The Problem with Index Funds and Superannuation

Work has been tough for me, and when I talk to people about it (that is, complain and whine about it), they either tell me to just quit or to endure it because “that’s the way it is.”

I would love to quit and retire right now in my early thirties, but I don’t feel like I have enough passive income. Passive income is a great measure of how much freedom you have. When I was younger, I set myself a goal of producing $1000 per month in passive income (mainly from dividends from shares), and I achieved that about half a year ago.

When I was very young, I was investing in boring and ordinary low-cost index funds. I also in eating in a few direct shares here and there. If you read any personal finance blog nowadays (e.g. Mister Money Mustache), this is the advice they give you: invest in a wide range of low-cost index funds. Most of these people invest with Vanguard. Many mainstream personal finance bloggers also advise you to put your money into tax sheltered retirement accounts. As many of these people are American, the advice is to plow as much of your salary into 401(k) and IRA accounts. In Australia, we have retirement accounts as well. Everyone who works has what is called a superannuation fund (or super fund). Employers must by law put in 9% of an employee’s salary into this fund. Employees can then elect to salary sacrifice a portion of his salary into the super fund in order to save on tax as any income going into a super fund is taxed at 15% rather than whatever a person’s marginal income tax rate it (usually 30%).

So I have been following this advice. I have invested in low-cost index funds and I have plowed a lot of my salary into retirement accounts. However, about six months ago, when my passive income reached $1000 per month, I decided to change plans.

The problem is that most mainstream low-cost index funds do not pay much passive income. For example, the ETF issued by Vanguard Australia that invests in the US (Vanguard Total Stock Market ETF) has a very impressive management cost of 0.05% per annum (extremely low) but has a dividend indicated gross yield of 1.87% according to Bloomberg. Furthermore, superannuation funds lock up your money until you are around 65 (i.e. too long). It is clear then that if you are investing in low-cost index funds and plowing your salary into retirement accounts, your passive income will grow, but it will not grow much, and because passive income is the key to freedom, I needed to make a change.

It should be noted that superannuation laws are very strict in Australia. As far as I am concerned (and I am very happy to be corrected) it is virtually impossible for anyone to have access to his super until he is 65 (i.e. very old). In the US, intelligent bloggers have found loopholes that allow them to access their retirement accounts early (see these blog posts by the Mad Fientist: Roth IRA Horse Race and Retire Even Earlier). The only arrangement that comes even close in Australia is the “transition to retirement” plan where you can take out money from super to top up any existing income if you take it out as an income stream. However, you need to be around 55 to 60 to be eligible for this.

Salary sacrificing into superannuation is definitely helping me build wealth, but this wealth could only be accessed far into the future, which meant that I had to wait until I was really old before I can be rich. I was building up too much future wealth while sacrificing present freedom. I started to realize all this when circumstances at work became difficult. Basically I had been saving up hard for about seven years but only had a passive income of about $1000 per month. I realized that most of my money was locked up in super as well as low-yielding investments.

My plan now is to take a hit with taxes, pay more, but focus on investing in funds that pay double-digit (over 10%) yield. Once I get about $4000 per month in passive income, I plan to quit my job and focus on trying to find a way to make money online. I am tired of working for a manager.

Rewards Programs are Usually Not Worth It

Myer sent me a $20 card as I am part of its rewards program.

I went to Myer one day and noticed that just about everything there was over $20, so no matter what I buy, I’d have to spend my own money.

This made me realize that a company can easily give away $20 vouchers to customers and fund it by lifting the prices of everything in the store by $20.

This demonstrates why most rewards programs are not worth it. Even if you are getting a discount, that discount cannot come out of nowhere. It is normally funded for by higher prices. Even if you are getting a free product from points accrued over many months, you have really paid for that product when you overspent numerous times earlier in order to accrue those points.

Rewards programs can be useful for products that are unique that you would have bought anyway. For example, there is a cafe near my work I usually use. I like this cafe because it is one of few Melbourne CBD cafes that give you the option of using almond milk in its coffee. The cafe also has friendly staff. Because I would go to this cafe anyway, I figure it makes sense to use their rewards or loyalty program to get “free” coffee every once in a while.