It has been hard not to hear about the tax cut we recently received – widely known as the Stage 3 tax cut.

NAB surveyed Australians about what they were going to do with the extra cash, varying between $350 and $4,500 extra annually depending on income levels. The data shows that there’s a sizeable segment of Australians that are using the funds to help meet increased costs given higher cost of living (29%). It also shows that 36% plan on saving the extra funds.

When you dive a little bit deeper into the cohort saving, it reveals the goals of this saving.

  • Travel: One third of respondents are saving for travel and a rainy day fund, with an average savings goal of $17,000.
  • Home: One in four are saving for the lofty goal of owning a home.
  • Retirement: One in five have their sights set on a comfortable retirement.

Travel was the most common goal across all respondents. Another study from moomoo surveyed over 1,200 participants and found that Australian millennials are prioritising travel over almost every other goal, with 48% listing leisure as their top financial goal. This is not surprising. Have you ever met anyone who does not believe that they find travel enriching? Especially considering we have come out of a period of exceptional circumstances where we weren’t able to leave the house let alone the state or country– travel is front of mind for many of us.

This episode of Investing Compass explores the how to create a portfolio that generates passive income for travel - or any goal that requires regular income. 

Read the full article here.

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The full transcript of the podcast can be found below:

Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature, does not take into consideration your personal situation, circumstances, or needs.

Shani Jayamanne: You're going on a trip, Mark.

LaMonica: I am going on a trip. In, what is today?

Jayamanne: Today's Tuesday.

LaMonica: Oh, geez. This week is going very slow, but I'm going on Friday.

Jayamanne: Yeah, so where are you going?

LaMonica: I'm going, well, you know where I'm going. I'm going to the U.S.

Jayamanne: You're going to see your Mum?

LaMonica: I am. So I'm going to start in Boston and then go to Nashville, see my mother, and see an Alabama football game.

Jayamanne: Love it.

LaMonica: Which I'm excited about.

Jayamanne: Roll tide.

LaMonica: Roll tide. And then I'm going to New Orleans. And then me and what's left of my liver will get back on the plane to come back to Australia.

Jayamanne: Well, that sounds like a great trip, Mark.

LaMonica: It is. It is.

Jayamanne: What are you most excited for?

LaMonica: Well, my mother listens to this. So if I don't say I'm most excited about Nashville, she'll get upset. I'm excited for spending two weeks not translating U.S. dollars back into Aussie dollars.

Jayamanne: Well, I thought you would say I'm most excited to get back and continue to write articles for the wonderful people that read them on Morningstar.com.au.

LaMonica: First of all, I work when I'm away on trips. So I don't know about that. But anyway, it will be exciting to come back and see you two.

Jayamanne: Okay.

LaMonica: And this is kind of relevant. This fact that I'm going on a trip to the podcast today. So why don't you start talking about what we're going to talk about?

Jayamanne: Okay. Well, we're going to talk about goals. And we talk about goals a lot in this podcast. And that's because we're strong proponents of goals based investing.

LaMonica: And that's really basing your investment goals around you. Of course, with you at the center instead of just seeking to maximize your wealth.

Jayamanne: And there are a number of reasons for this, mainly tied to increasing the success of building wealth and achieve your financial goals. But that's not what this podcast is about.

LaMonica: And this podcast is about helping you reach one of the most common financial goals that people have. And you can probably guess what it is by our little preamble. But it's not retirement. And even though probably 50% of our backlog is about retirement, we're going to take a break from that.

Jayamanne: So it's about travel. And we know that's a very common goal for a lot of us. It is a financial goal for both of us. But we also know it's a common goal because there's been a couple of surveys done.

LaMonica: And you love survey, Shani. And so the first one is from NAB. And it was around the stage three tax cuts. Remember, we all got a tax cut and then didn't notice because everything's so expensive. But that stage three tax cut that came out earlier this year. And NAB surveyed Aussies about what they were going to do with the extra cash. And so that varies between $350 for some taxpayers to $4,500 extra annually. The data shows that there's a sizable segment of Australians that are using the funds to help meet increased costs given the higher costs of living. So that's 29%. It also shows that 36% plan on saving the extra funds.

