aussielent – I Live Off Dividends

Is Salary Sacrificing into Super Worth It?

Because I live in Australia, there are some financial ideas that are unique to Australians e.g. franking credits, negative gearing, and superannuation.

Firstly, what is superannuation? Superannuation (or super) is a retirement fund similar to the US’s 401k. When your employer pays you, they are required by law to put 9.5% of your salary into your super. This super is locked up until you are old (about 60 to 70).

Why salary sacrifice into super? Compared to many other countries, income tax is high in Australia. Any amount you earn over $37k has a 32.5% income tax rate applied to it. If you earn over $90k then any amount over $90k attracts a 37% income tax rate. However, suppose you earned $100k per year and you arranged with your employer to salary sacrifice $10k into your super fund, then this means that rather than paying $3700 tax on that $10k and receiving $6300 in your bank account, you instead have that $10k go into your super fund and where it is taxed at only 15% i.e. you pay $1500 tax. This means you save $2200 per year assuming you salary sacrifice $10k per year.

If the tax benefits are so good, why not salary sacrifice everything into super? The answer is that there is a limit. The amount your employer puts in (9.5%) and the amount you salary sacrifice cannot exceed $25k per year. Take the example of someone who earns $100k. This figure does not include super. The employer is paying $9500 (9.5% of $100k) per year into superannuation by law. However, if the worker wants to top this up by salary sacrificing, they should simply find the difference between $25k and the compulsory contribution amount ($9500) and then salary sacrifice this amount. In this case, the person earning $100k should salary sacrifice $15500 per year to fully take advantage of the tax benefits. If you get paid every fortnight, simply divide this by 26 and therefore salary sacrifice $596 per fortnight. In my opinion, you should always salary sacrifice a little bit below the limit because your salary will likely increase bit by bit over time. If the amount you salary sacrifice is exactly $25k then the next salary increase (e.g. due to inflation correction) can tip you over the $25k mark, which leads to punitive taxes applied to you. Therefore, I recommend aiming for $23k or $24k just to be safe.

Using the example of earning $100k per year, if you are salary sacrificing $10k per year you’d save $2200 per year. If you salary sacrifice to the max then you’d be making $3410 per year.

Assuming you save $3410 per year over 30 year, then assuming 8% per annum returns, you’d have $250k.

What are the downsides of salary sacrificing into super?

Even though there are tax benefits, the main disadvantage of salary sacrificing into your super fund is that you do not get access to this money until you are around 60 to 70. However, there are hardship provisions in superannuation that allows you to access your super under severe financial hardship. Given that I am a long-term investor, I normally buy and hold investments forever. I will only ever sell if there is severe financial hardship. Therefore, keeping money in super doesn’t make much difference. For most people who do not salary sacrifice into super, their main reason is that they need to pay the mortgage, but they are simply building up savings in their house, and because houses have high transaction costs, chances are they will only sell the house under severe financial hardship as well.

One common argument people use against superannuation is that the “rules can change.” That is, while your money is locked up in superannuation, the government could change the rules and e.g. increase taxes on it. However, this is not a good argument. The risk of government changing rules or legislation apply to all investments. For example, if you do not salary sacrifice and invest in property and shares outside of super, the upcoming proposed changes to negative gearing, capital gains tax and franking credits will affect you. Unless you invest in offshore accounts or cryptocurrency, you are at risk of “rules changing,” and even if you invest in, say, offshore accounts, then offshore jurisdictions are subject to changes in legislation, and cryptocurrency protocols can change, leading to “hard forks.” You can never escape the risk of legislative or protocol amendment. The only way to mitigate this risk is to diversify.

The key downside of salary sacrificing into super is that you do not get passive income, which impacts on your ability to be finacnially independent. If you salary sacrifice $10k into super, that $10k does not produce dividends that go into your bank account for spending. It simply accrues in the super fund and accumulates until you are, say, 60. This means that if you seek to be financially independent quickly or retire very early, salary sacrificing into super can be a problem. However, there are workarounds.

The four percent rule

The four percent rule states that when you retire you spend 4% per year. Suppose you retire with $1 million in net worth. You simply spend $40k per year. Now suppose you had $500k in super and $500k outside super. One strategy is to continue to use the 4% rule but to retire at a time such that you can use the 4% rule and then time it so that you run out of your $500k outside of super just before you have access to superannuation.

