The Ultimate Investment Diagnostic Tool
The tool was designed to help people understand what the trajectory is if they stay where they are and just use their surplus income or dividends to reduce debt on their property portfolio; or if they considered putting capital into the world of alternative investments.
I think it’s difficult to wrap your head around the gravity that alternative investments can have on your property portfolio. So, today, I want to unpack what I think people are looking to understand.
Why Financial Projections are Important
The purpose of any modelling is to give you a flavour of what’s possible.
I’m a massive fan of using spreadsheets and similar tools in a basic way to help people understand what their future would look like if they carried on doing what they’re doing.
It’s not necessarily meant to be something that you hang your hat on. But I think people make investment decisions far too often without working out the impact on their wealth of time.
I know this sounds like a typical accountant thing to say, but I find that if you can get a basic grasp on how different line items compound, that can help you stay on track.
So, let’s get straight into Tim and Rita’s case study to illustrate how to keep on track and optimise what you have,
Case Study: Tim and Rita’s Situation
After the financial shock of COVID-19, Tim and Rita have been left feeling very vulnerable. Their previously successful event and catering business have been left limping.
They’re at an age and stage of life where they want out of the business in the next five years, but they don’t feel that they can rely on the sale of this asset anymore.
Their average household age is 52, and they have three children, ages 14, 18 and 20 years.
In their dream scenario, their inkosi, as we call it, their passive income stream from investments is $200,000.
The term inkosi, which we use inside our programme, is the Zulu term for tribal leader. It’s the guiding metric for our programme. It’s a great equaliser because it doesn’t matter whether your goal is $100,000 or $500,000.
Instead, what we’re tracking is the progress towards that goal.
I love this metric, and the reason I believe it’s a great equaliser is that you’re not necessarily trying to tell someone what their net worth is. Instead, the metric’s concept is establishing how close you are to your goal and what percentage of that passive income have you actually earned?
Going back to our case study, Tim and Rita need $100,000 to live off of. Then they want $50,000 deposited in their family bank account and $50,000 donated to charities.
The family bank concept is a phenomenal idea to create wealth that lasts long after you’re not around anymore – and we’ll definitely unpack that in another blog.
Pre-covid, Tim and Rita brought in around $330,000 per annum through their events and catering business.
They already have a portfolio of investment properties totalling to $4.7 million, excluding their family home, with the debt on those assets adding up to $3.3 million.
They do have their family home, but they’re not looking to downsize. They don’t want to move, and they’re working towards paying that off. But there’s very little debt left on that, and I don’t intend to try to utilise any of the equity on that.
In terms of their borrowing capacity, they have a maximum additional borrowing capacity in the Australian market, amounting to around $1.5 million.
Their typical annual ability to save, which they’re continuing to maintain now, is around $100,000.
Their objective is to diversify.
How we play the game inside of our programme is to look across the suite of available strategies, with the goal being, “how can we safely get them, as fast as we can, to game over?”
Game over here means that they have a passive income of $200,000 coming in, and they’re free to make decisions about how they spend their time.
Calculating Tim and Rita’s Numbers
So, the starting point is to bring up my calculator – I call it the investment diagnostic tool.
The purpose of the diagnosis is to give you insight into where you’ll be and how you’ll fare if you maintain the status quo versus putting a small percentage of your capital into alternative investments.
You can access my diagnostic tool here. You’ll need to make a copy of it and save it to YOUR Google Drive to be able to use it and play around with the numbers.
I’ve also created a short instruction video on how to use the tool, which you can access here.
Now, when I plug in Tim and Rita’s assets ($4.7 million) and their debt ($3.35 million) into the diagnostic tool, I can immediately see that they’re earning around $18,000 net income. So, the average net return on investment (ROI) of 1.3%.
That’s a reasonably typical ROI for the Australian market. Of the hundreds of investors and online statistics that I’ve looked at, the average net return for property, which is held without any debt, is about 1.33%.
So, Tim and Rita are probably going okay.
I’ve assumed that their average expected growth per annum on their local property portfolio is 5%. I’ve also assumed that the income they need will index at a CPI rate of 1.5%.
I’ve presumed that their surplus cash will be applied to, in the first instance, debt reduction.
If we look at the graphical representation of what happens if they maintain their current portfolio and I take $100,000 to apply to their debt every year, what we can see over time is that there are two lines that show a phonograph.
One is the required income going up over time. The other line is the income that’s actually coming off their portfolio.
I can immediately see that, even though $100,000 is a significant amount of money, the impact that has on the amount of income that increases each year is minuscule.
Even when we get to year 24, those two lines don’t intersect – which isn’t helpful whatsoever.
Working Out How Much to Invest in the Alternative Market
The second part of this calculator looks at what percentage of your assets you could consider investing into alternative investments.
If you’re not familiar with alternative investment strategies, you can access some previous podcasts here, where I talk about the five key buckets of strategies that sit inside the alternative sphere.
Typically, I’m looking for a net return of somewhere between 8% and 15% in the deals that I do. To calculate the impact on Tim and Rita’s outcomes, I’ve assumed that the average net yield on the alternative they earn is 10%.
I’m also going to assume that the surplus dividends or income will apply specifically to alternative investments – so $100,000. And then, just for a baseline calculation, I’m going to presume that they apply 20% of their investment portfolio to alternative investment strategies.
In this case, I can see graphically that the two lines intersect at about year eight. So we’re talking about two lines that don’t intersect at all, potentially for 25 to 30 years, now intersecting in about eight years.
The Reason Why I Made this Calculator Tool
The reason I’ve created this calculator is not to say you should trash an existing property portfolio and put it into alternative investment strategies.
You never want to go all-in on something like an alternative, no matter how lucrative it is.
But, in my mind, these investments are very stable assets – they pay a consistent, predictable and sustainable income. So the risk profile for a lot of these investments is not high.
The actual game here is working out how much of your capital you are willing to allocate to alternatives for the sole purpose of hitting your financial goals sooner.
Reaching Tim and Rita’s Goal
Tim and Rita are very much in a situation where they want out – they want to get to game over super fast.
While they hope to get to $200,000 so that they have extra income to give to charity and their family bank, their actual baseline is $100,000.
Once they reach that $100,000, it’s effectively the start of game over for them, and anything over and about that would be cream. So, when I look at my analysis here, and I change the $200,000 to $100,000, what I can see is that the timeline drops even further down.
They could reach their goal in four or five years if they invested $100,000 and 20% of their portfolio into alternative investments.
Why Alternative Investments Can’t Be Ignored
The point that I’m making is this is an asset class that can’t be ignored.
I think if you’re an investor who is sticking to the dogma of “what worked yesterday will continue to work tomorrow,” I believe that that’s a risky proposition.
Just because you’ve invested in something that has worked well doesn’t necessarily mean that it’ll continue to do well.
We’re living in different times – the economics are changing – and I think that the smart investor is trying to establish how to create more diversification and how to bring more stability to their portfolio.
I want to make sure that you understand that this calculator was designed for people who are already on their property investing journey – it’s not really for newbies.
It’s not a perfect tool, but it provides a great visual.
The big takeaway that I want to leave you with is to open up your mind to what else is possible!
If you’re keen to try out my Investment Diagnostic Tool, you can find it over here.
If you’re interested in understanding how to create wealth through alternative strategies, please check out my programs, where I help you get onto the path of generating passive income through investing or getting in touch today!
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