We’ve got some great questions today! So hopefully you find this informative and it explains my thinking in more detail.
By doing these posts, my aim is to share my responses with all of you, rather than just one person.
But remember: This is not financial advice, it’s general information only. You’re solely responsible for your own choices. As always, do your own research before making investment decisions. OK? 🙂
Question #1
Dear SMA
My question is in relation to VHY (Vanguard High Yield Fund) and your reasoning for preferring the VAS (Vanguard ASX300 Index) to VHY?
VHY in the past has given a much better yield than VAS. I am considering purchasing more VHY, however am also unsure whether I should be purchasing VAS in preference. Your comments would be appreciated.
Jim
Strong Money’s Answer:
Hi Jim,
VHY was actually the first fund I invested in. I liked the idea of owning just high yield, blue chip companies. But I ended up selling and am not really a fan anymore. While I like it in theory, in practice… not so much. Here’s my reply to a recent commenter…
It’s more concentrated than most older LICs or the index. It has less holdings and more sector concentration. Holdings are bought and sold based on future yield, meaning it’s less tax efficient and sometimes results in large capital gains paid out. I experienced this.
As an example, last 12 months turnover in the fund was 37%, which is huge. Turnover with VAS is less than 5%. Essentially VHY is more buy & sell, VAS is more buy & hold.
Stocks are bought solely on forecast yield, seemingly without regard to sustainability or growth. For example, years ago (when I invested) the fund owned BHP because it was on a massive forecast yield, but the dividend was becoming quite obviously unsustainable.
Later, the dividend was cut and BHP was removed from the fund. Compare this to the index or old LICs which hold a more diverse group of stocks, some high yield/low growth and some low yield/high growth. This gives the portfolio better balance and ensures income continues to grow into the future – a higher future yield, essentially.
And with VHY, if you look at the distributions, they fluctuate more year-to-year than VAS and the LICs, so that’s not ideal either.
Personally, I feel more comfortable with the larger more diversified portfolios of the index and older LICs, the lower turnover and the generally more reliable, growing income stream.
Don’t get too hooked up on the yield. VAS (the index) still has a solid yield and that income should grow nicely over time. VHY might have high payouts but generally less reliable, less tax efficient, less dividend growth over time and higher risk.
More thoughts here on yield vs growth when taking a dividend focused approach.
Question #2
Hi Dave,
I’ve invested in an index fund recently and also Argo.
Quick question, how do you keep track of when your dividends get paid and what do you do at tax time?
I haven’t really found much information on this topic elsewhere… Cheers. Mick.
Strong Money’s Answer:
Hi Mick,
Good question. I used to simply keep track of the company announcements – you can do this via the ASX website or your broker – and then keep the dividend statements when the payments are made, and use those for tax time.
But then the portfolio got bigger and it became more time consuming. So for a good while now I’ve been using Sharesight, which automatically records your dividend payments once a trade is entered.
Now at tax time, I simply click a button to run a tax report for the total income received for the year, including franking credits. Heaven!
This saved me a major headache recently when we made some changes to our portfolio. Luckily I didn’t have to do the dreaded job of calculating the capital gains/losses myself. I just simply ran another report!
Anyway, Sharesight is completely free up to 10 holdings, so get onto it. It’s perfect for someone with a smaller portfolio – you can sign up here.
And for those with a bigger portfolio (or multiple portfolios), you can get 2 months free using my referral link to sign up (full disclosure: if you choose a paid plan this blog will receive a commission at no extra cost to you – thanks in advance!).
Question #3
Hi Dave,
I note that some of the replies and your comments regarding Labor’s likely changes to franking credits could change the playing field a bit.
Also, I recently sold many of the shares in stand-alone companies, with the plan that I would put that money back into the market in LICs and some ETFs.
Because of possibility losing some of the income from franking credits I am also considering putting 10 to 15% into REITs. I am in the process of researching some of the ‘likely suspects’. Do you have any suggestions I could include in that research?
I am not overly worried about the changes that may occur. However if it were to happen do you think that would cause a selloff of LICs, pushing their market price down? And if there was a move to reinvest that money into REITs would that be likely to push their price up?
