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Written by Juanita Wrenn – Managing Director
Investing in shares is more accessible than ever before, with major changes in technology making it easier to invest, more affordable to invest and an abundant amount of information and research at your fingertips. Given the volatile nature of the direct shares, it is not advisable to invest directly with under $50,000. This is to ensure that an individual obtains adequate diversification over several different stocks and sectors – investing with smaller amounts of money severely hampers the ability to diversify and hence enhances risk (as only a couple of stocks are being relied upon to perform). Investing in managed funds is a great alternative to direct shares and particularly attractive for investors who would like to diversify across international, specialist and small caps. Of course this can all be done directly with shares, but the time and research it takes is prohibitive for many, not to mention the increased risk of investing into these sectors directly.
The most common grievance surrounding managed funds investing is the cost of ongoing management fees, regardless of how the fund performs. With any other industry you pay for a service, think lawyer, accountant, physiotherapist, and the managed fund industry is no different – you are effectively paying for the fund manager to control your monies on your behalf. This suits some individuals and not others. If you love owning a direct share portfolio, maybe you could consider diversifying into some international markets or some small-cap companies through managed funds, thereby increasing your diversification and spreading your risk.
Borrowing against your home is an aggressive strategy that some clients enter into, in order to increase their leverage into the share market. This is how it works:
Sam has a home worth about $700,000, with a mortgage of about $350,000.
Assuming Sam is able to obtain finance, he could borrow up to 80% of the value of his home in a Line of Credit. 80% of $700,000 is $560,000. Sam already has a mortgage of $350,000 so if he took maximum borrowings (without incurring Lenders Mortgage Insurance), he could take a further $210,000 to invest into the sharemarket. With current interest rates so low, we’ll assume a 3% interest rate on the borrowings. So around $525 per month to service a loan of $210,000. This $525 is tax-deductible and can also be prepaid before the end of the financial year to increase your tax deductions in the current year. This is a good strategy if you have a year where you incur capital gains or a year of higher income and you are looking to offset some of this tax.
If you are in the highest marginal tax bracket, after taking into consideration the tax deduction, the cost of holding the $210,000 portfolio will be approximately 1.5% per month. So if you can make more than 1.5% in the sharemarket, after accounting for fees, your portfolio is increasing.
Of course the more you have invested, the more you stand to gain and the more you could lose. If your $210,000 portfolio made 10% over the year, you have made $21,000 minus the cost of holding (about $3,000) so a profit of approx. $18,000 in this example. If you hadn’t borrowed the money and you were investing $250 (cost after accounting for tax deduction) per month into the sharemarket, by the end of the year you would have made $3,162, assuming a 10% return.
On the flip side, if the sharemarket had crashed and your adviser had not been able to talk you into holding your portfolio for the longer term, you would be in a world of pain with your borrowings, as you would now owe money with nothing to show for it.
Risk can often equal return, but you have to be prepared to hold strategies for the long term and to see your plan through. This is where the true value of your adviser comes into play.