Jayamanne: Okay, so let's dive a little bit deeper into this cohort that's saving. It reveals the goals of this saving. And one third of respondents are saving for travel and an emergency fund, with the goal being around $17,000. And one in four are saving for a home and one in five are saving for retirement.

LaMonica: So more people want to save for travel than a home or a retirement.

Jayamanne: There you go.

LaMonica: Is basically what we're saying. So travel was the most common goal across all respondents. And another study from Moomoo. And that is actually a real company. So Moomoo is a broker. I don't know why it's called Moomoo. Any thoughts, Shani?

Jayamanne: No thoughts.

LaMonica: No thoughts. But this survey from or this study from Moomoo surveyed 1,200 participants and found that Australian millennials are prioritizing travel over almost every other goal with 48% of them listing leisure as their top financial goal.

Jayamanne: And to me, at least, this isn't surprising. I think I've only met one person before that says they don't like traveling. And travel is front of mind for many of us after being locked at home and not being able to do it for a very long time.

LaMonica: Who is this one person, Shani?

Jayamanne: Well, I can't call them out on the podcast, can I?

LaMonica: I mean, you could. Do they listen?

Jayamanne: Probably not. But let's not put it out into the ether.

LaMonica: Okay, so I've embarrassed Shani there. But anyway, besides Shani's one person, I think we can certainly say it is common with a lot of Australian cities. But every winter, at least in Sydney, the city seems to empty and everyone goes to Europe, including you, Shani.

Jayamanne: Yeah, it's like an annual migration.

LaMonica: Annual. Okay, only if your leave is approved, though.

Jayamanne: That's fair enough. It was a very long time to leave you in the lurch. You did very well by yourself. But we do have this travel debt that we need to catch up on. And it's reflected through these surveys that Aussies plan to spend the extra cash on repaying this travel debt.

LaMonica: So when we consider these situations, what we're really talking about is individuals that are saving for their holidays from their wages, building up those savings and then, of course, spending them, in Shani's case, spending them on drinks in Italy.

Jayamanne: That's true. That is what I spent it on. But we're going to explore an alternative and that is the travel fund. So there are a few thoughts to consider around structuring a travel fund.

LaMonica: And the first is simply that travel is not a finite goal. There are some financial goals that have a certain endpoint. For example, in the NAB study, we can see that $17,000, and that's the goal that people wanted to save for, may cover a finite number of holidays, and usually it's just one. However, this is often a recurring goal. Most people do not decide that they're going to go on one trip and call it a day.

Jayamanne: For recurring goals, it's understanding how much you need for your travel goal and how often you need it. For example, if I want to have a $15,000 a year, if I want to have $15,000 a year to travel with my husband, if I want longer or I want a more costly break, say to Europe for four weeks, I can use the same $15,000 allocated over two years for the one holiday.

LaMonica: The other factor to consider is that travel costs continue to increase. Travel used to be very, very expensive. And as commercial travel becomes scalable, it's becoming cheaper and more accessible for the everyday person. However, it has reached a point where there are no more efficiencies to take advantage of. Now, like everything, travel costs increase over time with inflation and sometimes more than inflation. Your goal might be to have recurring yearly travel over the next 20 years. That original $15,000 is not going to have the same purchasing power in 10 years, let alone 20 years. So it's important when considering a recurring goal that's a moving target. You'll need to account for inflation.

Jayamanne: For example, if inflation is 2.5%, that $15,000 becomes $15,375 in the second year and $15,759 in the next. The other factor to consider is hybrid approaches. Not many of us will ever have the opportunity to create a large pot of money that can sit there and throw off this income, enough to comfortably fund a couple of luxurious trips overseas a year. What if 50% of the holiday was funded for? Or what if 10% was? When going through this exercise, you'll be able to determine what is feasible for you and your goals.

