The importance of yield

Financial planning Written by , Dec 12 2015

A 3.50% return on $1m only generates $35,000 per year of gross income.  Back out a bit of underlying inflation and tax and you’ll end up with about $15,000.  That’s not nearly enough to make you feel like a millionaire. If you live in Auckland, you might end up with $1m of equity in your home, but that's equity in a home and not of much use unless you move out of town. I'm more interested in what you save - so your investible assets. That raises an interesting question.  With the average mortgage in Auckland now heading over $500,000 realistically how much will homeowners save alongside paying the mortgage off?  Saving 5% of a $100,000 income into Kiwi Saver will get you to $500,000 in 40 years (inflation-adjusted and after tax). Paying off debt and saving at the same time and continuing to spend to support the economy is a thankless task! We now live in a low interest rate world.  The bad news for savers and retirees is it wont get any easier. There is simply too much debt in the world and we cannot continue to fund economic growth with more debt and printed money. Structurally things are not going to change unless we have some sort of major market correction. My view is that inflation wont rescue yields anytime soon.  Our debt-fuelled growth is being offset by technology led deflation.  Technology is displacing labour and will keep wage inflation low.  With Artificial Intelligence firmly on the horizon we will see human labour displaced at a scale not seen since the industrial revolution. Living off $25,000 of interest per year is probably not going to be sufficient.  So lets treat the $1,000,000 as an annuity and assume it is fully returned over a 25-year period. At a 3.50% gross interest rate it will create a payment of $3,500 per month in today’s money over 25 years.  I've adjusted for inflation at 2.00%.  If invested at 8.00% then the $1m generates $4,950 per month in today’s money.  That's an increase of $1,450 per month over 25 years, or a total of $435,000.  It’s a big difference based purely on the difference in yields. Put simply, the compound impact of changing the yield has a big impact on cash flow over extended periods of time. .

What's the relevance with Squirrel Money?

Firstly our loan investments behave like an annuity releasing principal and interest over the term.  Investors get consistent regular repayments which is great  for income. Second, we are currently generating yields in excess of 8.00% for 5 year terms. It could be that you hold the cash portion of your investments in Squirrel Money and the rest in other asset classes like shares and property. $270,000 invested in 5 year loans at 8.00% will return P&I repayment of $5,500 per month pre-tax. One of the benefits of investing in loans is knowing your return upfront with more certainty.  We protect investors with Loan Shield our reserve fund.  By setting aside reserves to cover missed borrower payments the risks from investing in loans are significantly reduced. We do not provide financial advice and the above example is illustrative.  For any financial advice around your portfolio you should talk to a Financial Planner or Authorised Financial Advisor.

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