Our old pal Warren Buffett knows where the money is.
This week Bloomberg News reported:
‘Warren Buffett’s Berkshire Hathaway Inc. jumped into the slumping private-jet market again with a record order valued at $9.6 billion, betting on a rebound later this decade with a third plane purchase in less than two years.’
It suggests that Buffett doesn’t think his proposal to tax the rich will have an effect on private-jet travel.
The timing of the deal was appropriate, because it came at the same time as a report from the US Federal Reserve that showed US household wealth is back to 1992 levels. According to the San Francisco Chronicle:
‘Median net worth declined to $77,300 in 2010, the lowest since 1992, from $126,400 in 2007, the Fed said in its Survey of Consumer Finances…Almost every demographic group experienced losses, which may hurt retirement prospects for middle-income families, Fed economists said in the report.’
Worse, after taking a big hit from falling house prices and stock markets, most investors would like to get some of those losses back. Many were too scared to get back into the stock market, and will have missed the US market’s doubling rally.
They went for the safer option of cash, which in the US returns barely more than zero percent.
Australian Housing and Retirement
Aussie investors and future retirees haven’t done much better. And if they’re not careful, as we’ll explain today, they could end up doing a whole lot worse…
In the Daily Reckoning yesterday, our old pal Dan Denning told readers about a news scoop in the Australian newspaper.
The article notes:
‘Subprime-style lending practices were rampant during the last property boom despite claims by lenders that local practices were superior to global standards.’
The author – Anthony Klan – reveals:
‘Fitch Ratings estimates low-doc and no-doc loans now represent 8-10 per cent of the $1.2 trillion national mortgage market. That’s between $96bn and $120bn.’
We were stunned when we saw those figures. We always knew the Australian housing market had a potential subprime ticking time bomb, but how could we prove it?
The suits at the Reserve Bank of Australia and their puppets in the mainstream press insisted Aussie banking standards were far better than those overseas, and that subprime lending was only a small part of the Aussie mortgage market.
As RBA deputy governor Guy Debelle said in a speech in 2008:
‘Non-conforming loans in Australia accounted for only about 1 per cent of outstanding loans in 2007, well below the 13 per cent sub-prime share in the US. The share of new loans in Australia that are non-conforming has also been very low over recent years, at about 1 to 2 per cent, significantly below the 20 per cent sub-prime share that loans reached in the US in 2006.’
The deputy governor even provided a chart to prove it, as you can see below. However, we’ve taken the liberty of adding the real level of sub-prime lending as revealed by the Australian:
That’s right, according to the Australian, there are eight to ten times more Aussie sub-prime loans than most previously believed.
In fact, if the Australian and Fitch Ratings are right, Aussie sub-prime lending was or is only slightly lower than US sub-prime lending levels.
So rather than the banks being more prudent with borrowing standards, they were knee deep in dodgy loan applications.
And arguably the only reason Aussie sub-prime lending didn’t reach US levels is because the Aussie banks joined in later and had some catching up to do.
So it seems the outlook for the Aussie housing market is even worse than we thought…and we thought it was pretty bad. Even a higher home-buyers bribe in New South Wales won’t stop the slow collapse of house prices.
But, that’s not the worst of it. There’s an even bigger problem, which could send hundreds of thousands of Aussie retirees to the poorhouse…
Avoid the Housing Trap
As you get older, you’ll probably realise you don’t really need a three or four bedroom house, with three lounge rooms, a big kitchen and two, three or four toilets.
The kids have moved out, and you just don’t need the space. So what do you do? You sell the house, unlock the equity and then buy something smaller.
Trouble is the relationship between house prices and house sizes isn’t linear. By that we mean a four bedroom house isn’t twice the price of a two bedroom house in the same area.
And a two-bedroom unit isn’t twice the price of a one-bedroom unit.
In other words, when it comes to downsizing you may end up paying more on a per-square-metre basis. But still, at least you get to pocket the cash difference.
But not everyone wants to move. And besides, when you take into account the cost of selling, moving and buying a new place, it soon eats into a big chunk of the proceeds anyway.
That’s why a popular choice for retirees has been reverse mortgages.
In short, a reverse mortgage lets you take out a loan using your mortgage-free home as collateral.
The idea is you can stay in your home after retirement, while still unlocking the equity. You can typically ‘withdraw’ 15-40% of the value of your home. For example, if your home is valued at $400,000 you could borrow up to $160,000.
Sounds fine, right?
Except for one problem: the power of compounding…
How Compounding Works Against You
Compounding is great when you’re saving money. You earn interest on your savings and when you receive the interest you earn interest on the interest.
But when you’re borrowing money with no plans to pay back the loan or the interest, then compounding works against you…and fast.
Let’s say you’re a 65-year-old male and you own a $400,000 house. According to the Association of Superannuation Funds of Australia, a single male needs $21,946 per year for a modest lifestyle.
So, you could take out a lump sum reverse mortgage of $22,000 and then receive monthly payments of $1,833. Again, that sounds fine. But here’s the bad news…
Because compounding works against you, you’ll never receive the full $400,000 value of your home. In fact, if you’re after a modest lifestyle of $21,946 per year, the monthly repayments you receive will only last six years. Not great for a 65-year-old male who, on average, should live to 79.
And what if you outlive the average? According to the Smart Money website, 50% of men aged 60 today will live to 84. And 10% will live to 95.
That’s a whole lot of living left after offloading your home for what is in effect just a fraction of the market value.
So what’s the alternative?
Plan Now Before It’s Too Late
Obviously the best alternative is to plan well in advance, so you don’t have to mortgage yourself in retirement. If you can plan far enough in advance you should be lucky enough to stay in the family home and still have a comfortable lifestyle.
Another idea is to downsize without selling up.
That is, rent somewhere smaller while you rent out the family home to someone else. You won’t make a packet after deducting agent fees and maintenance costs, but you should at least cover the rent for your smaller place while still leaving some cash left over.
That means you won’t have to dip into your other savings so much. Plus you’ve still got the house to sell at a later date if you need to.
Your final option is to sell up, downsize and move to a cheaper suburb. That can be a tough decision if you’re used to living in a certain area. But it’s not so bad…how about getting out of the city and into a nice place in the country?
But, what about falling house prices? Won’t that have an impact on what will happen in retirement?
In a way, yes. That’s why it’s important that you don’t use property and your home as your sole means of funding retirement. On the other hand, remember that if one group of houses fall in price, others will likely fall too.
So while you may get less for the family home, odds are the smaller house you buy will be cheaper too.
The bottom line is, it’s never too late (or too early) to start planning for retirement. If you think it’s OK to blow all your savings because you can just sell your house in retirement and live off the proceeds, think again. It’s not that simple.
Planning for retirement takes more effort than that. It means working out now how much you need in growth assets, how much you need in income assets and how much you need in protection assets.
It’s a strategy we’ve laid out many times over the past year or so.
For a refresher on how to allocate your money so you won’t face a pauper’s retirement, click here…
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
If you’re already a subscriber to these publications, or want to follow his financial world view more closely, then we recommend you join Kris on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.