The reason for my questions is that it may be better to look at REITs now and bide my time on the LICs.
Any thoughts?
Kate
Strong Money’s Answer:
Hi Kate,
As for a sell-off in LICs or fully franked dividend payers in general – definitely possible, but who knows.
And same goes for the increasing popularity of REITs (real estate investment trusts) – also possible, but one can never be certain.
Everyone dumping diversified LICs for a couple of property trusts doesn’t seem like a smart move from a diversification standpoint, if that’s what they were to do. But LICs could fall out of favour and trade at large discounts (possibly already happening to some extent).
I wouldn’t expect anything drastic to happen, but again I have no idea.
We do own a couple of REITs and I briefly look at others from time to time. Some that seem half decent to me are below.
Beware, a number of them are currently trading at large premiums to their net asset value and yields are not all that attractive. And to be clear, these are in no way recommendations or endorsements!
Shopping Centres Australasia – SCP
Centuria Metropolitan Office REIT – CMA
National Storage REIT – NSR
Aventus Retail Property Fund – AVN
Growthpoint Properties – GOZ
APN Convenience Retail REIT – AQR
Hotel Property Investments – HPI
I would only look into this if you’re happy having them as part of your long term portfolio. Not as a short term play because you have a hunch about REITs going up and LICs going down. I’m sure you know that’s just speculating!
And I would not buy most of those today as they don’t seem great value as alluded to before. But I’m not a stock picker and this isn’t a stock picking site, so make of that what you will.
Question #4
Hi, I recently rolled my super to a company with zero investment fees based on the fact I can invest 100% on the Australian and International Index.
What caught my attention the other day was that I can invest my entire super (currently around 90k) into AFIC by using a SMSF. I’m trying to weigh up what would likely be the best return when it comes time to retire of both options in 30 years?
I know you have studied AFIC in great detail but nothing has seemed to be mentioned about Super investments and how they differentiate? If you had any advice that would be great.
Simon
Strong Money’s Answer:
G’day Simon. Is that REST Super by any chance? I was actually looking at this recently.
To be honest, I would not expect AFIC to outperform the index by much, if at all. They may even lag the index as more competition all the time means beating the index is very hard.
I’d be happy with the indexed options you’ve mentioned. Most managers won’t be able to beat those returns and a reliable income stream isn’t needed inside super since we’re leaving it there for the next 30 years or so.
And considering the costs involved with an SMSF I wouldn’t go that route either – especially with a balance of $100k or so. Higher costs mean lower net returns for your super. Not to mention the hassle and extra admin involved.
Hope that helps mate.
Question #5
Hi Dave,
My wife (aged 64 now) left the workforce in November 2012 with $53,000 in super.
Since that time this amount has been sitting in QSuper’s Balanced Investment Option with no further contributions. The balance at the end of the last financial year was $82,000. She paid $770 in fees and charges in that year.
I’m 64 and intend to work until around 68-70 years of age. Therefore the money in my wife’s Super account won’t be touched for the next 5 years or so. Then we intend to combine our funds for optimum benefit.
The question is: Should she leave the funds in QSuper, or should she consider an alternative strategy (and if so, what?) to grow this little nest egg. I suppose the same question is relevant for my funds in my Super Accumulation Account…
At June 2018 I had $521,000 in Super. We have no significant assets other than the family home valued at about $850,000. The balance on the mortgage is $83,000, which will be paid off around 2023, by the time I retire.
Regards, Steven.
Strong Money’s Answer:
Hi Steven,
I’m not a super expert by any means, but here’s some thoughts.
Your super accounts may not be optimal but there’s likely real costs like tax implications if you were to move to a fund with lower fees right now. QSuper is not bad for fees overall, but the Balanced fund is quite expensive – list of fees here.
What I would do personally, is wait until you’re completely retired, so in a zero tax environment, then I’d look at switching to a lower cost fund if possible (like SunSuper, Hostplus etc). Your wife may be able to withdraw her super or switch now with no tax payable if she has declared herself retired, given she’s over 60.
