In this article we will refocus on the issue of wealth generation.

There are various investment strategies that can be utilised in achieving wealth in retirement. However, there are certain factors which must be considered as a matter of course in determining what strategy a particular individual will adopt.

The first issue to consider is risk. Risk is always related to the potential rewards. The higher the potential reward the higher the risk will be. There are two types of risk – non-diversifiable risk and diversifiable risk.

Non-diversifiable risk is the risk that is inherent within the economy. It is very difficult to avoid this risk. Examples are the 1987 share crash when it didn’t matter how diversified your portfolio was. You would be subject to the effects if the crash whether you had invested in shares, property, etc. Another example is the Asian crisis. The impact of this economic slow down in Asia was felt throughout the world and affected all countries to various degrees and accordingly could not be avoided by anyone.

On the other hand, diversifiable risk can be avoided. Diversifiable risk is the risk that is associated with any particular investment. By having a portfolio of investments, risk is diversified over all the portfolio, one bad result will not substantially effect the performance as the other investments within the portfolio will have continued to perform. Anecdotal evidence suggests that by having 12 different investments you have minimised the diversifiable risk. Accordingly, a well structured retirement portfolio will invest through a variety of assets and asset classes.

Business people have basically two methods of gathering wealth. They can either save their own funds, or borrow and invest funds to achieve higher returns.

One of the most common methodologies of saving which has taxation advantages is via superannuation funds. Funds invested within a superannuation fund attract a tax of 15% which is significantly cheaper than the top personal rate of 48.5% when those funds are held by an individual.

Taxation advantages can also be obtained with the contributions to the fund being tax deductible to the contributor at its/their marginal tax rate and assessable to the fund at 15% or 30% depending on the individual’s total income.

The alternative to saving for many people is to borrow money to make investments. This concept is commonly referred to as negative gearing and relies on the capital growth of the investment to offset the loss incurred on the difference between the income generated by the investment and the interest and costs of maintaining the investment.

Set out below is a table of investment returns for residential property, industrial/commercial property and shares. This table is based on average market returns for these asset classes. It can be seen that by borrowing funds to invest, and if normal capital growth rates are maintained into the future then this will add to the retiree’s wealth over the longer term as the capital growth exceeds the annual income loss.

An individual, using both the above methodologies (saving and investment) will increase their wealth more rapidly than an individual using only one methodology. In addition, using both methodologies will also increase the diversity of one’s investment portfolio which, as mentioned above, will decrease the overall risk of investment.

All values are expressed as a % of capital cost.

Note that the CPI over that same ten year time frame averaged 2.9% thus all investments showed real growth over inflation.

Assumptions

1. Assumes fully franked dividend.
2. The majority of commercial/industrial leases are done on a net return basis.
3. Tax is calculated at 48.5% (top marginal rate).

(4) Returns are calculated on Sydney property market as defined by Aust Bureau of Statistics