Tuesday, 5 September 2006

How much do I save?

Reading a post on Canadian Capitalist's blog about how much he saves started me thinking about how much I'm actually saving these days. Beyond a glib "as much as possible" it's actually not that easy to work out, as the use of gearing can complicate things.

It's easy enough to break down my standard home loan payments into a saving (principal repayments) and an expense (interest) component, and the same used to apply to my investment property loan. But nowadays we've switched the rental property loan to interest only, and the extra payments that used to help reduce the loan prinicpal (ie. were counted as "savings") are now being used to pay the interest (an "expense") on loans used for 100% geared investments in US shares (via a Portfolio Loan line of credit from St George) and an investment in the Macquarie Equinox Select Opportunities Trust (funded entirely by a loan from Macquarie Bank).

So, even though my income has hardly changed (a very slight increase in dividend income from the US shares and 1% interest income from the Equinox trust) more of my cash flow is now going into interest payments (an expense) than into reducing debt (savings). So it appears my savings rate has decreased, even though I'm not spending any more than before on consumption and household expenses.

Similarly, the bit of dividend income that is getting reinvested (via a DRP) is counted as "savings", but I don't think share purchases made using an increased margin loan balance can be counted as "savings", as this increase in assets is totally offset by an equivalent amount of increased debt (ie. there is no change in net worth when the purchase is made).

The dividends received add to my total income, and the interest on the margin loan is an expense, but using reasonably high levels of gearing the interest expenses generally exceed the dividend income - ie. negative gearing. While the main goals of using gearing are to increase the returns and diversification of my investment portfolio, it also has the effect of reducing my taxable income and replacing it with (hopefully) some long-term capital gains. But from a savings point of view it is simply converting one form of expense (taxes) into another (loan interest).

This is why the use of gearing makes any meaningful calculation of percentage of income being saved very difficult, and make it meaningless to compare the "savings rate" of investors using gearing with other investors that save without any gearing.

The best approximation I can come up with for FY 05/06 is:

Savings - 32%
Taxes - 9%
Mortgage Interest - 21%
Investment Interest - 21%
Other - 17%

nb. The tax figure is low as it is based on income tax assessed last FY as a proportion of my grossed up income, ie. before deductions such as superanuation (SGL and salary sacrifice) and margin loan interest. It also doesn't include any GST, fuel taxes etc.

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