In a listener requested episode, we look at investing and balancing goals outside of super.

You can find the transcript for the episode below:

LaMonica: Shani, we’ve had a big weekend for the Investing Compass family.

Jayamanne: We have. It’s a small family.

LaMonica: It is a small family, but Will, the producer of our episodes, got married on Saturday…

Jayamanne: He did.

LaMonica: …which was very exciting.

Jayamanne: Yes. And you went to the wedding.

LaMonica: Well, I was obviously there. I think the more important question is why were you not there, Shani?

Jayamanne: I had another wedding, which was in Brisbane.

LaMonica: Your dance card was full.

Jayamanne: My dance card?

LaMonica: Yes.

Jayamanne: What is that?

LaMonica: It’s a long story.

Jayamanne: Okay.

LaMonica: It has to do with dances and balls and the 18th century.

Jayamanne: Wow. Or the 21st century in Connecticut.

LaMonica: Exactly. But it was a great wedding. It was great to be there and big congratulations to Will.

Jayamanne: What was the highlight of the wedding?

LaMonica: Their first dance was pretty good. So, Will was nervous going into the wedding that they hadn’t practiced the first dance. And there was lifts involved.

Jayamanne: Wow.

LaMonica: There was a lot going on.

Jayamanne: One lift.

LaMonica: One lift. Okay. Anyway. Still, it was impressive.

Jayamanne: It was very impressive.

LaMonica: It was impressive. The low light was that Will – they had a bottle of Hennessy at every table.

Jayamanne: Why was that the low light?

LaMonica: It was a low light for how I felt on Sunday.

Jayamanne: Okay.

LaMonica: But let’s get into the episode. But big congratulations to Will.

Jayamanne: Yes, congrats, Will.

LaMonica: Very exciting. So, we have a listener-requested episode today, which we like because we know at least one person will listen to it.

Jayamanne: It’s good to have a guaranteed listen, but we also get that with Karen, your mother.

LaMonica: Yes. So, that’s true. So, this will have two listens at the very least.

Jayamanne: Yes. And the question that the listener requested was about investing outside of super. And I thought it was a good question because we always talk about the tax advantages, how powerful those tax advantages are in super. And so, now we’re going to look at the other side.

Jayamanne: We do. And with those tax advantages that you do get, there are some rules with the biggest one being that you can’t touch the money except under very specific circumstances until you reach retirement.

LaMonica: And given those restrictions, there are lots of reasons to invest outside of super. If you have financial goals prior to preservation age, and as a reminder for most people, that is 60.

Jayamanne: And retirement is a common goal, but the reasons that you might want to invest outside of super can vary. But Mark, why don’t we start with talking about you? So, how do you think about your investments outside of super?

LaMonica: Okay. Well, I think we need to get in time machine and go back to young Mark. And when I first started investing, so…

Jayamanne: Was your dance card full?

LaMonica: Unfortunately, not.

Jayamanne: Okay.

LaMonica: But one of the things that occurred to me pretty early on is the best thing possible is to get as much money into tax-advantaged retirement accounts as possible when I was young. And the reason for that, and we’ve talked about it on here before, is pretty simple, that those tax advantages allow your money to compound at a higher rate. And the one thing that everybody needs to know about compounding is the biggest enabler of compounding is time. And so, you get it in young, you take advantage of those tax breaks, you add time, and that’s a great approach for building wealth.

Jayamanne: And I think that is a really interesting point. It’s normal to have multiple goals, but the order you tackle them in can matter. So, it seems counterintuitive to tackle the goal that is the furthest in the future first. But given the tax advantages, it makes sense.

LaMonica: And you wrote an article once where you took a return and looked at different components of it. So, maybe if you could go through and explain that, because I think it illustrates tax.

Jayamanne: For sure. So, in the article, I took a 10% return a year that we typically hear from the share market that the share market delivers for investors. And I looked at the impact of different factors that reduce the returns that investors actually receive. And I used a number of assumptions about taxes. But in the scenario I ran, taxes reduced total returns by 1.8% annually, which is 18% of that hypothetical 10% return.