Coast FI or Barista FI

Another option is called “coast FI” or “barista FI” which are terms used among the online FIRE community (financial indepence retire early). Basically you can salary sacrifice to the max early in your career such that you have, say, $200k in super by age 30. Assuming 8% per annum growth, then this $200k in super will become $2 million by age 60 assuming no extra contributions. Therefore, through aggressive early savings, your 60s are covered. Having $2 million when you are 60 is more than enough. However, because you have locked up a considerable amount of money into super, you may live a lower standard of living up until you are 60.

One solution to this suggested by the FIRE community is “coast FI” which sadly has nothing to do with the Gold Coast. Rather, you coast to your 60s by taking it easy and doing easy jobs (e.g. a barista, although based on what I have seen being a barista is quite difficult). However, in my opinion, this is not a good strategy because even easy work is still work, and there is no guarantee that you will be able to find easy work in the upcoming age of automation. The whole point of financial independence is to enable you to live without a job so that you can pursue whatever you are passionate about.

Although there are problems with barista FI, the insight that barista FI brings up is that you don’t need to retire early. Once you live off dividends, rather than retire and stop working, you can keep working but simply don’t work as hard. You don’t need to work as a barista, but you can work the current job you work but simply work in a more relaxed manner. This may mean you spend more time at work chatting to coworkers or it may mean you work part-time and take more holidays. A more mainstream term for this is “semi-retirement.” Another option is to change jobs and do something you are passionate about e.g. you may build online social enterprises that help the world.

The solution to the superannuation dilemma

Superannuation presents many Australians with a complicated dilemma. Either you salary sacrifice and increase your wealth thanks to tax benefits but lock your money up unitl you are very old, or you do not salary sacrifice, reduce your wealth, but reach financial independence faster.

In my opinion, you should salary sacrifice to the max early in your career. However, to accelerate your chances of becoming financially independent as fast as possible, live as minimalist a life as possible (e.g. living with roommates or with parents, riding bikes or taking public transport, never having children, etc) and then with your money outside of super apply the Peter Thornhill approach by investing all your money into high dividend paying Australian equity ETFs and LICs (e.g. VHY, IHD, RARI, EINC, RINC, BKI, AFI, and ARG). Because Australian equities are blessed with high dividend yield and franking credits, this coupled with a highly minimalist lifestyle will allow you to quickly achieve financial independence. To use some example numbers, the cost of a sharehouse found via Gumtree or Facebook is about $700 per month. The cost of meal replacement drink Aussielent (which I use as the basis for the cost of food) is $256 per month. Then if you get a bike then you can cover all necessities for $1000 per month or $12,000 per year. Assuming dividend yield of 7% then this means you need to save up $170k. Adding income tax and offsetting it with franking credits, this means you’ll only need to save up about $200k in high dividend ETFs or LICs to be able to be financially independent. After you have $200k, you can start to diversify your portfolio away from Australian equity to reduce risk (e.g. into bonds and international equities). Then over time, as your dividend income increases, you can slowly increase your living standards, e.g. live by yourself rather than with housemates or parents. You can eat tastier food rather than Aussielent, etc. However, for the sake of financial indpendence, your living expenses should not exceed your passive income because you must minimise the amount of time you are dependent on your job.

Because you salary sacrifice into super, there is a good chance a large chunk of your net worth will be in illiquid assets, so your living standards will be low up until you are 60 and then suddenly after 60 you will have a very high standard of living.

Retirement (or semi-retirement) in Southeast Asia

If you salary sacrifice into super, you will have a considerable amount of money in your 60s or 70s, but before you are old, you will likely live a minimalist lifestyle assuming you live off dividends. A way to increase your standard of living is to retire early in Southeast Asia where the cost of living is lower. Before I spoke about how $1000 per month is enough to live a very minimalist lifestyle in Australia, but in many Southeast Asian cities e.g. Chiang Mai, Ubud or Sihanoukville, $1000 per month can afford a more comfortable standard of living. You can retire early and then come back to Australia in your 60s to collect your superannuation and then retire in Australia. Because Southeast Asia is a bit “rougher” than Australia, younger people in their forties or fifties can tolerate it better, so if you end up retiring early in your forties or fifties living off dividends, you can go to Southeast Asia for retirement and then come back to Australia to cash out your super. One of the benefits of living in Australia is its socialist healthcare system (Medicare) that provides free medical care for all. This is particularly useful for older people. That being said, if you reach the age of 60 or 70 with net worth of $2 million, that sort of money can buy good healthcare even in e.g. Thailand. Cities such as Bangkok have international-standard private hospitals that many people from all over the world travel to for medical treatment.

