What would you do?

[HC1811]

Hi

I want advice on how you would invest 500K I want it to generate an income rather than capital growth.

Can you give me an idea of what kind of return it would generate.

I am new to investing and want as many different opinions as possible!!

Thanks

 

[Mr._johngalt]

Hello HC1811! I will not tell you what to do, just what I am doing as my situation is not too different from yours.

A disclaimer: Most folks here do not and would not
follow my path.

I have a "ladder" consisting of MM accounts, CDs,
very safe bonds, bond funds and some "junk bonds".
Don't know the average return, but by category
the present yields are about as follows

MM accounts 3.25%
Short term CDs 2.75%
"Safe bonds" 5.00%
High yield bond funds 7%
"Junk" 7% to 8%

We have 50% of our net worth in real estate.

Hope this helps.

JG

 

[HC1811]

What is the % split of your investments?

 

[Mr._johngalt]

MM/short term CDs 15%
'Safe" bonds 30%
High yield bonds 30%
Junk/near junk 25%

JG

 

[HC1811]

Thanks JG

So is a realistic overall return about 6%?

I assume this is before tax?

My goal was to generate about 3K a month but this would need to achieve 7.2% after tax - can it be done?

Thanks

 

[brewer12345]

Depends. How long do you need the income stream to last and are you willing to invade principal? Does the income stream need to rise with inflation?

 

[WilliamG]

Following is link to Paul Merriman article. He recommends dividing into 4 equal parts of Short, GNMA, High Yield and Long for income oriented investors.

http://www.fundadvice.com/FEhtml/Misc/rising_rate_vs_bondfunds.html

 

[HC1811]

Thanks.

I am not worried about the capital growing.

50% of the income stream would need to keep pace with inflation though.

Basically - I have 500K cash

Mortgage on main home - 230K (1480 per month)

4 let properties with total mortgages of 260K (mortgage payments covered by tenants)

And I don't know what to do to generate an income.

I am unsure whether to clear the let properties which will generate about half of the income I need (1.5K a month in rent) and invest the remaining 240K.

Do I clear my main mortgage as well, which will take away the monthly mortgage and give me what I need - but then all the nearly all the money has gone.

Or should I invest the lot!

I need to get 3K a month if I keep the main mortgage or 1.5K without it and I can't work out the way to do it.

 

[brewer12345]

What are the rates on these mortgages? What currency are we talking about?

 

[HC1811]

I am in the UK £

Mortgage rate on main home is 3.99%

On the let properties is about 6%

 

[brewer12345]

Is the interest tax-deductible? What is your marginal tax rate? Sorry for all the questions, but it is hard to make suggestions without enough info.

 

[charlie]

Hi HC1811,

If you pay off the mortgage on your rent properties
you would have about 1/2 of your income requirement
that would rise with inflation.  Right?  That's cool!

3.99% rate on your home mortgage is a pretty good
deal, IMHO.  The fur flies on the forum when "pay off
the mortgage or invest"  questions come up.  Search
the files to get all the pro's and con's.

You need about 6% return on about $250k if you
decide to invest.  Right?  To achieve that you
would need to invest in a total return vehicle
instead of strictly bonds.

The rub, if I am reading between the lines correctly, is
that you are not too thrilled about equity investment.
Right?  OTOH,  long term bonds are a bit risky now
if interest rates go up ..... unless you hold bonds to
maturity.  

If it were me, I would hate to give up the 3.99%
mortgage as I don't think we will see rates that low
again in a loooong time.  I have a little river boat
gambler in me so assuming you can live off of the
rental income, I would invest in gov bonds with the
same maturity as your mortgage plus a MM account
that you could tap to make up the interest income
shortfall between your 6% need and about 4.5%
you can get with "safe" bonds.  The MM account
would also give you a cushion for unexpected
expenses.  

Another plan, a little more aggressive, would be to
invest in something like Wellesley Income which
is paying about 3.6% now.  The total long term
return should be near 6%, IMHO.  If you choose
this route, set up a MM account to hold 3 years of
mortgage payment and invest the distributions
into the MM.  Add to the MM account in years when
the total return is greater than 6%.

Keep in mind that if you decide to pay off the home
mortgage, you still need a cash cushion for
emergencies.

Cheers,

Charlie    

 

[peteyperson]

Thanks.

I am not worried about the capital growing.

50% of the income stream would need to keep pace with inflation though.

Basically - I have 500K cash

Mortgage on main home - 230K (1480 per month)

4 let properties with total mortgages of 260K (mortgage payments covered by tenants)

And I don't know what to do to generate an income.

I am unsure whether to clear the let properties which will generate about half of the income I need (1.5K a month in rent) and invest the remaining 240K.

Do I clear my main mortgage as well, which will take away the monthly mortgage and give me what I need  - but then all the nearly all the money has gone.

Or should I invest the lot!

I need to get 3K a month if I keep the main mortgage or 1.5K without it and I can't work out the way to do it.

The UK property market is overpriced. You should diversify your holdings. I would not put the money into the properties by paying of the mortgages but invest it elsewhere for diversification. If you wanted to reduce the risk levels, you would be better advised to sell two of the let properties and use the proceeds to own the other two free and clear. This would reduce the risk that the UK residential market drops affects all of these assets together and the rental stream they throw off. With no debt on the rentals you will have much more flexibility to reduce rents to maintain the occupancy level than your competitor landlords. This ensures you will not face losing a property if the mortgage exceeds rental income in a particularly bad recession.

Owning any asset class that has compounded at a 15% rate (12% real) for the past two decades is not smart. Returns cannot continue like this for the UK residential market. It is due a correction and a far lower future returns. Prices of apartment are completely out of reach of singletons and out of reach of most couples too. This cannot continue forever. So I would sell some, reduce your tax basis and diversfy.

Getting income will not be easy. UK, US and Euro markets are overpriced and yields average 2.5% across those markets. UK Small/Micro cap is 2.1-2.7% yields in the UK. Asia large yields are a little better, one could index that via Legal & General Pacific Index Fund (www.landg.co.uk/). I would diversify into timber (TimberWest.com, PlumCreek.com or Rayonier.com). Commercial real estate works differently to residential, I would put a little into that but make sure it is int'l not UK just in case residential/commercial UK tanks together. Energy stocks would add income. Natural Res. like Rio Tinto would too.

Petey
London, UK

 

[charlie]

Petey, I may be reading too much into HC1811's
posts, but I gather that he is happy being a
landlord and is not interested in diversification
strategies.  

IMHO, paying off the rental properties and living off
of the income is a no brainer.  As you suggest, he
has the flexibility to raise or lower rents as necessary
to meet competition without regard to a fixed
mortgage payment.  The current value of those
properties is not important ..... just the income they
produce.  One would assume in a depression that
his living expenses would be reduced along with his
rental income.  He always has the option of selling
a property if/when circumstances warrant.  

OTOH, his home mortgage amount is a fixed payment
which will not rise or fall with inflation.  I see no
downside in buying fixed rate government bonds
to offset his mortgage payment.  All he needs to do
is calculate the shortfall and put that amount in a
MM account to make up the difference.  Both his
interest income and mortgage expense are fixed
and independent of inflation.  

I don't know what mortgage rates are in the U.K. but
I suspect they are higher than 3.99%.  Perhaps his
lender would be willing to buy back the mortgage
at a discount rate higher than 3.99%.  If that is the
case, HC1811 could pay off the discounted mortgage
and have some cash reserve left over.

Cheers,

Charlie  

 

[Mr._johngalt]

Excellent post, Charlie!

JG