How to build wealth and financial security as a renter

It is hard to go a day without the media covering the high costs of housing in Australia. We’ve faced a constant onslaught of commentary on proposed policy changes to make housing more affordable. We’ve heard about the bank of mum and dad. We’ve seen countless approaches to quantify the lack of affordability.

And we all know the implications. More Australians can’t afford to buy. More Australians buy later in life and retire with a mortgage. Residential property prices have led to handwringing, anger and, in some cases, inter-generational recriminations. I’m not here to add to this pile of commentary. I want to focus on the financial implications of not owning a home. And more importantly, how to overcome them.

I bring the perspective of being a renter which I covered in my article why I've chosen to rent for life. I will not re-hash my decision. But I will say that I am a firm believer that you can build wealth and achieve financial security as a renter. Like anything in life all it takes is an acknowledgement of the challenges faced and coming up with a plan to overcome them.

The challenges faced by renters

I am going to focus on long-term retirement challenges faced by renters. That isn’t because the recent run-ups in rent have not stretched budgets. But this is not a unique challenge for renters. And it can be argued that despite the breathless media coverage of rental inflation many homeowners have faired even worse from a cash flow perspective. They’ve had to content with interest rate hikes combined with inflation driven increases in home maintenance costs.

House prices have had a great run. And some people actively plan to extract value from their homes through reverse mortgages, downsizing or relocating to a cheaper place to live. Many don’t. I am going to concentrate on the advantage of paying off your mortgage prior to retirement.

Housing makes up a large portion of household budgets. Removing those expenses means a lower level of retirement savings are needed. In some cases, a paid off house can increase the money coming in the door during retirement as primary places of residence are not counted in the means test for the age pension. As my colleague Graham Hand wrote homeowner ‘shouldn’t’ run out of money in retirement.

This is the gap a renter needs to fill. Super and other assets have to be able to fully support spending plans in retirement. How much more? This will vary by personal situation, but we can make a back of the envelope calculation.

The weighting to housing in the basket of typical spending that makes up the CPI calculation in Australia is just under 23%. For some people that spend a far higher amount on housing that may seem low. But as I point out below the goal should be to reduce the amount of earnings that goes to housing over time as your salary increases. At 23% and assuming a 4% withdrawal rate in retirement the typical renter will need approximately 30% more in retirement savings than a homeowner. That is the challenge I will address in this article.

How to support your living expense in retirement

As previously mentioned, I’m a firm believer that anyone can build wealth and financial security without owning a home. It doesn’t take an advanced finance degree or expertise in investing. It just takes some effort to understand some basic concepts, saving money and the fortitude to focus on the long-term and ignore gyrations in the share market.

The high-level approach for a renter is the same as a homeowner. The following steps should be taken:

Having an emergency fund in place to protect your investments from short-term cash needs
Set investment goals
Establish an investment plan

I’ve included several resources at the end of this article that can guide investors through the steps. For renters I would keep several things in mind as going through this process.

Be thoughtful about how much you spend on rent

I want to premise this by saying that I know many renters are struggling to keep their heads above water. I am not ignoring this reality and I was in a similar situation when I moved into my first apartment. But as your salary grows the key is to prevent lifestyle creep.

Go ahead and make your coffee at home and bring your lunch to work. But understand that lots of good small decisions can be negated by making the wrong decision on the big expenses. And that is housing. This applies just as much to a homeowner who can barely cover their mortgage as it does to a renter.

Focus on continuing to reduce the percentage of your salary spent on housing. Do what you can to grow your salary. Think very carefully about any choice that increases housing costs. That is a pathway for anyone to build wealth. It is also a key input into the next steps.

Starting as early as possible

This is also good advice for anyone. The biggest influence on the amount of wealth that can be amassed is the amount of time available for compounding. Renters need larger portfolios to support retirement. Get money into the market as soon as possible. Get it into the most tax advantegous situation possible – for most of us it is super. Work hard to prevent anything that slows compounding down. That includes investment costs, taxes generated from overtrading and transaction fees.

Save more money than homeowners

This one should also be obvious. If you need more money in the future you need to save more money now. If you keep lifestyle creep to a minimum it enables higher levels of savings. Homeowners make sacrifices to build a downpayment. Even if this isn’t in the cards think along the same lines to boost savings levels.

And understand that you do not face the same expenses as homeowners in equivalent dwellings. No large downpayment, no stamp duty, no conveyancing and property lawyer fees, no settlement fees, and no ongoing repair and maintenance costs. This only works if you don’t use these savings to simply rent a more expense place or spend more money. At least a portion of these savings need to be saved and invested.

Not getting too conservative

Growth assets like shares face the short-term risk of volatility or fluctuations in prices. Most people are overly focused on this short-term risk. Over the long-term your biggest risk is not achieving the returns you need to reach your goal. For almost everyone it is impossible to generate sufficient real – or inflation adjusted- returns without heavy exposure to growth assets.

90% of AustralianSuper members are in the balanced fund with over 20% allocation to defensive assets like cash and fixed interest. And most super funds place members into a balanced fund in the default or MySuper option. For me this is too conservative. Figure out the right asset allocation for you by focusing on your risk capacity or how risk you need to achieve your goals. I’ve outlined the approach in the goal setting resources.

Rent will continue to increase in retirement

The foundation of retirement withdrawal strategies involve maintaining a real – or inflation adjusted – standard of living. In theory this accounts for rent increases. But as rent makes up a disproportionate amount of expenses high increases in rent can torpedo retirement outcomes.

This means being thoughtful about withdrawal rates. I’ve outlined this process in my article on estimating the savings needed to retire. A more conservative withdrawal rate means higher levels of savings are needed. Build in that buffer for the unexpected.

Does any of this apply to homeowners?

All of these tips and the high level-approach I’ve outlined to getting your finances sorted are valuable for anyone that is trying to build wealth. However, there is one group of homeowners who should pay special attention.

High property prices mean that the average age of first-time homeowners has dramatically increased in Australia. It is now around 36 years old. It was 26 years old in the 1970s. Already we see more people carrying mortgage debt into retirement. That number will increase over time. Having to pay a mortgage in retirement also means more retirement savings are needed.

Final thoughts

Building wealth as a renter means doing things differently than your peers who own homes and from previous generations who have built wealth from decades of climbing house prices. You may need to take a different pathway but that doesn’t mean it can’t be done.

Many readers will see facing the challenges associated with not owning a home as a poor trade-off. And I understand this reaction. I’ve made a different choice but I’m fortunate to have the resources to make a choice. Many Australians don’t. More than anything this article is a call to discard the conventional wisdom in Australia that the only pathway to wealth and financial security is through homeownership.

The power of investing is that we can all transform our lives. We can all achieve a higher degree of independence. It isn’t easy. It doesn’t come without sacrifice. But it can be done.

If you have thoughts or questions email me at mark.lamonica1@morningstar.com