Disclosure: I currently own IHD.

How Much Passive Income Do You Need?

Most people I speak to, when they want to measure someone’s wealth, measure wealth by referring to how many houses they have. For example, “John owns 14 houses. He is rich.” However, someone may own 14 houses, but each house may only be worth $200k, which gives total assets of $2.8 million. However, what if he also had $2.7 million worth of debt? His net worth would be $100k whereas someone who owns one house worth $1 million that is fully paid off would be 10 times wealthier even though he owns 14 times fewer houses. This example clearly demonstrates how misleading a count of houses is. A more sensible approach is to calculate net worth.

However, net worth can be misleading as well. For example, suppose you inherited a house from your parents that was worth $500k and you live in this house. Suppose suddenly this house went up in value to $1 million. Are you better off? Your net worth has increased by $500k, but because the extra wealth is within the house, you cannot unlock it unless you sell the house. If you sell the house, you’d still need a place to live, so you’d buy another place. The problem is that if you buy another place, that home will have risen in value as well, so the net effect is that you have paid taxes, real estate agent fees, conveyancing fees, etc but there is no difference in your living standards. You are worse off. If you downsize and buy a cheaper place, you’d be able to unlock your extra wealth, but then your living standards drop (e.g. extra commute time).

This point highlights that net worth, although better than a count of houses, has its flaws. An alternative metric, in my opinion, is passive income. Passive income (e.g. from dividend income but also from rent, interest, etc) is income you receive by not working. Passive income should subtract any debt as debt is negative passive income. Debt is the opposite of passive income because you must work to pay off debt. This applies if you hold debt as a liability. If you hold debt as an asset (e.g. you own bonds) then this is passive income. The bonds generate interest for you that you can live off without any work.

Passive income is more useful because it directly measures your standard of living. If your net worth goes up by $500k, that may have zero impact on your standard of living. However, if your passive income goes up by e.g. $1000 per month, that is actual cash in your hands. It directly impacts how much you spend and directly impacts your standard of living.

So how much passive income is enough? It all depends on the person. Everyone is different. It also depends on the city you live in. Some cities are expensive while others are cheap.

However, using Melbourne, Australia for this example, in my opinion, to cover the basic necessities of life, passive income of about A$2000 per month (US$1500 per month) at a minimum is needed, in my opinion.

Currently I work, and I do like my job at the moment, but loving my job is a recent experience. For a long time I have hated my job mainly because I have had bad managers. Something I have learned is that things change all the time at work, so you need to have an exit plan at all times. Too many people get a job, expect they will always love the job and always make good money, so they go into debt to get a mortage, have children, inflate their lifestyle, etc and then suddenly they find they hate their job, but by then they are trapped. I made this realization early on in my career because, when I started working, I went through a restructure in the organisation. I learned quickly how risky it was to have debt and obligations, and I realised the value of structuring your life so that you have the ability to walk away from anything, not just your job but from any person or any organisation. There is great power in being able to disappear at the drop of a hat, and this is achieved with passive income coupled with minimum or no obligation (including financial obligation i.e. debt).

Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.

~ Neil McCauley

Even if there were a restructure at work or a tyrannical manager took over and started legally abusing staff, with passive income of $2000 per month, it is easy to stop work and live an urban hermit lifestyle e.g. renting a one-bedroom unit on the outskirts of the city (e.g. this place in Frankston), living off Aussielent, and surfing the internet all day. The only costs are rent ($1000 per month), Aussielent ($320 per month), wifi ($50 per month), electricity ($100 per month), and water ($100 per month), which comes to a total of $1570 per month. I round that up to $2k per month just to give a little buffer. Nevertheless, this is quite a spartan minimalist lifestyle. Doubling it makes $4k per month passive income, which I feel is enough to really enjoy a comfortable and luxurious lifestyle e.g. travelling, living in the city, eating out, etc. Nevertheless, $2000 to $4000 per month in passive income is a good range to aim for.

Advice to Millennials: Don’t Buy a House

Where I live in Australia, most people are obsessive about property investment. There is an assumption that you must buy a house otherwise you will fail financially. As a millennial who doesn’t own a home, people always ask me when I will plan to buy a house or whether I have made any progress in saving up for a deposit on a house. People are either pressuring me to buy a house or to get married.

