And, like lottery tickets, inheritances can all too easily be wasted.
In fact the Wall Street Journal found that of inherited money, 90% of it was gone by the third generation and 70% of it gone by the second generation. Many people who suddenly get this windfall are unprepared to handle it and can blow it all on fleeting products or rapidly depreciating assets. It’s too easy to forget that money is finite. And that money in itself isn’t enough but you need to use that money to create new income or revenue streams.
People with a sudden bounty of cash at their disposal are all too often easy prey for scams and dodgy investment schemes. It’s the equivalent of having a large target on your back.
One common option for people with new-found wealth is to buy a property for themselves to live in. Say, they get a $1 million inheritance and use this to buy out a larger home for themselves and their family. They’ve paid off the entire house and are debt free. This is a good use of the money, right? They’ve surely set themselves up for life and their children will have a home too. Surely a wonderful solution?
The answer is no. This is a trap that is easy to fall into. For although they may have paid off the house, it’s not generating any income other than its capital growth. This is likely to be offset by inflation, maintenance and other cost factors. One house slowly gaining in capital growth over decades with all the money tied up in it, is not a good revenues stream at all. And, in fact, by the third generation of this family, the inheritance (the house) may have gone and been sold.
Now imagine, this. If instead of taking the $1 million and pumping it all into a house, what if the lucky heirs split the money to purchase three houses in a solid capital growth area. They may put $300 K into each house and take out mortgages of, say, another $300K. Each house is paying off itself through rental income and also adding on capital growth. Ideally they’re making money each year from their investments and perhaps getting a tax deduction if they’ve purchased new houses. So they have a neutral or positive balance each year plus they are now getting three separate streams of capital growth that are tax free. You can see how these are far better assets to pass on to the family and future generations. The family can sell one or all of the houses at any point. But why would they? The solid streams of income coming in won’t abate provided they’ve chosen a well researched, growing area. They still have another $100K left over they could keep for their own deposit on a home or use for more property investment or reduce their current home mortgage.
Another very common scenario is where, instead of money, the beneficiaries are left a house or part of a house in the will. What’s the best way forward in this situation? Again, it comes down the person’s situation. But if they already have an outstanding mortgage then the best option would be to sell the inherited property (assuming there’s no debt on it) and pay off the mortgage on their current home. Their current home has no tax benefits so there’s point in keeping the debt going. They could then use the money remaining to invest in property as their cash flow has improved by no longer being slaves to a mortgage.
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Quite simply, there are very few investment types that allow people to have so many different bites of the cherry, different income streams off the one investment as well as getting tax benefits.
What’s key in all these examples is that the beneficiary of the inheritance has used it carefully and prudently, treating it as a starting point to generating more wealth rather than wealth in itself. We see the culture of waste all the time. There’s any number of stories about celebrities who go bankrupt because they live extravagantly and their spending outstrips their earnings.
This is why for anyone lucky enough to receive a financial windfall, property investment, in Australia especially, is always a fantastic option.