. This would make accessing the equity easier for investors using this strategy.
I think these days with various lo-doc loan products available, it becomes less of an issue with property refinances. You might not be able to draw out the equity to the same high LVR levels possible with a standard loan, but you can still access a portion of the increased equity.
But I do agree that a margin loan LOC is a marvellous thing - so easy to use (trap for undisciplined players !!).
The only downside is that one of the things that makes margin loans so great (quick and easy access to increased funds as the market rises), can also work against you (quickly losing available funds as the market falls). But this is manageble by maintaining careful control over your LVRs.
The other thing that's nice about margin LOCs, is that the larger your share portfolio, the less impact there is from drawing out some of the money. Eg, $5,000 withdrawn from a $1,000,000 portfolio has a lot less impact on the LVR than a $5,000 withdrawal from a $100,000 portfolio.
(Note - posts in this thread which refer to a spreadsheet have now been moved to a new thread: Living on Equity Spreadsheet - Sim')
Sim / Steve,
Ecellent article. Really explains the whole process succinctly.
For those interested, I've built a little excel spreadsheet to quickly mock up your current situation and see how close to LoE you are.
Attached here. My situation shows me a fair way off just yet...
I will just mention that Nigel did most of the work to get the article ready for publishing - I just checked his adding up and corrected a few grammatical errors
Thanks Nigel !
r youse sayin me grammer ain't two flash?
The work that has gone into producing these LOE articles has been a huge project all by itself. Well done lads
Thank you Nigel/Sim for all the layout and checking
a BIG thank you to Steve for writing it!
Great stuff guys, looking forward to the last one then I can sit down and really put it all together.
Using Michael's spreadsheet I am 1/3 of the way towards the $100k club. Somehow I feel alot further than that
You are! Your growth will follow an exponential curve pattern and not a straight line, so the first third will take a lot longer than the next third which in turn will take a lot longer than the last third.
You're probably over half way there if you look at it from a "time" perspective.
nice spreadsheet Michael
one comment I would make about the article (and therefore the spreadsheet) is that of the capital growth each year, you could only drawdown 80% and therefore drawing down 65% of that amount, makes quite a difference eg looking at your 5% CG scenario, instead of having 100K available, you would only have 80K, so your income for lifestyle at 65%, goes down to 52K (13K difference).
another comment is from my perspective, it is not the dollar amount invested in the fund that should be used when calculating the income rather it should be the number of units. not everyone managed to invest all the money in the fund at $1 per unit. for example if i invested 500K at 1.10 per unit, I would receive 454545 units. Now at a 10% return which might equate to around 10c per unit, I would receive $45454 not $50000 (based on 10% of the value of the holding ie 500k). Again this might make a difference to the bottom line.
Sorry, I meant I thought I was further from the goal rather than further into the journey towards the goal. That is, I was mildly suprised in a good way
1. I think the 65% drawdown is a valid one. Sure, you could draw up to 80% of the growth, but you should leave some money in the bank to compound so to speak. Taking 65% of 80% is irrelevant and I'm not sure why you suggested doing that exactly. What Steve is suggesting is to leave some equity in there (i.e. 35% of the growth) for leaner years where you don't get the 5% growth. So just draw "an average" of 65% each year for the sake of the exercise.
2. Steve's point around the fund is that, regardless of unit prices, you should expect 10% income out of it each year and 5% growth held back. They are the working assumptions of his model that I used in the spreadsheet. This is independent of unit price.
Sim - typo I think
On p 11 the first table reads - share income $162,500 times 10% = $162,500.
I think there is a zero missing in the first mention of $162,500.
You are right - that is a typo, but this should have been updated already - I uploaded a new version first thing this morning.
What I'd like to see in the model is some way of showing the "net" income that this would generate. At present its just the gross income, but if you're living off the growth in your portfolio for some of the income, then I guess you have several ways to access this. If you sell down units in your managed fund for example, then you might be liable to CGT. Alternatively, you can access it via an LOC against the growing equity in an IP/PPOR, but then there's a 7% odd cost impost to this that needs to be factored in. That seems a better "tax" than the 47% odd the government would take, but the issue is that this tax compounds year on year too unless you pay it back somehow, maybe with the passive income... Also, can you set up an automatic rolling LOC every year for say $65K, assuming the balance is the passive income, or do you need to go to the bank every 12 months and draw up another one?
