The salary you need to earn to have it all
Turns out that we all want very similar things from life. We look at the salary needed to achieve the most common financial goals.
At some point we’ve all imagined what life would be like if we had an unlimited about money. For the vast majority of people that is not reality, and financial goals are all about opportunity cost and the trade-offs we make in our day-to-day lives. We have limited resources (salary), and many goals we want to achieve. We need to adjust expectations and prioritise goals that we want to achieve with the limited resources that we have.
What if that wasn’t the case and we didn’t have to choose? Here’s what you would need to earn to be able to have it all as a 30-year-old Australian that has existing expenses that meet the average Aussie monthly expenses of $4,312 per month (Move Bank).
It’s impossible to provide an accurate representation of costs and expenses for different locations, ages and circumstances. As such, the figures that I will use in this study are representative of the median experience. It also does not account for dual incomes.
With that out of the way, let’s get into the numbers.
1. A house-deposit or debt-reduction
The main financial goal across Gen-Z, Gen-Y and Gen-X is to own your own home for non-homeowners or to pay it off for homeowners (InfoChoice).
Let’s start with a deposit. The median house price in Australia is $1 million, requiring a $200,000 deposit to avoid Lender’s Mortgage Insurance (LMI). This $200,000 deposit is also not indicative of the full costs of purchasing a house and it will likely be closer to $250,000, with the frictional costs such as stamp duty, conveyancing fees and bank fees included.
To save a house deposit as a single person in three years, you would need a salary of $197,000. You would need a salary of $150,000 over four years. If you were to save for the national average of 5.6 years for a deposit, you would need an income of $120,000. I’ve calculated these salaries by adding the amount needed to be saved to the monthly expenses provided by Move Bank.
Then, the mortgage. To avoid mortgage stress, many financial professionals say that the mortgage repayments should be kept to under 30% of pre-tax income. The goal, however, is not just to afford the mortgage. It is paying off the mortgage early which involves paying over and above the mortgage repayments. A loan of $800,000 at 6.44% (indicative of Westpac’s variable interest rate at 13 November) would be a $2,319 fortnightly payment. A 10% topper would put this at $2,551.
This would require $7,326 a month, including the median household costs and the mortgage. To avoid mortgage stress, the mortgage amount should be less than 30% of your pre-tax salary. This would mean a salary of $221,086.
So for this goal, let’s assume a salary of $197,000 to save for a deposit, and then $221,086 for debt reduction towards the mortgage. The extra repayments save an estimated $260,660 of interest and 6 years 7 months off the loan, with all variables staying equal.
2. Retirement
ASFA’s retirement standards figures believe that the lump sum needed for a comfortable retirement for a single person is $595,000, alongside owning your own home. This figure would be much higher in retirement for a 30-year-old today due to inflation.
Assuming that you are on $221,086 at 30, the employer contributions will support this ‘comfortable’ retirement without much effort. In fact, it’ll likely provide double that balance.
In the below model, we have looked at a 30-year-old with a balance of $50,000 who retires at 65. 2.5% inflation and the 15% contributions and earnings tax (on a 7% p.a. rate of return) have been considered. The value in today’s dollars of the account at 65 would be $1.247 million.
At a 4% withdrawal rate, this would be around $50,000 a year without accommodation expenses as the house would be paid off by this point.
Figure: Portfolio Projection tool on Morningstar Investor projects retirement balance.
This goal requires no further additional contributions, so the $221,086 salary suffices. However, it would be remiss not to speak about the difference between the income before and after retirement. On a $221,086 salary, there is around a $49,000 surplus once expenses are taken into account. This surplus matches your whole income in retirement.
Your income will likely vary in retirement. It will differ from your pre-retirement salary for several reasons. The first is that there will be less incidentals that are associated with work. For example, transport to and from work and lunches that you may buy most days.
However, you will have free time in retirement that could mean increased leisure costs and travel costs. This will depend upon how you envision retirement and what it is achievable with your retirement savings. As retirement progresses you may need professional care. Like retirement in general, the duration and extent of care is difficult to predict.
Regardless of this variation, it will be a variation in your disposable income and ability to spend on the same activities if you are going from a $49,000 surplus to a $50,000 total income.
I’ve written before on the impact of asset allocation on your total return outcomes. Asset allocation decisions are at the core of my investment strategy. We will speak further down about the levers that investors can pull to maximise their outcomes. However, over long time horizons like retirement, a change in asset allocation can result in a much better outcome. For example, we can look at Australia’s largest superfund. The 10-year return (the longest time period available) for AustralianSuper’s High Growth option is 9.24% after fees and taxes. Achieving this return would result in a $2.744 million balance instead of a $1.24 million balance. This would result in a $109,000 income at a 4% withdrawal rate.
