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Reader Case Study: Daniel Wants To Dump His Job and Retire Early

June 30, 2018


Welcome to the first reader case study on Strong Money!

This series will look at different reader’s situations, and see if we can come up with a way for them to create more freedom in their life than what they currently have.

While acknowledging I’m not a financial advisor, this is about throwing ideas around and giving some perspective on what I might do in a similar situation.

Any suggestions from you – the readers – are most welcome too!

 

Daniel’s Dilemma

Our first case study comes to us from Daniel* in Sydney.  He’s 32 years old and single, working towards financial independence.  But he’s not quite sure where the finish line is.

Let’s take a look at his position…

Current Work Income (After Tax):
$42,000

Current Living Expenses (Including Rent): 
$37,000

Current Investments/Savings:
Investment Property Equity: $923,000  (see details below)
Vanguard Shares: $20,000
Argo Shares: $5,000
Cash Savings: $50,000
Vintage Car: $40,000
=Net Worth: $1,038,000

 

Investment Property Figures:
Property Value: $1,200,000 (conservative according to Daniel)
Loan Amount Owning: $277,000

Rent: $41,600  ($800 per week)
Strata Fees: $6,400
Management Fees: $2,500
Council + Water Rates: $2,500
Insurance/Other: $600
Repairs + Maintenance: $2,000
Vacancy: $1600 (2 weeks per year)

Annual Rental Income: $26,000 after expenses
Loan Repayments: $20,400 ($1,700 per month)
Positive Cashflow After Loan Repayments: $5,600 per annum

 

As we can see, Daniel is quite wealthy at this point.  In fact, he’s a millionaire.  But he’s realised it’s not much fun being Equity Rich, Cashflow Poor when you want to retire early.

He’s already winding down his work situation and wants to quit his part-time job as soon as possible to give him space to relax for a while and do his own thing.

While I don’t have all the juicy details, Daniel is living an impressively low-cost lifestyle in Sydney.  The next thing to note is, the cash tied up in the Vintage car can probably be put to better use!

Unless it’s an important family treasure with huge sentimental value, there’s little reason to keep it.  Sure it may appreciate in value, but our reader needs to start collecting dividends, not dust!

What do you think?  Can Daniel declare freedom at this point?  Or should he stick at it for a while longer?

 

Here’s my take

Well, leaving things the way they are is probably not a good idea.  Although there’s over $900,000 of equity in the property, it’s only providing $5,600 of income each year.  Something needs to change.

Even if he somehow manages to pay it off, the rental income is still not enough to live on.  After costs, the net yield from the investment property is just over 2%.  Certainly not an ideal income stream for early retirement.

After some extra correspondence with our reader, he told me this property used to be his home, which he’s rented out for the last 5 years.

This is wonderful news!  Daniel can actually sell his property and pay absolutely no Capital Gains Tax.  How?

Currently, the ATO allows you to still claim the CGT exemption if you sell your home within 6 years of moving out, even if you use it to earn rental income during that time.  Here’s the ATO explainer.

Of course, our reader will have to pay selling agents fees and settlement costs, which would likely amount to around $30,000 – $35,000 (commission is likely to be around 2.5% and the remainder being settlement costs).

So after selling the property, Daniel would be left with around $890,000 in cash, free and clear.  And if he decides to sell the vintage car, he’ll have a total of $930,000 of investable cash.

So far his portfolio contains some income-producing shares already, including Argo.

The best way for Daniel to maximise his passive income in a diversified and simple way, could be to plough his property proceeds into low-cost dividend-paying funds like an Aussie index fund or LIC like Argo, for example.

This would take the portfolio of shares up to $955,000.  At an average yield of 4% the dividend income received would be $38,200 per year, along with franking credits of up to $16,300.

Under current franking rules, this gives a gross income of $54,500, and an after-tax income of $44,365.

If franking refunds are abolished, Daniel would still receive his $38,200 of dividends and pay no additional tax.

In both scenarios the dividends cover his spending and he still has some cash set aside for a rainy day.

 

Concerns

Initially, our reader raised some concerns about a sharemarket downturn and how that would affect his income.  The assumption was the property income would be safer.  Let’s see.

