Overinvesting puts retirement at risk


A Goldilocks investment strategy means that you are making the most of your financial opportunities without overdoing it and taking unnecessary risk. That is, your level of investing is exactly right (i.e., perfectly balanced).

Underinvesting means that you risk not having enough investment assets to enjoy a comfortable retirement.

Overinvesting means that you have taken unacceptable risks which may compromise your ability to achieve a comfortable retirement.

The goal is to achieve a perfect balance – invest enough to ensure you will meet your lifestyle goals – but not too much that you put your lifestyle goals at risk.

Overinvesting can do a lot of harm

I recall working with a mortgage broking client (not financial planning) for several years prior to 2008. The client purchased 6 investment-grade properties over a relatively short period. After the sixth acquisition, I advised the client to not purchase anymore properties, as I felt taking on more debt would be too risky. The client ignored my advice and purchased two more investment properties – which I only found out about after the fact!

Unfortunately, the GFC hit Australian shores in 2008/2009 and the RBA cash rate climbed to 7.25% which put pressure on the client’s cash flow. Worse still, credit rules and policies were rightfully tightened which locked this client out of their ability to refinance. The client had no choice other than to sell all but two of their properties in the years following 2010 because they wanted to retire.

This client’s story is a perfect cautionary tale. Debt is a wonderful servant, but a terrible master. Borrowing to invest can be a very powerful and beneficial strategy but it must be used carefully. You must never borrow more than you can afford and should consider your ability to service repayments when interest rates rise. For example, what if you are forced to eventually repay principal and interest. Or due to borrowing capacity, you can’t refinance e.g., you are trapped at your current lender. You must consider these risks.  

Underinvesting comes with great opportunity cost

Arguably, underinvesting is just as bad as overinvesting. Underinvesting means that you risk not accumulating sufficient investment assets to achieve your lifestyle goals i.e., funding a comfortable retirement.

I wrote a blog earlier this year (here) setting out the three common reasons that tend to cause people to underinvest. It’s worth reading if you suspect that you have underinvested.

Invest enough to achieve your goals

If you are already going to achieve your goals with the investments that you currently own, why invest more? Investing always carries some risk, so why exposure yourself to greater risk if it’s not going to have a positive impact on your life?

Some people will argue that it’s prudent to ensure that your money’s working hard for you.

Other people are driven to continue to invest so that can leave more money to their beneficiaries.

I don’t think there’s a right or wrong answer to the question of; how much is enough? It really depends on your circumstances and risk tolerance.

However, it is worth considering a few things. Firstly, whether it’s necessary to invest more to achieve your goals. If not, are there any other reasons to invest more e.g., to provide more for beneficiaries.   

How much debt is too much?

Typically, the most common way people overinvest is by borrowing too much (e.g., the client story that I shared above). There are several factors to determine the right level of borrowings for your circumstances and goals.

Of course, the obvious consideration is ensuring that you can afford the loan repayments considering any expected changes to your income, and also after factoring in higher interest rates. To do this you must review your annual cash flow i.e., income minus living expenses, loan repayments, tax and any other commitments such as school fees. 

In addition, it is important to formulate a debt repayment strategy. It is usually important to reduce debt before you retire because you can no longer rely on any personal exertion income (e.g., salary). If your sole income source is from investments, then your cash flow can become even more sensitive to changes in interest rates, so it’s important to minimise this risk by actively reducing debt. I discuss this in this video (from 5:30 minute mark), which illustrates a typical investor lifecycle.

The government body that regulates the banks (APRA) considers borrowing more than 6 times your gross income as risky. Whilst there’s always exceptions to all rules of thumb, it is a good guide to consider. Generally, I would consider borrowings more than between 6 to 8 times gross income to be quite high risk, be it really depends on many factors.

The more borrowings you have, the more important it is to have a well-considered debt management and repayment strategy.

How to unwind an overinvestment position?

It can be costly, timely and sometimes painful to correct a situation where an investor has over invested as it requires the sale of assets (property) and potentially a reinvestment of equity in ungeared investments such as shares. If you are in this situation, it’s very important that you seek independent financial and taxation advice, sooner rather than later?

Please be careful

There’s always an endless supply of good investment opportunities. And many people will try to convince you to invest, especially if they have something to gain if you follow their recommendation (e.g., a commission-based salesperson). But realise that you must live with the consequences of investing, not them.

And just because the bank will lend you more money certainly does not mean you should borrow it, or that its safe and prudent to do so.

Often a slow, steady and considered approach towards investing, whilst, at the same time avoiding procrastination, yields the best outcomes in the long run. If in doubt, pay for professional and independent advice.