My response is that I will never ever buy a house. There is simply no need to buy a house when there are investments available that are far better. For example, BetaShares (a brilliant organization, in my opinion) has recently issued the BetaShares Global Banks ETF. This ETF tracks an index that invests in big multinational too-big-to-fail banks. The top 10 holdings are disclosed on the BetaShares website and is reproduced below:

Investing money in large too-big-to-fail banks, in my opinion, is a wise strategy. For years now, Australians have only had access to Australian banks on the ASX via ETFs such as QFN and MVB. Banks are an excellent investment because typically they pay very high dividends.

The more dividend income you have, the more freedom you have in your life. Dividend income is true passive income because you don’t have to do anything to earn it. Even if you own property and rent it out, you must still find tenants, fix broken showers, and unless you own the property outright you have to slave away at work in order to meet monthly mortgage repayments. Then you pay outrageous taxes such as stamp duty, and every year you must pay bills and council rates, as well as land tax. If you own the BetaShares global bank ETF, you pay virtually nothing other than a minuscule 0.47% management fee. You can literally sit back, relax, do nothing, and watch the dividends enter your bank account.

When you own property, you typically need to borrow money from a bank. If you’re borrowing money from a bank, you’re not generating dividends. Rather, you’re paying for someone else’s dividend income. If you borrow money from a bank, you make the bank rich, which effectively means you’re making bank shareholders rich.

What happens if there is a GFC 2 and bank shares collapse?

This is a fair argument. One could make a strong argument that the financial system is more precarious now than ever. However, even if we are nearing a massive recession (which I suspect we are), I don’t think that is a reason to not invest in bank stocks (or stocks in general) because we don’t know when the bubble will pop, and bubbles can perpetuate for decades or centuries.

When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.

~George Soros

Furthermore, if you own a property and the global economy collapses, how will owning a house help you? Property prices can go down just like stock prices can go down.

One of the benefits of owning bank stocks is that, even if these banks fail, many of them are too big to fail. They are so integrated into the economy that in the event of an economic crisis they can hold society as hostage and demand ransom (or bailout money) from the government. The government will typically give money to these banks, either from existing funds or from simply by printing new money to hand to the banks. Once banks receive bailout money, they can use it to repair their balance sheet, and stock prices should go back up again.

Below is a passage from the Financial Systems Inquiry report in Australia:

Global history records governments of all political persuasions using taxpayer funds to support distressed institutions. As undesirable as it may be to put taxpayer funds at risk to support financial institutions, in the midst of a crisis it is often the fastest and most certain option to stabilise the system and avoid widespread economic damage.

Investors can rationally surmise that the government is likely to rescue systemically important institutions if no other options exist, as their collapse would cause the most damage to the financial system and broader economy. This leads to a belief that some institutions are too-big-to-fail — that they receive an implicit government guarantee.

http://fsi.gov.au/publications/interim-report/05-stability/too-big-to-fail/

In a world characterized by wage slavery, big banks are basically the apparatuses of wage slavery. Whips and chains have been replaced with mortgages and credit cards, and banks are the institutions responsible for distributing these instruments of oppression to the masses in order to enslave them.

If the big banks are in trouble, the entire system of wage slavery is under threat, and for this reason I don’t think the government will allow the banks to collapse. They might make one bank fail just to make an example of them (e.g. Bear Stearns) but if you buy a broad-based index fund, you’ll be investing in the entire banking sector, so it’s not a problem.

How can you live without a house?

Of course you need to live somewhere. Shelter is a necessity. However, shelter is not expensive. I currently live with my parents and pay some of their bills. Other people can easily lower costs by sharing a house with others. They can rent (or even buy) a place and then rent out spare rooms. I recommend buying or renting a place far away from the city in order to get the cheapest price or rent possible and then simply use public transport to travel into the city if you need to work.

Living with others can be problematic because it can be difficult to get along with other people, but there are easy ways to fix this problem. Try to find people who are kind and who will not cause drama. Also try not to interact with people you live with too much. Personally I am always out of the house, either at work or at the local library. If I am at home I usually stay in my room. I have food cooked for me, but even if there is no food, I have a large supply of Australian Soylent (Aussielent Body) that I can drink should I need to eat. This ensures I never have to bother with cooking or cleaning, and arguments over who should clean the dishes are common when people share accommodation.

