Author Topic: Investing in index funds, on margin, in Australia - (i.e. negative gearing)  (Read 5568 times)

misterhorsey

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Hi all

Just wondering if anyone had any thoughts or experience with buying index funds on margin?

In an ideal world I would own my own PPR and use the equity on that to buy index funds.  But I don't (due to relationship changes, moving interstate, the priciness of property and other factors).

I've also thought it would have been great to have ploughed into the market post GFC and scooped up broad based indexes, and waited for the recovery. But I appreciate that this is something that only becomes obvious in hindsight, as during big falls no-one knows when it will recover.

Currently I'm not timing at all. I'm ploughing all my savings in to a Vanguard Life Strategy Fund. Its great. But it also means I don't really have any cash to snap up bargains.  Again, i'm generally committed to dollar cost averaging so happy to keep it this way for now.

However, I've known that the chinese market seems a bit irrational for a while. I've sensed there may be a correction, but this has not dissauded me from my regular strategy as I have no faith I'd be right. But seeing the Chinese market starting to stumble is provoking me once again to try and get my head around buying on margin if there is a dramatic fall.

I've used this helpful calculator / cynical marketing tool, to calculate a possible scenario. 

https://www.commsec.com.au/mleofy?icid=124248:commsec:cm:public:Public_Home:B1:text:MarginLending:EOFY_ACQ

(Note: I think its pretty outrageous that they set the default expected growth and returns to 5% each.  There is a disclaimer but they are definitely trying to max out the return to try and drum up business.)

I've input some numbers as an example, and used:
$160k equity
$0 cash contribution
$100k loan
(giving a LVR of 40%)
and assuming growth of 3% and income of 3%

The calculator tells me that the non-geared strategy will outperform the geared strategy by about $600.  This is a fantasy calculator of course and assumes that you will get the growth/income you have entered consistently across a year.

Now the appealing thing about this is that the interest expense is $7,178.08, which then becomes deducted against your income for the year reducing your taxable income.

Australia seems to have so many distortions in the tax system that punish the non-PPR owning PAYG earner, that this seems the only legitimate, investment aligned, non superannuation related, tax minimisation strategy available to us non-PPR owning chumps!

Of course, the downside is the increased risk resulting in falls to the index funds, “The market can stay irrational longer than you can stay solvent." etc etc.

But with a long term investment horizon, and a conservative gearing ratio, what could go wrong.........?

I'm in no rush to implement this idea.  I've been toying with it over the past few years so not going to lose my head.  But very curious to hear what other Australian mustachians might have to say about it.

I do appreciate that there are quite a few threads about the dangers of margin lending into the market.  I do plan to read some, but if anyone can point me in the direction of a particularly good one that would be appreciated too.

I think what may may give this strategy an advantage in Australia (compared to the same strategy in the US example) is the fact that interest on an investment loan is tax deductable against your personal income.  If so many crazed property speculators can chase tax deductions on over priced off the plan investment properties, wouldn't it make sense to gear (to a conservative level) into indexes, which  may be volatile, but over the long term seems to provide consistent gains?

Feel free to deliver some face punches as well if you think there deserved. Cheers!



Coffee_Snob

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I thought about this topic myself. Ended up running some numbers on it and decided that it is a goer to gear ETFs at around 50%

You need to have the CF to fund the interest payment, but it seems like a good opportunity to take up some tax shields

See this article for reference / maths: http://90million.blogspot.com.au/2015/06/negatively-gearing-stock-market.html

povertystrickenbastard

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In on this.  I like that I can use my margin loan to 'invest' my paycheck each week by making payments on the loan.  Then when I have enough collateral I can buy another parcel of an ETF.  ie/ 1.5K available you can buy a 5K parcel, 3K you can buy a 10K parcel etc.  VAS or STW the dividends are ~7% when you include the franking credits and you can get fixed rates from as low as 4.7% (westpac)

povertystrickenbastard

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See this article for reference / maths: http://90million.blogspot.com.au/2015/06/negatively-gearing-stock-market.html

Interesting article but he used a crap example to neuter the ETF.  'I did not factor in franking credits'.  WTF?  That's like saying you do not factor in a 3rd of your rental income!  Also why would the margin loan holder be 'paying off' the loan?  He would be paying 'in' to the loan so as to make more regular purchases and dollar cost average, growing the portfolio and number of shares and growing the dividend stream.  A margin loan is not a mortgage, why would you ever want to pay it off?

bigchrisb

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I've used margin extensively since 2007. That article is pretty flawed, the main ones being:
Ignoring franking credits. This boosts annual returns by about 2%.
Interest rate. My margin loan (4.15%) is lower than my mortgage (4.19%).
Transaction costs have been ignored. These are much higher for property.
Liquidity. It's easy to reinvest $1000 in more shares. Not so with property.
Black Swan events. Vacancy, repairs, damage etc. Over a 10 year period a high probability of something happening with property that should be provisioned for.