Starts to get a little tricky in the specific execution side of things, but in theory is nice and simple.
Maybe I'm pre-empting instalment number 5!
My point of the 80% is to do with how much income you have to fund your lifestyle.
While your whole portfolio grows at 5%, the only way you have access to the full growth is by selling. In general , you will want to keep your LVR at 80% and therefore will only have access to 80% of the growth for draw down purposes. Of that amount, I agree with Steve, that you would only ever draw down 65%, leaving 35% to cover lean years.
For example :
Portfolio 1 mill
Growth 5%pa ie $50000
Reval/refinance gives you $40000 (80% of 50K)
Steve (and you) are drawing down 65% (of the full 5% growth of 50K) of that ie $32500, leaving a buffer of $7500
My way draws down 65% of the 40k ie income of 26K , buffer of 14K
I guess I would prefer to work on my numbers as I have a 50% better buffer for those lean times. Each to their own.
In terms of the number of units versus total value of holdings in the fund. I have had this debate with Steve and others at NI a number of times. Steve's numbers are generally based on buying in at $1 per unit and it makes the sums easier but ultimately people buy in at different price points Lets say someone puts in a million at 1.10 ie 909090 units. when the distribution is announced, the actual payment is based on cents per unit. say for example the distribution this quarter is 3.5% which equates to 3.5 cents per unit, the person would receive $31818 (909090 units x 3.5c). If the income was calculated on value of holding, the person would calculate 35K (1mill x 3.5% but that is not what he received. so again from my perspective, it is important to look at the number of units held when calculating your income (rather than the value of the holding). Again this could just be me, being a bit conservative (some might say anal ) when calculating income when LOE but I'd prefer to calculate a lower amount than find that I wasn't ready to do it after I had started to.
No problems. As you say, each to their own. I personally am happy to run with the assumptions of drawing down 65% of my growth, plus allowing for 10% income plus 5% growth on my shares on average over the long term. I reckon only drawing 65% of your growth is already a conservative figure, but as the article points out we all have different risk tollerances so would need to tailor the model accordingly to our own specific circumstances. In your example you're just drawing down 52% of your growth (60% x 80%), so just change that assumption in the model.
They're all just assumptions anyway. With regard to your Navra units, I think you're really just saying that you're challenging the assumptions based on your personal experience over a short period of time. The model assumes you'll be doing this until the day you die. So, at least the next 40 odd years for me, so trying to pick a unit price is a bit of a moot point. Its just a working assumption of 10% income plus 5% growth. i.e. a total return of 15%. So, the fact that the income distribution reduces the unit price is again moot. At the end of the year, you'll still have 5% growth left in there plus the 10% distributed income. If you don't like that assumption then just reduce the growth on your shares to 1% or even 0% and just count the income component.
Just read it again and this is where I think you're getting confused. 3.5% does not equate to 3.5c per unit. In your example, a distribution of 3.5c on a unit price of $1.10 equates to a 3.18% distribution. It would only equate to 3.5% distribution if the unit price were exactly $1.00 at the distribution date, which is extremely improbable. The assumption is that the fund will return 10.0% pa, but what this means in actual distributed cents per unit is irrelevant.
Again, if you don't like the 10% assumption, then just reduce it. But I think historically, the fund has distributed more than 10% pa in income, so its a pretty good assumption.
I did look at the percentage versus the cents per unit on the NI website before I posted. If you look at the retail fund - 03/04 10.58%, 9.9842 cents per unit, 04/05 16.17% 15.6093 cents per unit, 05/06 7.92% 8.5 cents per unit hence my decision to use a roughtly equal amount ie 3.5% and 3.5 cents per unit.
Im my situation, I tend to be conservative with a view to saying am I in postion to live off equity right now or in the next year? Given I have a bearish view on property prices over the next couple of years, I look at the worst case scenario to see if I can do it and that requires a bigger buffer and more accurate calculation of income.
Overall I am still a believer in LOE and am a moderately aggresive investor (Steve might disagree and say I am an aggresive investor) and I still believe the model can work.
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