And since you’re only 5 years away from using this money, I wouldn’t be trying to speed up the growth of your portfolio, the time-frame is just too short and anything could happen.
If you just keep plugging away your house will be paid off and you’ll have a very healthy Super balance (likely over $700k). Combine that with any part-pension you may be entitled to and you should be looking pretty comfortable 🙂
Question #6
Hey there
Great website!
Can you please do a blog or article – in layman’s terms for Labor Govt proposed changes to LIC dividends?
Does it affect newbies about to dive in? Or just retirees only?
I am confused after reading few news articles on it.
Cheers
Andrew
Strong Money’s Answer:
Thanks for the suggestion. Since getting this question, I’ve now written a pretty in-depth article about this very topic!
Basically if you are paying 30% tax or more (which is most people working) your dividend income will remain the same. You get the cash dividend but will have to pay top-up tax as the franking credit doesn’t quite cover the entire tax owing.
In ‘retirement’, the proposal means we’re still allowed to use franking credits to offset tax owing on our dividends, but would no longer receive a refund for unused franking credits. This currently takes the after-tax yield from 4% to 5.7% (if paying zero tax).
Not exactly great! But considering the other options out there, I’m still happy with a 4%+ yield for a reasonably diversified and hassle free income stream which grows over time (whether LIC or index fund).
Question #7
Hi Strong Money. I have followed your blog/advice and bought AFIC, Argo and Milton.
I know I should only be interested in the dividends and not the share price. But I am getting a little nervous that the banks are going to come in for a hammering when the Royal Commission report is released on Friday and the 3 LICs above all have around 20% + in banking shares. (Note: this is clearly a very old question!)
AFIC have granted a special dividend of 8 cents as well as the half yearly 10 cent dividend but that may not cover a big drop in the share price
Do you have any thoughts on the matter? Rudy
Strong Money’s Answer:
First off, I’m not giving advice! I’m sharing what I’m doing and why it makes sense to me. Others are free to choose whether they think it makes sense too or it’s complete rubbish!
I understand your concerns, but nobody really knows what the Royal Commission will bring.
But the thing is, the banks have already been hammered by this (and other worries) in recent years. All are well down from their highs. Remember CBA was nearly $100 a few years ago?
Despite this and the other banks falling share prices, those LICs you mention have paid stable or increasing dividends over that time. And that’s what matters to me.
Don’t bet on the prices, bet on the income stream.
The market isn’t stupid. It’s likely that much of the negativity is priced into the market already. That’s not to say they can’t fall further, of course they could. But that could happen anyway with a housing downturn etc, as is always a possibility.
The other way side of the coin is those LICs have around 75-80% of their investments outside the banks – so I don’t believe there will be any long term dramatic consequences if banks fall.
The only way to avoid banks is to start picking stocks or avoid those LICs and go for LICs or ETFs which focus on smaller companies. But those have higher expenses, usually lower dividends and no guarantee of better long term performance.
There is always something to worry about. We can choose to keep investing anyway, let it paralyse us into doing nothing. Or worse, scare us into selling. I’m doing the first one.
If you have a genuine fear that Australia is a poor place to invest for the foreseeable future, then by all means look at something else like an international index fund.
But if you believe Australia will work through it’s problems and the economy and population will continue to grow over the next few decades, then company earnings and dividends will be much higher in the future and there’s no reason to be worried by short term issues.
So if that’s the case, we want a broad exposure to Australian shares in a low cost way, and the two main ways to do that are by buying an index fund or old LICs.
Bottom line: I don’t care about bank share prices. I care about earning dividends from a broad group of Australian companies over the next 50 years. The banks may become smaller or larger over that time, who knows. Either way, I’ll still own lots of other companies from a range of sectors that are bound to be doing just fine.
Hope that helps Rudy! And of course, these are just my thoughts and what makes sense to me 🙂
(Turns out bank share prices didn’t move much after the Royal Commission report. In fact, they’ve gone up! Should teach all of us not to jump at shadows or try to be too clever about this stuff, by thinking we know what’s going to happen!)