In short, I believe he has a heavy bias to property in his assumptions.

There are some wins for property in non cash deductions which is accounted for. The stress and timing of margin calls is also not accounted for (a negative for shares).

deborah

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Some time ago, someone put a link to an ASX paper on returns over the last 10 years - I think it was this one

 http://www.asx.com.au/documents/resources/russell-asx-long-term-investing-report-2015.pdf

Towards the end, it looks at returns with and without gearing. My take was that it is just not worth it to gear, the actual advantage was so marginal.

arebelspy

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My take was that it is just not worth it to gear, the actual advantage was so marginal.

BOOM!

The best unintentional pun I've seen in awhile!
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
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deborah

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My take was that it is just not worth it to gear, the actual advantage was so marginal.

BOOM!

The best unintentional pun I've seen in awhile!
How do you know it was unintentional?

dachs

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There is even a book about that topic: http://www.amazon.com/Lifecycle-Investing-Audacious-Performance-Retirement-ebook/dp/B003GYEGK2/ref=sr_1_1?ie=UTF8&qid=1456401617&sr=8-1&keywords=lifecycle+investments

In my opinion I it might be true that you can get away much better and even lower your risk of the end result but I'll definitely not start that kind of strategy before I've experienced a real market drop with (lots of) my own money invested. It's hard to handle emotionally, they say, and I bet they are right.

I've also made some calculations with past stock market returns and a loan invested vs. investing the equivalent amount every month (or year) that you'd have paid for the loan over a couple of years. I've calculated that for lots of 8-year periods and you usually get away ahead with one investment and borrowed money vs. lots of small investments over time of your own money (that is why dollar cost averaging doesn't make sense if you already have the money, but only because you don't have the money to invest yet). However, sometimes you can get away worse (that was like in 20% or less of the years), especially when you started that strategy in a bull market.

So I would analyze if you really want to start a strategy like that in a bull market that has lasted for 7? years now.

PS: Thank you for that tax hint, I'll check if that applies to me as well.
« Last Edit: February 25, 2016, 05:12:02 AM by dachs »

Murdoch

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If the interest on your margin loan cost you $7000pa, and the dividends on the shares that loan bought earn you $3000pa, then I thought you could only tax deduct the difference of $4000pa?
Same a rental income vs cost of ownership for rental property?
Can someone clarify please?

The tax benefit of such a strategy is maximised if you are paying the top rate, but becomes less worthwhile in lower tax brackets.

I've thought about this strategy a lot over the last couple of years, but have never run the numbers. Income from our shares is attributed to my wife who is in a much lower tax bracket, and I always just felt it wouldn't be worth the risk and effort.

Interested to hear more about your approach BigChrisB.

Cheers


bigchrisb

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Re: Investing in index funds, on margin, in Australia - (i.e. negative gearing)
« Reply #10 on: February 25, 2016, 08:45:26 PM »
There is a fair bit about my experience with margin on my journal page.  The quick summary is:

- I have been using margin since the 07/8 financial year
- I leveraged up too heavily at the start of the GFC
- Had some margin calls on the way down
- Continued leveraging in to shares with available cash flow, and on the way back up
- I've had a fairly mixed portfolio - some direct stocks, some LICs, some domestic ETFs and some international ETFs.  Allocation has been about 40% direct AU stock and REITS, 30% AU ETF and LICs, 30% international ETFs.
- I've had about 500k in margin debt for a few years now
- I've kept the leverage ratios high to keep the deductions in my own name, and typically owned low yielding stocks in my name.  I hold higher yielding stocks un-geared in a trust.
- I've been able to get by with high gearing ratios (often bouncing along at 60-70%) as I have the additional liquidity in the trust if I need it, and I have a high income (total loan is about 2 years pre-tax income).

Its worked out OK for me over the medium term (last 9 years).  However, it has come uncomfortably close to being un-stuck a few times.  I'm not sure that the wipe-out risk is worth the small premium in returns.  I've progressively negotiated my interest rates down too - at the moment the gross yield on stocks is higher than my interest rate, so its actually adding to taxable income.  Margin loans for positive cash flow - I guess that's a good problem to have?

qwerty8675309

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With interest rates so low at the moment, it is very tempting to gear part of my indexed shares. The risks associated with not being able to service the debt if I lose my job, or being forced to sell part of my holdings to make a margin call / interest payment is worrying. You'll cop the CGT event on sale, not to mention that a margin call will happen when the market is heading south, so its a double whammy.

The difference between no gearing and gearing isn't negligible either. Based on the the Russel report, it adds a full percentage point of return p.a over the 20 years (I do wonder how well this would have worked if we didn't include the bull market in the early 2000s though).
« Last Edit: March 01, 2016, 05:46:51 AM by qwerty8675309 »