There is no guarantee that we will experience the same returns over the next few decades, but it is illustrative of the power of asset allocation.
3. Travel
Travel is a common goal for many of us. A NAB study revealed that travel is the most common goal for their respondents. One third of respondents want to save on average, $17,000 for travel.
There are some financial goals that have a certain end point – for example, $17,000 of savings may cover a finite number of holidays. It could be one large overseas holiday.
However, travel is often a recurring goal. Most people do not decide that they are going to go on one trip and call it a day.
For recurring goals think through how much you need for your travel goal and how often you need it. For this example, say that I want to have $15,000 a year to travel with my husband. If I want a longer or more costly break – say, to Europe for four weeks, I can use the same $15,000 from two years of savings for a single holiday.
Travel used to be very, very expensive relative to income levels. As commercial travel became scalable, it became cheaper and more accessible for the everyday person. However, it has reached a point where there are few additional efficiencies to take advantage of. Now, like everything, travel costs increase over time with 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. Therefore, it is important when considering a recurring goal that it is a moving target. You will need to account for inflation.
Almost $25,000-$30,000 could comfortably be contributed towards travelling each year above the average expenses and mortgage, without having to save for a passive income. The reason for this is my assumption that mortgage payments would only make 30% of income. By keeping those costs at that level it provides more for discretionary spending on activities like travel.
For those who are looking to start a passive income stream to fund travel, I’ve written on how to do this here.
Our resources are finite
An income of $221,086 puts you in the 97th percentile for income range. It is unlikely that you will reach this salary and is out of reach for the vast majority of Australians. The purpose of this article is not to instruct you to go out and earn $221,000. It is understanding that for many of us, there are opportunity costs that we must weigh up and prioritising of goals that must be done after we understand what is truly important to us and what makes us happy.
There are a few ways to maximise your outcomes and make the best of your circumstances.
The first, is properly defining your financial goals. Yes – it may be to have a house, to retire comfortable or to travel. You need to get more specific.
Our behavioural research team and Morningstar have done research into digging deeper for your goals. It will understand what you’re actually looking for.
Due to cognitive biases, people can be strangers to themselves and what you think may be a financial goal might not actually reflect your true motivation.
Research findings
When investors that took part in the study were asked outright to name their financial goals they tended to list common financial goals. For example, retirement or buying a house.
These are called ‘surface goals’. When investors were put through a framework to dig deeper for their goals – they ended up changing. The changes reflected their values like donating to causes that they believe in and maintaining relationships with family and friends. These are called ‘deeper goals’.
For example, a person’s original Surface Goal could be to buy a vacation home in Watsons Bay. Upon further review, this person’s Deeper Goal may be to spend dedicated quality time with their family, which they hope to achieve via the Watsons Bay vacation home. However, this same Deeper Goal can also be achieved by buying a much more ‘affordable’ house in Avoca.
This article runs through how to dig deeper for your goals.
Investing to harness your goals
There are only a few levers that investors can pull to change the outcomes of their financial goals:
1. Contributions – to contribute more, you need to earn more or spend less. There is a limit to how much you can manipulate this number. However, the amount of contributions can increase if the situation includes dual incomes.
2. Time – you’re able to delay the time until you reach your goal. Instead of taking three years for your deposit like in the first example, you could take five. You could take longer. Many investors may consider doing these goals sequentially. For example, saving first for a house, paying it off, then saving for retirement. This is perfectly fine if investors understand the opportunity cost of doing so, as less time to compound, especially if the money is invested, may impact all goals negatively. This is especially true in the case of a real asset like a house, where the value of the house may appreciate but you must sell to realise the gains. It does not do much good for individuals if they’re living in a fully paid off house that they love but have no retirement savings to live on.
3. Returns – apart from the retirement example, saving for your goals can be supercharged by the miracle of compounding and investing. Investing can help with getting to the goal that you need faster and allow you to achieve more within your circumstances. For example, if the return for your superannuation was 3.9% to match the average return of cash products in Australia since 1990, you would have $690,000 instead of $1.2 million.
What you do want to avoid is investing without centering it around a goal. The notion of wealth maximisation is investing to have the most money possible. Many investors either subconsciously or outwardly have this goal. The issue is that this strategy mostly leads to poorer outcomes. It is not the concept that is the problem. It is the behaviour that it encourages.
A logical extension of trying to have the most money possible is to chase returns. An investor trying to have the most money possible will constantly be searching for where the highest returns are and then moving money to that sector, asset class, product – whatever it is at the time.
Part of being a good investor is humility. Understanding what is achievable within your circumstances and prioritising your goals so you’re able to achieve the maximum outcome given the range of your levers – contributions, time and returns.
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