LaMonica: Part of this is realizing that there is an opportunity cost to saving for the future means you are not spending it on holidays now. This is an opportunity cost that Shani and I are both trying to balance.

Jayamanne: And I spend most of my time surrounded by messaging that stresses the importance of getting started early and the magic of compounding. And I definitely write about it and speak about it myself. It's easy for financial commentators and advisors to tell you that the money is better sitting in the share market where it compounds rather than spending it. And in theory, this is of course true. Warren Buffett used compounding potential to decide the value of goods and services. And famously, he had the $300,000 haircut. A haircut might cost $30, but he was stressing the opportunity cost of not investing the money and having it grow to $300,000 in the future. When it comes to travel and leisure, you can save to have more luxurious or longer experiences when you're older.

My perspective is that your tastes, preferences and inclinations change over time. As Mark spoke about earlier, I was recently on holiday and I went to beach clubs in Capri. I climbed mountains at 30 degree inclines in Lake Garda and I watched my husband and my friends go cliff diving in Milos and I'm not going to do that at any age. I swam a fair distance into old pirate caves. These are experiences that I would be able to afford 10 times over if I invested the money instead and let it compound. But would I have the ability or the proclivity to do it at a later age?

LaMonica: Well, that was a lot about your vacation.

Jayamanne: Yeah.

LaMonica: Pirate caves.

Jayamanne: Pirate caves, they were great. If anyone's in Milos and it seems like a lot of people are because all I heard was Australian accents. The pirate caves are amazing.

LaMonica: Did you see any actual pirates?

Jayamanne: No, they're long gone.

LaMonica: That's too bad. If you want to see pirates, you can go to Disney World for that, I believe. Different type of vacation. The point is of Shani's long diatribe about her vacation is that there's no blanket solution to juggling instant gratification and savings. I've always been a saver. Spending a large chunk of money is never pleasant until you feel enriched by the experience. So it's of course a cliche to say you only live once, but taken too far and you risk financial instability.

Jayamanne: So my approach is splitting my goal in two. So one, that is for short-term savings and holidays. The other, that is for longer-term travel funding. In my case, I've chosen to delay reaping the dividends from my travel fund and have less extravagant or frequent holidays in the short-term.

LaMonica: Okay, so let's go back to working out how much you would need to have a passive portfolio to fund travel. Theoretically, this approach looks to use the income while preserving the capital. If invested, the capital can continue to grow, although it's important to note that most published returns include the reinvestment of income. And the income is an important component of returns. If you're spending the income, you will see less growth. The growing pot of money can still help you achieve other financial goals. This may be important to you as part of your legacy in estate planning. However, you can also draw down on this capital as part of your strategy because at some point, you're not going to be as mobile or travel inclined.

Jayamanne: So let's move on to the nitty-gritty. How do you know how much you need for your travel goal? And the first step to that is understanding the income that you're going to generate.

LaMonica: Okay, so this will, of course, change, but there are several main asset classes that generate passive income. So there is property. And of course, with a property, you are renting it out to somebody who's paying you that rent. So the gross yield has been sitting between 4% and 5% since 2010, according to SQM research. There is fixed income and cash. And of course, you get interest for that. So over the last 10 years, it's averaged around 3% to 4%, according to MoneySmart. And then of course, there's shares and managed funds or ETFs. And then you get dividends and distributions. So the average is around 3% to 5% over the last 10 years with a franking rebate for those Aussie shares of between 1% and 2%, according to the ATO. It's important to note that these are gross figures and different asset classes do have fees, their transaction costs, their maintenance costs, and there are of course taxes. When you receive income, tax needs to be paid on it. So just keep this in mind when assessing your total return.

Jayamanne: You don't need to prescribe to one church and can diversify across these asset classes. The general rule is that the more secure the income stream, the lower the return. One of the main characteristics that is vital to an income investing strategy is sustainability of that income stream.