For this example, we’ll pretend Daniel has paid off his property worth $1.2m.

If there’s a recession and we assume property rents stay stable, Daniel would earn $26,000 from his property.  The same $1.2m would be earning $48,000 in dividends, plus franking credits.

But if we assume dividends drop by 30% in the recession, Daniel would earn $33,600, plus franking credits – still much higher than the rent.

So while the property income might feel safer, the numbers don’t make much sense.  Leveraged property can create large wealth, but it’s notoriously bad at generating income.

Since share prices move around constantly, and they mention it on the news every bloody day, we think it matters.  It doesn’t.

What matters is the companies going about their daily business, and the earnings and income they generate over the long term.  That’s how they create wealth.  And those long term earnings and dividends are generally more stable than share prices.

That’s why focusing on the growing dividend stream is a more reliable strategy and easier to stick with, rather than worrying whether your retirement is going to be affected by fluctuating markets.

 

Other Points

After further discussion, Daniel even shared that he was looking at moving out to a bush-land area where he’d have more space to relax and grow his own food.  And he said this would also drop his living expenses dramatically.

So it seems Daniel is definitely ready for early retirement.

By massively increasing his investment income through dividend-paying shares, reducing his expenses and keeping some cash on the side, it looks as though his situation is shaping up to be pretty rock-solid.

Even in a worst case scenario, a very small amount of part-time work will easily smooth over any bumps in the road.  This is unlikely to be necessary though, given his passive income looks set to be much higher than his expenses.

The only other thing he could do to boost his safety margin is increase how much cash he holds.  However, this will decrease his dividend income, so it comes at a slight cost.

Another decision to make is whether Daniel invests the lump-sum all at once, or drip feeds it into the market on a monthly basis via dollar-cost-averaging.

Statistically, research shows the lump-sum approach to be superior most of the time, although we just don’t know the future.  He may invest all the money and then the market drops, meaning he could’ve got a much better price when buying in.

To avoid regret, many people (myself included) would use a combination of lump-sum and monthly investing.  There’s a trade-off in Daniel’s case though.

The slower he is to put the money in the market, the longer he has to work.  That part is up to him.  But there’s probably a happy medium in there somewhere and investing large sums of money is not something you want to rush.

 

Final Thoughts

Some of the main takeaways are things we’ve discussed here on the blog.

It’s crucial your equity is put to good use in creating a strong income stream for you to live on.  Being equity rich, cashflow poor leaves you stuck in your job, albeit with the warm and fuzzy safety of property.  Even if sharemarkets crash, dividends are much more stable than share prices, as we saw with AFIC during the GFC.

And finally, lower expenses are your fastest ticket to financial independence.  Clearly Daniel has mastered the art of killing his bills!

Hopefully you enjoyed our first reader case study.  Let’s wish Daniel all the best on the next chapter of his life, and congratulate him on his upcoming freedom!

34 Comments

34 Replies to “Reader Case Study: Daniel Wants To Dump His Job and Retire Early”

    1. Hi Sally, I just went on the details Daniel gave me. I’ve now added his age in but unsure of his family situation. Understandably some people may not want to share everything which is perfectly fine.

      I think we had enough information to work on ideas here – it’s the numbers that dictate early retirement at the end of the day 🙂

    2. After getting some extra info from Daniel, he’s 32 and single. I’ve updated the text 🙂

  1. Critical point here: Even if sharemarkets crash, dividends are much more stable than share prices, as we saw with AFIC during the GFC.

    AFIC never missed a beat through the GFC paying out dividends. That should further give Daniel confidence to ditch the house.

    1. Cheers Scott. Absolutely, this is one strong advantage LICs have over index funds – the ability to smooth the income stream. This will help psychologically in a downturn.

      Focusing on the dividends instead of prices gives a behavioural edge, and given LICs will provide a smoother income stream in bad times, this will help comfort the investor further and help them stay the course. And that could make the difference between sticking with a plan and bailing out at the worst possible time.