Question #8
Hi Dave, I was wondering if I could please get your thoughts on debt recycling when there is a decent balance in an offset account, and does this make it more advantageous?
We have a mortgage of $470k, with $440k cash currently offsetting the mortgage (recently received inheritance). We have an investment portfolio of $75k.
My wife is not comfortable investing large amounts, hence the guaranteed return we are getting from the cash in our offset. If we were to take out a line of credit, would we still get the same benefits considering we currently only pay about $100 per month in interest on the mortgage?
I get all of the benefits of debt recycling, just can’t get my head around how the cash in the offset impacts this and would appreciate your thoughts. I totally get this is not financial advice.
Thanks in advance. Pete
Strong Money’s Answer:
Interesting question Pete. Debt recycling is mainly for people who have mortgage debt they want to pay off sooner and turn into tax deductible debt.
In your case, you effectively have no mortgage if you were to pay off the home loan within the next 6-12 months.
At that point it becomes a choice of whether you want to take out all that equity to put into shares, or stay debt free and use your savings to buy shares each month.
Given your wife’s hesitation, dumping the equity into shares is probably not a good idea, unless you feel 100% comfortable with it and you can get her on board somehow.
To be honest, it sounds like the best option for you would be to pay off that mortgage completely, which will solidify your position and permanently reduce your expenses. And that’s an incredible position to be in by the way!
Then simply invest whatever you can each month into the market. And as you see the dividends coming in, maybe your wife will come around to having a bigger portfolio and you can look at using debt again later if you really want to.
Borrowing for shares is not a slam dunk, due to the emotions involved and how the volatility can affect our decision making. And no real need to make your finances more complex than they need to be.
All the best with it. Thanks heaps for reading the blog!
Question #9
Hey SMA. A stupid question perhaps…
Given how all established LICs are very similar to each other in terms of their investment portfolio, what exactly is the benefit in spreading our investment in choosing multiple of them? Aren’t we giving ourselves very limited exposure?
Thanks a lot for the new blogs, they are quite interesting. Kathy
Strong Money’s Answer:
Good question Kathy. If choosing to invest in LICs, the main benefit of purchasing more than one is to reduce manager risk – the rare chance that something funny gets into the water at Argo for example and they start making crazy investment decisions (bitcoin anyone?).
Also, it gives us more opportunity to buy shares trading at a discount to NTA. It perhaps also adds a smidgen more diversification in that those LICs will own different stocks in their portfolios, even though many holdings are similar.
This gives exposure to around 100-150 companies in total. If you want more than that you can go for an Aussie index fund like A200 which is the top 200 stocks, or VAS which is the top 300 stocks.
You can also diversify internationally with an index fund like VGS which is global developed countries outside Australia and holds about 1500 stocks.
Totally up to you how diversified you want to be!
Question #10
Hi Dave,
Firstly I just want to say I love your articles. They are detailed and best of all easy to read and understand. So thank you.
I am contacting you to ask your opinion on what you believe are the best funds to put superannuation into to boost retirement balance.
I am 32 years old and currently have $50,000 in my super account with Hostplus (Indexed Balanced Fund). Whilst this is a low cost fund which performs well, I know that if I use the Choiceplus option I can
improve my returns and retire with a bigger balance. Also, I don’t like my money sitting in Cash and Term Deposits in the indexed balanced fund.
Outside of super I have started to invest my savings in AFIC and I will continue to do so in the aim of receiving good dividends in the future, and to hopefully allow me to retire earlier by getting some good dividend cheques.
Do you have any favourite ETFs that you like for inside superannuation investing?
I understand you probably cannot give direct advice, but I am interested to know if you have some favourites for me to look into. There are so many and it’s proving difficult for me to decide where to put my superannuation.
Many thanks,
Reynold
Strong Money’s Answer:
Glad you like the blog Reynold. And I appreciate your kind words, thanks!
Super is on my mind lately as we have been doing a bit of a stock picking experiment in there for the last few years.