LaMonica: Okay, so let's keep this simple and invest in shares and managed funds and ETFs. For this example, we can use the Vanguard High Yield Index Managed Fund. The five-year distribution is 5.45%. To simplify this example, I'll take a conservative franking rebate of 1%, bringing the income to 6.45%.

Jayamanne: We've used a managed fund, meaning there's no brokerage costs to consider, like with shares and ETFs. So any maintenance costs such as with house repairs with property.

LaMonica: And then we have to think about Shani's favorite topic, which is tax. I don't think it's paying tax. It's just talking about tax, right?

Jayamanne: Thanks for making me sound very interesting.

LaMonica: We just had you in a pirate cave. So I think maybe you were thinking about tax in there. I have no idea. Someone on a median salary of $100,000, the effective tax rate is around 23%. You can work this out using websites such as Shani's favorite, paycalculator.com.au. And basically, this is tax paid divided by gross salary times 100. That equals your effective tax rate.

Jayamanne: So this brings the net return to approximately 4.96%.

LaMonica: And the maths are pretty simple from there. What is the capital base needed to generate $15,000 with a 4.96% return?

Jayamanne: So divide $15,000 by 4.96%. And the answer is approximately $302,419. Or precisely, $302,419. And that is a large capital base. To get to this amount, it requires present sacrifice. So let's say that I focus purely on building my capital base and reinvest dividends.

LaMonica: And there are a few pathways to get to this goal. The levers that investors can pull are time. So how long until you want to start generating this income? And additional contributions. Increasing one of these will reduce the other. So you could reach this goal in seven years with $3,000 of contributions a month between two people. You could reach this goal in four and a half years or $5,000 of contributions a month between two people.

Jayamanne: Alternatively, you could just adjust your goal. Say, as we mentioned at the beginning of this example, that you were happy to receive 50% of your income payment from your fund. You could adjust your goal down to reach it quicker and supplement your travel fund.

LaMonica: One important part of this is that you need the income to grow. And that is because the goal that we set is looking at the cost of goods and services, staying static for the next 20 years. And unfortunately, this is not going to be the case. So we need to account for that inflation in this exercise. Again, there are a few ways to approach this. The low maintenance option is understanding that your travel fund is finite and drawing down the capital can make up for this shortfall. Those same numbers that Shani went through before. So $15,000 in the first year, drawing down $15,375 and the next and $15,759 after that. So just increasing the cost. And this works if there are no intentions for legacies or other goals attached to the capital base when travel becomes less feasible. So examples of that could be using it for specialist healthcare or housing in your retirement when you're no longer mobile and can travel.

Jayamanne: The second option is to contribute to your capital base. And the last option is to invest in assets where income is tied to inflation. So this could be income from property or rent can be adjusted for inflation or investing in shares that grow their dividends.

LaMonica: And I've written an article in shares that grow their dividends. One I was actually updating today, Shani. But you can also find a podcast version of this, which is our dividend aristocrats episode. So go and have a listen to that if you're interested in finding shares with a track record of income growth.

Jayamanne: Ultimately, investments are just vehicles that help us to reach our financial goals. Although we've gone through an example goal that focuses on travel, all we're really doing is creating a source of passive income. Passive income offers flexibility. It gives its recipient the freedom of independence to make decisions that align with how they want to spend their time.

LaMonica: The income that comes from this fund is earmarked for travel, but at the end of the day can also help in cases of job loss, large costs such as home renos, or unexpected medical costs. It offers a more comfortable life and peace of mind for the person who it's intended for. And this is something that all of us desire. So thank you very much for listening to Shani's travel hour on the Investing Compass podcast.

Jayamanne: And if you could please send emails to Mark just to encourage him to approve my next lot of leave, that would be great.

LaMonica: Maybe people will miss you and they want to hear you on here.

Jayamanne: Maybe.

LaMonica: We will see. But anyway, that email address is in the show notes. Thank you for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)