LaMonica: And I think that was a good way that illustrated my approach. So, in the US, I was in the US at the time, the retirement accounts and the rules are a little different, but the biggest difference is that the contributions are not compulsory. So, just like Australia, however, there are limits to how much money can go into these tax-advantaged retirement accounts on an annual basis. So, my focus initially was to get as much money into them as possible and try to get to a point where I could max out those contributions. And this obviously was hard when I first started working and I didn’t make much money, but over time, I was able to work my way up so that I could max out those accounts.

So, I think in an Australian context, I would also focus on getting as much into super as possible with concessional and potentially non-concessional contributions as well. Do that when you’re young. And I think checking off that goal means that you aren’t trying to catch up on retirement later in life, which is really, really hard. It’s hard to course correct later in life.

Jayamanne: And as a reminder, the concessional cap for super contributions is currently $30,000 a year. There’s also a carry forward provision of five years that allows you to apply any unused portion of the concessional cap as long as your super balance is under $500,000 at June 30th from the previous financial year. Non-concessional contributions are after-tax contributions to super. The cap there is currently $120,000 and you can only make those contributions if your super balance is below $2 million.

LaMonica: Shani, we’re doing an episode on investing outside of super and we spent the entire time talking about investing in super.

Jayamanne: Yes, but it’s always important to get the foundation right. And I know everyone wants to rush into investing to be a successful investor. And that means getting the foundation right. So, making sure you have an emergency fund and making sure you’re minimizing the impact of taxes as you try to build wealth.

LaMonica: And that was also my focus. So, I turned to trying to invest outside of super. And we do talk about goals a lot on this podcast because we obviously think they’re really important. And one of the reasons why I was investing outside of the US equivalent of super was to retire early. So, I wanted out at 50.

Jayamanne: That’s pretty soon, Mark.

LaMonica: It is. Well, I’ve changed my mind. I’ve changed my goal. And we can talk about that in a minute, but originally that was my goal. So, what I was trying to do is have enough money to support myself until I was old enough to start accessing those retirement accounts. And my plan to do that, which I do speak about often on here, was to try to build up enough passive income to pay for my life until I could get into that retirement phase.

Jayamanne: And I think that’s something really important that we need to talk about. We’ve obviously focused a lot on tax and outcomes of tax on investment outcomes. So, income investing is not the most tax-efficient way of investing because each year as those dividends come in, you owe tax on them. Did you think about that at all when you came up with your income strategy?

LaMonica: I did. I think all of that is true. There is one caveat to what you said, Shani. So, I was living in the US and dividends are actually taxed differently in the US. So, for most people, they’re not taxed at a marginal tax rate. They’re taxed at 15%. And that goes up to a certain limit of income. So, dividends do turn out to be significantly better from a tax perspective than earning income.

Now, in Australia, that obviously isn’t the case, but there is that tax advantage of franking credits. But I think really my attitude was and is still to this day that this is just earning income, like earning income from any other source. So, my boss wanted to give me a raise. I wouldn’t turn it down because I was paying more tax on it. And I just thought that there were a lot of advantages of taking an income approach. And it just made sense to me to focus on income investing because it improved my behavior as an investor. I had this intellectual alignment with taking that approach, kept me focused on the long term because that’s obviously a slow strategy of building up passive income. And ultimately, there are also tax advantages from having a long-term approach and not churning your portfolio all the time. It also helped me to keep saving because I had this tangible goal of trying to march towards financial freedom.

Jayamanne: Well, I do think it’s worth saying something here about asset placement. If you have super and non-super investments, it makes sense to think about the assets with the higher potential tax outcomes in super so you can take advantage of that lower tax rate. And generally, the higher potential tax outcomes are the investments with the highest returns.

Now that’s all things being equal. There are obviously rules around super so if you have a goal like Mark’s goal of retiring early, you need to take that into account.

LaMonica: And the one other thing I would add is just account for this in your plan. I was reinvesting my dividends which meant that I had to save money outside to pay for that inevitable tax bill at the end of the year. And I knew while I was starting to do this, I knew I couldn’t do this forever. I knew that at a certain point my passive income would build to a point where I wasn’t able to save that money and pay off the taxes, but I just thought okay, well, at that point, I can just reinvest a portion of the income and then use the other dividend income to pay off the taxes.