  2. Hi Dave

    Enjoyed reading this case study. I think it sums up concisely the blueprint for what your blog’s approach is about with regards to financial independence.

    I have a question. If Daniel’s property’s loan interest is less than the 4% yield from AFI / ARG / VAS, is it reasonable not to pay off the loan but rather maximise the loan and invest in the LICs instead? Would this particularly be the case if the property was not an investment and hence, no tax deductions for loan repayments?

    1. Thanks Jon. Yes I suppose it does!

      I reckon this is such a common scenario and so many people could at least semi-retire and live a life with way more freedom than they currently have (and probably dream of and buy lotto tickets for) if they could just get over their love affair with property and become comfortable with investing in shares. This is what I’m trying to help with and hopefully together we can help convince people there’s a more effective way – to living and investing 🙂

      Well he could do that but he wouldn’t be able to retire. Think of it this way.

      Let’s say he can somehow borrow up to $900,000 against the property (75% LVR) – he can pull out equity of just over $600,000 to invest in shares (there’s basically zero chance he can do this because he works part time and has small investment income, but let’s say he can.

      It doesn’t matter so much whether the existing house is an investment or not, it matters how much over the interest payments he would be making – and it wouldn’t be enough to retire. And he’d be taking huge additional risk in doing so.

      If he’s paying 4% interest and receiving 6% dividends (provided franking refunds are continued) he will make a margin of 2% in yearly cashflow – which is $12,000. Plus the $6,000 positive cashflow from the property currently. This is nowhere near enough to retire and with risk that interest rates increase. He’ll also have to pay principal and interest at some point which would wipe out this cashflow altogether.

      He may make larger capital growth with that approach from a higher asset base but it would result in far less cashflow compared to selling and buying shares with the cash, therefore killing his hopes of retiring anytime soon.

  3. Thanks for sharing Daniel. I love the idea of living on dividends from LICs. Income is not lumpy like property. Property is a great vechicle for creating equity, terrible for yields.

  4. Great read thank for sharing at the end of the article would like to see a PDF download of it for refence keep the good work up very helpful.

    1. Glad you enjoyed it Mac! See blogger’s tip for copying. I had no idea you could do that 🙂

  5. Hi Dave have found your blogg recently and am enjoying the information and perspective.Currently in the process of investing in LICs what are your thoughts on BKI .Thanks Regards Bill.

  6. Could the vintage car be seen as an investment if the cost improves with time and Daniel keeps it in good nick? I don’t know much about cars, or how fast they appreciate, but it might be an interesting side project for cash generation. Perhaps Daniel could put the equivalent car cost from his cash reserve into his Argo funds?

    1. Thanks for the ideas Luke! Yep technically it’s an investment, and it may appreciate in value, but Daniel is better served generating income at this stage.
      I don’t know much either mate, but I would guess that vintage cars are a bit like property – expensive to maintain when things go wrong. I wouldn’t recommend he use his cash buffer because then he’s running it pretty fine. Not ideal in retirement. And if he needed to sell the car, it could take a while to sell being a limited market?

    1. Thanks mate. Yes slowly over time, perhaps every 2 years or so (or when it makes sense depending on each market) and eventually will be 100% shares.

  7. Hi Dave
    I would value your opinion. I notice that currently several LICs are trading at a good discount to NTA e.g MLT and AFI. For example MLT share price is 4.62 and NTA as published on their website is 4.73. Why is there such a discount when the market is so strong? Is it a screamingly good time to enter now especially given that MLT ex dividend date is only a few weeks away?

    Many thanks. Jon

    1. Hey Jon,
      You can think of the old LICs as slow movers, in the sense that when the market goes up, they go up slower, and when the market goes down, they go down slower. They tend to be slightly less volatile and this does create opportunities at times to buy at a discount. They look good to me, a 2-3% discount is always nice but won’t make a massive difference either way over the long term. The dividend being soon is neither here nor there I think. After the dividend is paid, NTA will be lower – some people wait till after the dividend is paid so they can buy at a lower price = higher yield. I’m not fussed either way, I’ll just keep purchasing regularly as it’s likely to give the best result over time as this stuff tends to even out.

