Some people work hard all their lives. They live within their means and pay of their house. They move to a bigger house, and pay if off again (and perhaps a few more times). Next, they sell the house and downsize or rent. In this scenario they used to be house rich and cash poor. Now they are cash rich and house poor. What to do? Today a Case Study: €800.000 in cash.
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OMG, we are rich!
Today I like to introduce to you Rich and Rochelle (not their real names, go figure). Both are 65 years of age and retired from their day jobs. They used the current housing market madness in the Netherlands and sold their primary home. At the end of the day they are left with €800.000 in cash. They asked me what they could consider doing with that cash. Here is my assessment and some ideas to play with for R&R.
What do we need the know about R&R? Here is a breakdown of the essentials we need to take into consideration:
- They both have a pension/old age security, which covers their basic expenses (and a bit more, but not much);
- They sold their primary residence and are moving into an rental apartment. The money from the sale will be hitting their bank accounts shortly;
- R&R want €50.000 in cash available at all times (i.e. in a savings account);
- R&R would like to invest their remaining funds and use the excess to support their 3 kids and give themselves some extra spending money for fun stuff;
- They want to rent for at least the next 2 years, but want the ability to buy a small property (max €400.000) if the right situation presents itself; and,
- They are open to discuss various investment strategies, but are conservative in their approach (i.e. low to medium risk) and prefer cash-flow over capital gains (i.e. they want to focus on capital preservation, rather than growth).
R&R have done well in their lives, but like most folks they always focussed on paying down the house, taking little to no “risk” with their hard earned money. That is why they were house rich and cash poor for most of their lives. Now this situation has reversed, but their psychology has not. They are not suddenly ready to “gamble” with their newly found wealth. They do recognize that putting everything in the bank is not a smart move, for more reasons than one. But they are keen on preserving their “new found” wealth for their inheritance to their kids. They would like to have more money in retirement (for the fun stuff) and support their kids where possible.
Furthermore, the way (a part of) their money is invested has to be somewhat liquid. This as they want to be able to buy a property if it comes across their path. This provides some limitations to the investment strategy. Albeit not one that needs to be a big challenge considering the amount (~€400.000) that needs to be readily available.
An ideal world
In an ideal world, R&R’s wealth should increase with time. That means that their wealth needs to grow at a rate similar or higher than inflation + wealth tax + some money for them to actually spend. How much is that?
A couple with a wealth of €800.000 will be required to pay €700.000 *0,04501*0,31 = €9.767,17 in 2021 in wealth tax (the first €100.000 is tax exempt). Or effectively 1,22% on the total €800.000 net worth/wealth. Inflation was about 1.28% for the year of 2020.
In short, you need to make more than 2,5% to get ahead in the world, at least financially speaking. Realistically, R&R need to make about 4,0% per year on €750.000. This would give themselves an extra €10.000 per year to spend/donate to their kids, whilst being able to pay tax and stay ahead of inflation.
Let’s evaluate a few options as to how their €800.000 can be divided into various “investments” that might work for their situation. Remember that combinations can also be made to tailor available investment options and risk spread! Also, in order to make the 4% return on investment as noted above, one will automatically need to accept some (moderate to high) risk. With the current low interest rate environment, R&R might actually need to take on more risk than they might like, just to be able to achieve the desired returns.
Really low risk Option
The first option that comes to mind is to put all money into savings accounts. Actually, this is the first thing you need to do once you received the money from the house sale anyway. Funds in savings accounts are generally less affected by problems with stolen/skimmed debit cards/account passwords/online fraud and similar events.
Once the money is safely transferred into savings accounts, one can start to look at other options. The second low risk option it to put a part of the money in fixed term deposits (Dutch: Deposito’s). Obviously, where the money in the savings accounts readily available. The money in fix term deposits is only available once the term lapses.
These (really) low risk investments don’t make you a great return. I’ve done some digging around at the various banks. This is what I found in terms of (negative) saving rates for savings accounts without any restrictions.
Based on the table above one should check out the NIBC Direct to “store” their money for the short term. This is one way to at least avoid paying negative interest in the short term. There are obviously more banks, so there might be even better options!
But take note, R&R are only (automatically) insured for €100.000 per accountholder per bank by the “depositogarantiestelsel” of the Dutch Central bank. That means that in times of crisis, one might lose a lot of money. There is however a 3 month grace period where an additional €500.000 is covered if one keep funds in the bank to buy a house, or just sold their house. Good to know!
Fixed term deposits give you a bit higher interest rates (see example below of Raisin). Based on this site, the rates will vary from 0,1% to 1,4%, depending on institution, duration and amount.
Anyhow, in most cases R&R won’t be able to pay for their wealth tax with the gains they get in these accounts. In all situations they will effectively lose money, it really just depends on the account they have how much they would be losing. That being said, R&R should put a large portion of that €50.000 emergency fund they wish to have, into a savings account. But what to do with the rest?
Low risk Option
Okay, let’s kick it up a notch. Bonds, government bonds to be specific. To make life easier (and simpler for R&R) we will look at bond ETF’s. This will give R&R slightly more risk, more volatility, but generally more return on investment than a savings account. Buying an ETF rather than a few individual bonds does also give R&R more of a risk spread, obviously. Yields range roughly from around 1-3% (not taking into account government bonds from less “stable” countries).
An example for those in the Netherlands would be the Euro country bond ETF from Meesman (~3% return over the 3 years and ~4% over the last 10). But there are also options from Vanquard, Ishares (see some example in the paragraph below) and others to choose from. Returns vary by year and by ETF setup/content. On the commonly used investment risk scale from 1-7, these generally range between 2 and 3.