Jayamanne: And many investors do get surprised by a tax bill at the end of the year, so that is important. So, let’s get back to your story. You’ve said that your goal changed and you no longer want to focus on retiring early, so maybe you want to talk about that. Was it Investing Compass that just reignited your passion for work and…?

LaMonica: Oh, you know, I’m going to be doing this when I’m 75.

Jayamanne: Who with?

LaMonica: Who with? Are you not going to be around when I’m 75?

Jayamanne: We’ll see.

LaMonica: I think in terms of switching goals, there is an important lesson there. And we hear a lot from younger investors that they can’t set long-term goals, it’s a useless exercise, because they don’t know what they want to do 20 or 30 years down the line. And so, because they know these goals will change, they think there’s no point in setting them. And while that may be true, and I think we’ve talked about it on here before, there is this notion that probably contributes to people not wanting to set goals, this end of history illusion, and that just says that we all have this cognitive bias that says we underestimate the amount of change in our life going forward. So that’s something that’s probably holding people back from setting goals as well.

Jayamanne: And I think we both think that it’s completely fine for goals to change in the future and you can acknowledge that and still set goals. The purpose of a goal is to help you put together a plan and motivate you to follow it and goals are really important to keep an investor on track and to minimize mistakes. And even if your goals change, it’s probably going to cost money. So, it’s a lot better to have some savings invested than not having it.

LaMonica: Absolutely, Shani. And in my case, I shifted from this mindset of reinvesting my dividends, to grow my passive income, to try to stop working, to trying to figure out a way I can make my life better and that’s actually spending them. So, I think I talk about this a lot, spending dividends, and we can call this the Carpe Diem approach, Shani.

Jayamanne: And that’s not something you hear a lot on investing podcasts, but just spend the money and forget about the future.

LaMonica: Exactly. And obviously, I pointed out before that I’m still saving, I still have goals. I’m just a proponent that the reason that we save and invest isn’t some academic exercise. It is trying to make our lives better. So, it’s not all self-sacrifice and denial. It’s trying to find tangible ways that our assets can make our lives better. So, I switch to what I consider a responsible way to have my investments benefit my life now but also staying focused on the future. So mentally, this is very hard to do. You get yourself in a certain mindset and I think you’re one of these people, Shani, I hope that you are able to actually spend money on yourself. You struggle with that.

Jayamanne: I do. But that would take a whole episode to dig into and maybe some drinks.

LaMonica: Well, you have a bottle of champagne for Will. We can pop that open.

Jayamanne: It’s for Will. It’s not for me. But this isn’t uncommon. Many people struggle with this when they retire, and they’ve been so focused on sacrificing and saving money for decades and then all of a sudden, they start spending their portfolio down and that can be really hard and it can make people very vulnerable and feel like they’re going to run out of money.

LaMonica: And I think it’s fine to acknowledge how hard it is. And I don’t think I’m the only person that thinks this way, but as you save and invest, it can be easy to fall into a situation where you dissociated yourself a bit from what you were actually doing. So, I think you get competitive and you see the numbers in your brokerage account and you see that as a scoreboard and competition and you want to just keep seeing that number going up. But guess who helped me with this Shani? Our old friend Ernest Hemingway.

Jayamanne: I feel like we mentioned Hemingway now a lot on the podcast.

LaMonica: We do. I do because I know that you make fun of me. But there’s this book called A Moveable Feast. So, it is Hemingway’s story of his early days in Paris, and he wrote it at the end of his life and actually when he killed himself, it still wasn’t finished.

Jayamanne: This is bleak, Mark.

LaMonica: I mean, it’s just his history. But the point is that because he wrote the book later in life, obviously he was looking back on those early days or some nostalgia. But the whole point was he was living in Paris with his first wife named Hadley and they had no money. And he was trying to hold down this job, he was also trying to write and Hadley had some investments and they earned a little bit of money off of them and eventually they decided he was going to quit his job, focus on writing, have some adventures in Europe and they would just live off of the income from the portfolio.