Personally, with food technology so advanced nowadays, cooking and cleaning are quaint, archaic and useless activities that must be eliminated from your life. People are always trying to tempt me into a life of slavery by telling me that I must get married because I need a woman to cook for me, but Soylent has now made the housewife’s cooking skills completely redundant.

Conclusion

You don’t have to buy a house. Live with your parents or find good housemates, and then keep interactions with them minimal to prevent drama.

Drug dealers have a saying: “Don’t get high off your own supply.” In other words, drugs dealers make money off their customers’ drug addiction, but if a drug dealer were to consume his own product, it will be to his detriment because the strength of his business depends on the weakness of his customers. The same applies to banking. Everyone in society is addicted to debt. The “drug dealers” who supply this debt to the masses are banks, and anyone smart enough can become a drug dealer by buying bank stocks or bank ETFs, but as a drug dealer you should not “get high off your own supply,” that is, you should be very cautious about going into debt.

The goal of my life is to produce passive income mainly from dividends. This ensures I can obtain income without working, which gives me freedom. I am not dependent on anyone. Even though I live with my mother, I rarely speak to her as I’m out of the house all the time, and even if she wants me out of the house, I can easily rent a small one-bedroom apartment paid for with dividend income. Most people move out of their parents’ home, buy a house, and drown in mortgage debt, which makes them slaves to their managers. Because I live off dividends, I am not dependent on my work. I don’t need a job. If I get fired or even if I dislike my work, I can simply find a different job that I enjoy or I may even fly off to Chiang Mai where US$1000 per month ensures you live like a king, and in Chiang Mai I can spend all my time in coworking spaces where I can work on whatever I want that I am passionate about regardless of whether it makes money or not since I don’t need income to live since I live off dividends. None of this would be possible if I had a massive mortgage over my head that forced me every month to pay a large chunk of my income to the bank so that other people can collect their dividend payments. I’d rather be on the receiving end of a dividend payment.

Typically when someone has a large mortgage over their head, they have more than a mortgage. A house has associated costs such as electricity and gas bills as well as taxes, and people who are desperate to buy a house in order to keep up with the Joneses are usually trying to show off in other ways as well, so they will likely have expensive furniture, massive kitchens, refrigerators, huge couches, and expensive TVs. People always put me down for being a minimalist. Some do it with more subtlety than others, but people always try to put me down for not owning a house or having expensive furniture or having a trophy wife or multiple children in elite private schools. I am usually very honest nowadays. I tell them I am trying to have more freedom in my life so I can do what I want, and I tell them I am trying to build up dividend income. This usually comes as a complete surprise to most people because most people have been conditioned by society to buy things and to go into debt. All the money they earn is eaten up either by debt or by lifestyle expenses whereas all the salary income I earn is invested. My savings rate is 100 percent, and I subsist off dividends of approx $30k per year. I do not live a hand-to-mouth existence. I am not fed with money obtained from my own labor. I am fed with money obtained by other people’s labor. My hands don’t feed me. Other people’s hands feed me.

Living off dividends and escaping slavery is not about showing off, in my opinion. I have no need to show off to people because I am quite detached from people. As such, other people’s opinions don’t matter because I am not close to them. Most people must care about what others think because they’re forced to be around them due to circumstances, and if they’re stuck with these people, they need to get along with them, which means these other people must have a good opinion of you.

But I don’t need to be around anyone. I am not dependent on anyone for anything. I am completely independent. I am not afraid of bullies. Bullies can bully me, but because I live off dividends, I can use dividend income to block them from my life. I don’t need to suck up to anyone because, unlike salary income, dividend income doesn’t impose upon you an obligation to keep someone happy. I am no one’s slave.

But from my position of freedom, I am a witness to all the manipulation, deceit, propaganda, slavery, and oppression in this world, and I personally cannot be willfully ignorant of it. I cannot close my eyes and pretend that atrocity does not exist in this world.

Doing something about it is the difference I can make. I can spread the word and help vulnerable beings escape from oppression. That is my purpose in life: to be free myself and to help others be free as well.

Can we change the world? No, but hell, we can all try.

~Rupert Murdoch

There is nothing in life more important than freedom. Even if you don’t want freedom, being free will give you the freedom to not be free. Better to be free and have the choice of being a slave or not rather than be a slave and have no freedom to be free.