  8. Any thoughts on adding some international diversification instead of just Aussie LICs?

    Something like VTS would be good.

    This also has the added benefit of being able to sell for capital gains when needed. (As VTS yield is very low due to the preference for stock buybacks instead of dividend payouts in the US). This can offset the risk from the government removing the franking refund, as you can use your franking credits against your capital gains from US stocks.

    1. Sure that’s an option if Daniel is interested in owning overseas equities and selling shares. I got the impression Daniel wanted to keep it pretty simple, and with his ultra-low expenses and the ability to do a little part-time work, I think sticking with an Aussie income-focused portfolio isn’t a problem. Even if franking refunds are removed, he’ll still manage just fine.

      Personally I think it would be increasing his risk to add US shares right now and try to harvest the capital gains as part of his retirement income. Market volatility would add stress and decision-making and the US market won’t always go up like it has for the last 10 years – meaning there might be no capital gain to harvest when he needs it. Generating income from dividends will be more stable with no action required on Daniel’s part.

  9. I have just found this blog and I love it! Your advice is fantastic – more case studies if possible please! On anything and everything! Like a snapshot of someone’s income and portfolio and what you would do differently/how long until FI etc.
    I would read that for hours!

    1. Thanks Alison and welcome!
      Great to hear you’re enjoying the blog 🙂
      It seems popular, so I’ll continue to sprinkle in a case study here and there, with my take on the situation and some thoughts on getting to FI.

  10. I have just discovered your website, and loving what I have read so far! I am still very new to some of these ideas, but very much hoping to head toward FI asap.

    This is probably a stupid question (and maybe slightly off-topic), but in your scenario above, where Daniel could achieve a “gross income of $54,500, and an after-tax income of $44,365” – if Daniel decided not to earn any other income in the financial year, could he make concessional contributions to his super, reducing his tax right down? Is this something that people do when reaching early retirement?

    1. Thanks for stopping by Steve! There’s no stupid questions, we’re all learning all the time 🙂

      I’m no super expert but my guess would be yes he could divert some money to super, but the problem with that is, Daniel is very young (32!) and needs that income to support his financial independence. But he likely wouldn’t be able to access his super until age 60.

      So the benefit might be higher tax efficiency, but the trade-off is his freedom. That’s not a great trade-off as far as I’m concerned. It might not surprise you then I never add money to super, despite the juicy tax benefits. If I funnelled excess cash to super along the way to save tax, I would be still at work today vs being FI now at 29. You’ll probably agree it’s worth paying a bit of extra tax for that 😉

  11. Yep agree totally with this. I would sell down the house and the car (money pit) and invest in LICs asap. He is in a great position. Obviously made good use of the Sydney market. Now best to get out and put that equity to good use.

    I would probably still work maybe 1 or 2 days a week or fortnight to contribute to SUPER or just as added income to play with but that is up to the individual. He will probably find after a while not working he will want to do this too.

    I just hope when the time comes and he settles down with someone he is smart and protects himself financially. Great work for him and another great article Dave. Very jealous of his position.

    1. Thanks for the input Ben.

      He’s in a wonderful position and he has lots to look forward to, including the option of working on something new if he feels a burst of productive energy 🙂

  12. Hello Dave, I’m a new reader (through Mr HM).
    Just want you to know how great your posts are and I’m looking forward to sharing them with my kids when they’re a little older.

    As far as Daniel’s case study goes, I noticed you haven’t mentioned that the Sydney property market is supposedly cooling. The flow on effect of a cooling in the market is that his property could decrease in value over the next year or two, eating into his equity. Just more reason for him to sell the property now, and invest in shares. You’ve given him great advice, and this is just one more reason!

    1. Hi Jay, welcome!

      Thanks for the kind words 🙂

      You make a good point, I think it was mentioned in our emails but left out of the post. Hard to foresee what prices will do but it’s definitely true the market has cooled off quite a bit, hopefully Daniel gets a sale done sooner rather than later!

  13. Any chance of a follow up to this case study to see how *Daniel is doing now? I’m sure we’d all be interested in knowing what he ended up doing and how it’s working out for him.

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