Jayamanne: And just as an aside, we obviously have Mark’s email address in the episode notes and we get a lot of emails and we’ve gotten an increasing number of emails saying that they love your food posts at the end of your column, Unconventional Wisdom, and you have an Instagram account Mark…

LaMonica: Called Mark’s Moveable Feast.

Jayamanne: Yeah, so if you want to follow…

LaMonica: …from that book.

Jayamanne: …more of Mark’s food adventures. But how did this work out for Hemingway?

LaMonica: Well, he left Hadley and then married a very wealthy woman. Another strategy we could have a whole episode on that.

LaMonica: We should do another episode on that.

LaMonica: So that’s one financial pathway. But I think the concept of not touching the principal and spending the income, that was really the inspiration and that obviously goes far beyond Hemingway. I used Hemingway as an example because I know how much Shani likes talking about Hemingway. But I think the fact that I’m not selling anything and still have opportunities for capital growth helped me make this transition into spending from just saving.

LaMonica: And one of the questions that the listener sent in was how much money should be saved within super and then outside of super. So, any thoughts on this?

LaMonica: I mean, I think the first thing to say there is no rule of thumb. This is once again why it’s really important to have a goal. So, in this case, it would be two goals. So, a retirement goal for how much you want to have in super and then the goal for whatever you want to spend this money on that’s outside of super, and I think that will help with the split in terms of how much you need to save.

Jayamanne: And all roads lead back to goals.

LaMonica: Exactly, it’s all about goals, Shani. But I think there’s one other element that we should probably talk about in terms of money outside of super and that is extra mortgage payments. So, you of course are better able to address this than I am, Shani. So, why don’t you talk about how you think about that, investing outside of super versus extra mortgage payments?

Jayamanne: I think this is another thing that’s really hard for me. Debt makes me really anxious, so having a big mortgage is something that I think about a lot and it’s hard for me not to want to put every single dollar I have into paying off that mortgage.

LaMonica: Okay. So, this has turned into this psychological examination of Shani.

Jayamanne: Yes.

LaMonica: So, guilt over spending, anxious about debt.

Jayamanne: It really has.

Jayamanne: So, good times here, right? But I will say this shows how different you are from most Australians. So, people seem quite comfortable taking on a lot of debt and don’t hold back on spending money on themselves. But I take it that just because you want to spend just because you’re anxious and you want to spend all of your money paying off your mortgage, you aren’t. So, maybe you can talk about balancing paying down your mortgage with doing other things with your money outside of super.

Jayamanne: I mean, that’s the million-dollar question, right? And we’ve just said this, but I am very averse to debt. And when I log into my ING account and I see a hefty sum of money being thrown at it and the balance not really going down, it’s not the best feeling. And so, it’s hard not to just stop everything that I’m doing including my other investments and put all of my money into my mortgage. But that is just the reality of a mortgage. You look at a mortgage amortization schedule and you’re able to see the logic behind how the loan works. It will get paid off. My husband and I have other financial goals that we want to achieve and we want to save and invest for them concurrently, and we want to enjoy and take part in activities and travel while we’re younger. And without oversimplifying it, it is about balance and understanding the planned path forward to your goals. It’s mapping the course so you know the actions that you’re taking and why they’re purposeful so you can maximize the quality of life and your outcomes.

And the approach isn’t revolutionary in any way. There is really no secret. But we have an offset account for our emergency funds and cash for our shortest-term goals, and it all sits there. But for us, we figured out it’s much more important for us to have experiences at all stages of our lives and not just later in life. We also bought when interest rates were meaningfully higher and we haven’t changed the payments that we make into our mortgage. So, I get some sort of emotional satisfaction out of knowing that we’re already contributing more to our mortgage without any extra effort.

LaMonica: There you go. And in terms of experiences, you’re able to do things like travel to Brisbane for weddings and miss Will’s.

Jayamanne: Yes, exactly. Although, you can tell from my voice I’m not very well. I wasn’t very well for the wedding, so I didn’t get to enjoy much of it. But…

LaMonica: That is too bad. But anyway, we’re going to leave that there. A little bit of a hard question to answer. We covered a lot of different angles. Hopefully, the requester, the listener that requested that episode is happy and thank you guys very much for joining us.

Invest Your Way

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