I’ve pretty much lost interest and thinking of moving it back to a regular low fee super fund and just choosing a 100% shares option and leaving it alone!
Firstly, you want to keep it simple. You don’t get higher returns from complexity. In fact, I think you get it from simplicity. That way there seems to be less desire to fiddle with your portfolio or second guess what you’re doing.
To try and improve your long term returns, you don’t necessarily have to build your own portfolio. But instead, you can switch to an option which lets you have more ‘risky’ growth assets and less ‘safe’ cash assets.
Personally, I’d aim for a fund which allows 100% shares at low cost, but I know that’s not for everyone.
Most of the big names offer this option – Hostplus, REST, Australian Super, Sun Super etc.
As for choosing your own ETFs to get higher returns again, well, then we’re trying to beat the market. And honestly, the likelihood of that is not good. So I’d be satisfied simply having 100% indexed shares or whatever ‘high growth’ option is available at low cost.
Simply thinking out loud, I’d probably set mine up as 100% international shares if possible. This would give us higher growth and more diversification overall, since outside super we’re 100% Aussie shares for higher income.
But that’s a personal choice that you’ll have to think about. Hope that helps mate, thanks again for reading the blog!
Notes
Hopefully you enjoyed this post and found it interesting or helpful.
Remember, the point isn’t to blindly follow my words. It’s simply to share more behind-the-scenes thinking, clear up common queries and give readers extra info to evaluate things for themselves.
As always, you can send me a question through my Contact Page, and I’ll do my best to answer it. Thanks so much for reading!
How about you? Do you have any additional thoughts for our readers?
re: Question 3, I’d add ARF to that list of possible REIT’s, invests in childcare centres and healthcare buildings and has been on a steady rise this year. Another smaller REIT which has attracted a few mates of mine is GARDA(GDF).
I spoke to one fund manager recently at a meeting and they do expect investors to bail out of LIC’s that are paying lower yields and expect some of the REIT’s to pick up those shareholders.
Given what happened last GFC to REIT’s I wouldnt be carried away with over investing in them and around 10-12% of a portfolio is about the max you would want to be invested in total.
re: VAS vs VHY…I own both and while I agree VAS is a more reliable solid payer there is no doubt that when the market is doing well that VHY gives you a much better return. I’m happy to continue with VHY but have a bit more in VAS for balance and security.
Thanks Mark. I’ve looked at Arena before, and while it looks like a decent REIT, one thing that I didn’t like was that a chunk of their earnings comes from developments. So they’re much less a pure rent collector which I prefer.
Will definitely be interesting to see what happens – whether retirees flock to REITs or other high yielding options.
Appreciate your thoughts on Vanguard High Yield fund. If having both suits you and your portfolio, then that’s what matters in the end 🙂
Hi Dave
Enjoyed reading through this questions and answers post. I would like your thoughts about the following strategy. Over the past 12 months I have accumulated a basket of LICs – ARG, MLT, AFI – which have not shown much capital gain. It seems like many commentators are now predicting with a change in government, prices of LICs will fall and that a recession is imminent in the next 12-18 months. Would it be a good idea to liquidate the entire portfolio of LICs now (when the overall Oz and US markets are at a high point) and buy back in down the track at the predicted cheaper prices? All investment strategies revolve around backing a theory and I would value your thoughts on this.
Hey Jon, appreciate the question, but you know by now that I can’t give advice. Instead, here are some general thoughts…
Commentators say a lot of things lol! The old joke is they’ve predicted 9 out of the last 5 recessions. If it was so obvious we’ll have a recession in a year or so, markets would not be going up at the moment!
Personally, I don’t liquidate holdings based on forecasts or anything like that. The whole point is to build a large and growing portfolio over time which spits out more income each year. Selling down and trying to time the market is the opposite of that, so it takes us further away from our goals! Playing the market timing/forecast game is about the worst thing we can do for our wealth. But only you can decide what feels right for you.