R&R could also consider corporate bonds (or mixed corporate – government bonds). These can be higher in both risk and returns, but they don’t have to be (subject to credit ratings of the various companies/governments)! Digging around in the selection of the various ETF providers, R&R should be able to find ones they like/fit their preferences. Yes, it does take time for them to do their homework and find out what suits their needs!
To get started, R&R could check out these to wrap their heads around some low cost bond ETF options:
- Vanguard EURO Corporate Bond UCITS ETF (ticker: LECPTREU)
- Vanguard EURO Eurozone Government Bond UCITS ETF (ticker: LEATTREU)
- iShares Core Euro Corporate Bond UCITS ETF (ticker: IEAC)
- iShares Core Euro Government Bond UCITS ETF (ticker: IEGA)
Moderate risk Option
In this category one will thus find investment options around the “category 4” risks. R&R can thus consider higher risk bond ETFs (both corporate and/or government) to increase their return on investment. Such investments could give them returns around the 3-5% mark, but will be more volatile (and have more downward potential).
Other options that R&R could consider in this category is to provide family mortgages to their kids or other people that they know. The idea is that R&R provide them with a ~2,5-4% mortgage and secure it on their property (one would get a notary public to register a mortgage on that property). This might be one of the only ways to secure a house in the current crazy housing market, which is great for their kids (or their friends). At the same time, R&R get cash-flow on a monthly basis with a moderate risk.
Why is this a moderate risk you ask? One is depended on the local housing market for their Loan-to-Value (LTV) ratio. Their money is only secured against one property, and only one or two people with an income. If all goes well, you have no problem. But if things go wrong, they tend to go sideways fairly quick and R&R could lose a substantial amount of money (forced sell, with negative equity. Owners would be indebted to them, risk of not seeing a portion of their money ever again) or their cash-flow dries up. Neither is what you want to have happen.
Other options in this category are various (sustainable) loans for solar projects (3-5% return), lower risk crowdfunding projects (think real estate with low LTV = <70%). There are obviously many more options, but realistically they cannot all be listed.
High(er) risk Option
Now, as discussed, this option is not applicable for R&R as it focusses on stock market and/or real estate investing. But for the completeness of this assessment, I wanted to add these options nonetheless.
The easiest way to invest into the stock market is obviously opening a trading account at a brokerage (see banner below) or bank. Buy well diversified index funds/ ETF’s (e.g. Vanguard FTSE All-World UCITS ETF (VWRL)) and hold indefinitely. Enjoy the dividends, the capital gains (if all goes well) and collect roughly 7-10% per year (before inflation).
Besides the ETF’s/Indexfunds one can also invest into individual stocks. Higher risk, higher rewards (potentially that is). But again, this takes skill and homework. It’s not for everyone.
One can also directly or indirectly invest into real estate. Directly investing entail to buy a property (with financing or without) and rent it out. Finding the right property can be difficult in todays market, finding tenants is easy thou! Finding the right tenants can cost a bit more money/time/effort. Gross rental income currently is around 4-7% for most properties. Net income depend on many variables, but is likely in the 2-5% range (unleveraged!). Leveraged returns are likely in the 6-9% range, but can be higher depending on interest rates, gross rental income, operating costs and loan to value ratios. Any capital gains are the cherries on the pie.
Indirectly real estate investing can be done in a multitude of ways:
- REIT ETF’s
- Mortgages and loans (directly or via intermediary)
- Participations (see banner below)
Returns of indirect real estate investing are often lower (roughly 3-6%) due to various management fees involved, but depending on the investment type risk might be lower too. It all depends on what is done and how it’s done. Never bet on one horse though!
In addition to the stock market and real estate, you could also consider crowdfunding/crowdlending, cryptocurrency (see banner below), private lending, options trading, etc, etc,. But one really needs to do their research before getting started, make sure to diversify and manage risk. No risk, no return! Not guts, no glory! But if one gambles, ones (generally) loses. The house always wins 😉
Discussion & Conclusion
So what are R&R to do? There are a thousand ways to Rome. But considering their preferences, this is one way to go:
- €2.500 cash on regular checking account
- €47.500 in savings account (no fixed term – 0,15% interest)
- €350.000 in low risk bond ETF’s (to maintain option to quickly liquidate for home purchase – assumed 2,5% average return)
- €400.000 in moderate risk investments (assumed 4% average return), such as higher risk bonds, property mortgages/loans.
Based on this divide, they would make €24.821 in total returns (3,1% effective return on €800.000). They need to pay about €9.767 in taxes. They lose about €10.200 in purchasing poser due to inflation (i.e. this money needs to be reinvested). Leaving them with €4.854 to play with (after inflation “correction”). This is not what they wanted, but considering their preferences/risk tolerance, it’s likely the best they can do.
In reality, considering their age, they might want to consider not to reinvest the “inflation correction” but use this money instead for themselves or their kids. They have enough as it is (cash and retirement income), anything the kids will inherit is a bonus anyways. At some point you need to also focus on yourself and not only on money/saving/investing. Life is a balance, which one should enjoy!
Personally I would take on a bit more risk with the funds, primarily because of the potential upside on capital and because of the existing pension and old age security benefits R&R already have. This is what I would do (taking into account their preferences, but with higher risk):
- €2.500 cash on regular checking account
- €22.500 in savings account (no fixed term – 0.15% interest)
- €750.000 in moderate to high risk investments (assumed 5% average return) – likely unleveraged real estate to rent out / property loans. Something that can be (partially) liquidated or leveraged in a short time frame in order to quickly generate the cash to purchase a primary residence.
Based on this divide, R&R would make €37.534 in total returns (4.7% effective return on €800.000). R&R still need to pay about €9.767 in taxes. They still lose about €10.200 in purchasing poser due to inflation (i.e. this money should be reinvested in this scenario). But it would leaving them with €17.567 to have fun with.
What would you do with €800.000 in cash?