Inflation is a thief, a silent tax that erodes the value of our currency.
It had subtly changed the rules of money and had plundered wealth from many who uphold conventional beliefs such as saving money and being ‘debt-free’. As I write, I believe both concepts are non-existent. Let’s start with ‘saving’ money. Well, in actual fact, what most people are doing is amassing currencies, not real money like gold and silver. Real money has long lasting purchasing power unlike currencies, which tend to rot over time.
Also, essentially, a currency is a form of debt. For instance, if you own RM 1,000 today, what you own is our national currency where its value today is reliant on the creditworthiness of the Malaysian government. Here, the word ‘Credit’ also refers to debt. Therefore, what you have is not money but a debt backed by the financial strength of our nation. So, you own some debt and debt shall continue to be part of our daily lives.
In this article, I’ll share some light as to how wealthy people see inflation, adapt to the new rules of money and emerge victorious through savvy investing. They are as follow:
1. Savers are Losers?
So, are savers really losers?
It sounded harsh on people who cultivated the healthy habit of ‘saving money’.
Personally, I first heard of this quote from Robert Kiyosaki, a master in the topic of personal finance. From his materials, I don’t think his intention is to discredit anyone who has a habit of ‘saving money’. Rather, I believe he is against people who believe that they can literally save their way towards financial heaven. This is because it is not the most practical method of achieving financial freedom.
In Malaysia, our inflation rate is, on average, 1.86% a year for the past 10 years, which is close to 2% per annum.
So, here is what it means to us. Let’s say, we have RM 50,000 and we park them all in fixed deposit that yields 2% per year. Hence, 1 year later, the RM 50,000 in fixed deposit will grow to an amount of RM 51,000. However, before the rate of inflation in our nation is also 2% per year, essentially, your RM 51,000 after one year would have the same purchasing power as the RM 50,000 one year ago. In this case, you did not make a real gain in purchasing power from placing money or should I say, your currencies in fixed deposit.
2. Who Will Win in Today’s Economy?
So, if savers are losers, then, who shall be a winner in today’s economy?
I believe one of the winners lies in a person’s ability to build wealth using debt.
This includes savvy real estate investors. For instance, let’s say we start with the same RM 50,000 in capital. Instead of FD, we use it to buy an apartment for RM 300,000 in the subsale market. Here, let’s assume that we take a mortgage that amounts to RM 270,000, where its interest rate is 3% a year and its loan tenure is 35 years. Thus, its monthly instalment is RM 1,039 a month.
The RM 50,000 in capital is used to pay for the 10% downpayment (RM 30,000) and other related expenses (transaction costs and minor refurbishments).
Essentially, what it means is that we can borrow RM 270,000 (current value) for the purchase of our apartment today and then, repay the debt with ‘currencies’ that are worth lesser and lesser in future years to come.
Hence, if the mortgage rate is 3% a year, after 1 year later, if the inflation rate is 2%, the real cost, in purchasing power, of your mortgage is 1% a year (3% – 2%). It is almost free money to own an apartment.
3. Who Pays for Your Mortgage Interests?
Let’s move back to the RM 300,000 apartment as an example.
The mortgage instalment is RM 1,039 a month. From which, in the first 10 years of servicing the mortgage, RM 615 (59%) of it shall be interest costs to the bank while RM 424 (41%) of it shall be used to repay the loan’s principal.
And, we rent the apartment unit out for RM 1,000 a month.
Let’s say, we also incur a monthly expense of RM 200, consisting of both service fee and sinking fund. This means our beloved tenant will bear our interest cost of RM 615, pay for the monthly expenses of RM 200, and finally, will chip in RM 185 per month to help us settle our loan’s principal (known as amortisation). In this case, we just need to fork out RM 239 a month to repay the loan’s principal which is basically a type of ‘forced savings’ as it is still our property equity.
As the tenant pays for the full interest cost of our mortgage, basically, we’ll own the apartment literally ‘interest-free’. Isn’t that awesome?
4. Real Wealth in Real Estate
So, let’s say, we manage to keep our apartment tenanted for 10 years.
Our tenants had been paying for our interest costs for 10 years. Meanwhile, the outstanding principal of our mortgage will fall gradually over time and after the tenth year, the amount of mortgage outstanding will reach RM 219,121.
Let’s assume that the value of our apartment has increased at 2.0% per annum, which is the average inflation rate in Malaysia over the last 10 years. Hence, the market value of our apartment shall increase to RM 365,698.
Our property equity at Year 10 is RM 146,577. (RM 365,698 – RM 219,121). This works out to be a CAGR of 11.35% from RM 50,000 in initial capital in 10 years.
A CAGR of 11.35% on your capital sure beats the inflation rate of 2% a year and this is a method of how the rich gain their wealth in an inflationary economy.
5. Extra Perks for Real Estate Investors
Remember the RM 1,000 a month in rental income from our apartment?
Do you know that it is possible for this income to be tax-free?
If you deduct the RM 1,000 a month in rental income from deductible expenses such as mortgage interest costs, quit rent, assessment, service fee, sinking fund … etc, you could be in a rental loss position. If that is us, then, we don’t need to declare an income from our apartment as we will put in RM 0 in our income tax file and thus, paying zero taxes on the rental income received.
But, our banker, the one who lends us money to invest in our apartment, would love to extend us more ‘almost-free money’ to buy more investment properties as we make RM 1,000 a month in rental income.
Do not underestimate the power of RM 1,000 a month in rental income.
To them, based on a maximum debt-service ratio (DSR) of 60%, they can extend their mortgage lending to you by approximately RM 120,000 for each RM 1,000 a month in rental income. This lending is crucial for you to continue to build up your property portfolio over time.
Will You Emerge a Winner in an Inflationary Economy?
Here, I’ll leave with you some key takeaway points:
1. Currencies rot over time due to inflation, a form of silent tax.
2. Saving currency alone is a hard way to attain financial freedom.
3. Learn to use debt to invest to build real wealth.
4. Mortgage interest rates are the cheapest form of debt.
5. But, with that being said, have your tenants pay for the interest cost.
6. A 2% a year growth in property value can do magic to your property equity.
7. Don’t underestimate small rental income. It adds to your loan eligibility.