The key to wealth in retirement isn’t about inheritances, lump sums or cash flow per se, but how well these assets are used to generate passive income so that investors no longer have to work for a living.
Not knowing what to do with a large inheritance a few years ago, thirty-something Sydney executive John Smith decided to play it safe by simply putting it in the bank. Given the state of the share market at the time, parking the money in cash wasn’t such a bad move.
The trouble was a dramatic improvement in equity markets, and corresponding downturn in cash rates rendered Smith’s ‘do nothing’ strategy wealth-destroying. In other words, based on an interest rate of around 2.75% or less, Smith’s cash would struggle to keep pace with inflation.
“The goal is for John’s share and property portfolio to eventually be big enough to generate sufficient passive income to replace his active income, namely salary, within 10 years.” says Sikar
Concerned that Smith was seriously diluting his long-term wealth creation, the accountant completing his annual tax return referred him to North Sydney financial planner Mike Sikar of Delta Financial Group in March 2011. Admittedly, as a young bachelor with no dependents and a $121,000 salary (plus super), Smith didn’t need to draw on this cash windfall to maintain his lifestyle.
While Smith’s money was sitting risk-free inside a major Australian bank, Sikar says he’d overlooked the opportunity-cost of not actively managing his assets properly. Equally concerning to Sikar was his capacity for risk, especially given his age, and future earnings potential. “Like a lot of people, John didn’t recognise how maximising wealth accumulation adds greater freedom and lifestyle choices, including when and how to retire,” Sikar recalls.
Much of the long-term wealth creation plan Sikar recommended to Smith revolves around creating financial independence through passive income from his investments. As well as wanting better advice on investing into super, Smith also wanted to be able to fund living expenses – in the event of trauma or accident resulting in an inability to work – through adequate insurance cover.
With Sikar putting the passive income strategy in the table early into the advice process, Smith says it made it easier to understand the steps involved in delivering to that strategy over time. “I wasn’t a savvy investor, when I first approached Mike Sikar for advice, and hadn’t even ventured into the property market,” admits Smith. “So it was quite cathartic to be able to put clarity around some vague financial ambitions.”
Assertive and balanced
But in the short-term, Smith’s more immediate need was for advice on how to best invest the $417,000 inheritance that was going nowhere fast in an “at-call” account. Ideally, Sikar wanted Smith to build a balanced and well-hedged investment portfolio comprising direct property, listed shares and managed funds in equal measure, based on his ‘assertive balanced’ risk profile of 70% growth assets and 30% defensive assets.