Hi Dave What do you about investing in bonds index as a defend instrument when the share market collapses ? Isaac
Good question Isaac. Personally I don’t worry about bonds, nor do I know a lot about them. For money I don’t want exposed to the sharemarket I simply hold in cash, whether a high interest savings account or in an offset account. But the advantage with bonds is sometimes they go up a bit when the sharemarket goes down – either way the long term return is more or less tied to interest rates, similar to a savings/offset account. Personal choice as always.
Your best “defence” against a dropping market is to keep investing. Buy the dips, embrace the volatility the sharemarket offers and bring the average cost of a share / unit / whatever down. Just as gambling is a tax on people who don’t understand statistics, bonds are a drag on investment returns for people who don’t understand the market (eventually) always goes back up.
Hi Dave, Once again i enjoy reading your articles. It is interesting to read that you do not over concern yourself over the growth/prices of stocks but the income stream. I am 60yo and after being made redundant around 3 years ago i transferred my Super into ING Super lite (smf). Being just a casual worker now i do not put towards my Superfund and only get what my current employer puts in.
Starting with ING in early 2016 i have built up a portfolio of around 20 stocks. As you would know the market has been up and down like a roller coaster over this period. Sometimes it gets frustrating seeing the portfolio drop a lot then bounce back up.
I currently am getting around $12,000 pa in dividends with an approx balance of $370,000. Unfortunately with the SMF with ING i can not automatically reinvest into the shares, that’s why i have bought other shares along the way and now have those 20 stocks.
My concern at the moment is i have seen my shares drop from highs to lows and some of them slowing climbing back and others are higher than i originally purchased but as i do not have that long to go to retirement will my dividends be enough to increase my portfolio if the shares do not climb back to highs eg ANZ got as high as $31 then dropped all the way back down to low 20s. Sometimes i wonder would i have been better to have sold ANZ when it was high and then pick them up again when they dropped? Surely you would get a better return on the stock price then just getting the dividends and the price is lower? Maybe I am just panicking because I am getting older…LOL.
Recently, with the dividends that I have received they are going straight in the cash hub of my SMF which currently is at around 5% of my portfolio. Would you suggest to continue building up my cash hub as a buffer as i get closer to retirement or still build up my portfolio. I always have this feeling what will happen if i lose my current job, as i think my current balance is not enough for someone my age? I do not day trade on my Superfund as I hope to build up the portfolio as best as I can over the next few years.
regards
JDC
Thanks for still reading JDC, I appreciate it!
Your questions really have no perfect answer to unfortunately. Would it be better to sell a share when it’s high and buy back when it’s low? Obviously, yes. The problem is, nobody knows the future, so we can only see looking back what would have been the ideal thing to do.
A share can go higher than anyone expects too by the way. We only know it was ‘high’ after it falls and looking back.
This is not advice, but these are some thoughts from one random internet person to another. If I was close to retirement, I would definitely increase the amount of cash I’m holding, so I have money to live on just in case. Other than that I would just try to keep working and saving where possible and build the portfolio steadily. And hopefully the portfolio combined with the pension would be enough to live on when the time comes.
Thanks for your reply and your views. I know it was a hard one to answer. I think i will just keep rolling along and and try to boost up the cash hub when dividends come and keep holding on to what i have at this stage. By the way, i had to come back and search to see if you had replied. Is this the way it works or for people who email in do they they get an email with a link to say that their question was answered. Thanks again
No problem mate. Good question. There’s no automatic email that says questions have been replied to. You can either check manually or where you fill out the comment I believe you can check the box which says notify me of comments? If this was an email you sent me I would have replied directly so you should’ve got it, if not check your junk inbox 🙂
Hi Dave,
I always get some new info from your blogposts. Keep up the good work.
One question regarding REIT investment. You listed the number of REITs you are investing. But like index investing, won’t it be a good idea just to buy REIT index like VAP ?
Appreciate the feedback, thanks!
Good question. I’ve been asked that before and I don’t really like the REIT index for a few reasons…
1. Low yield of 4.4% currently. That’s pretty poor for REITs, since that is close to 100% of earnings. Similar yield from VAS or LICs with better growth prospects.
2. It’s extremely concentrated for an index. 10 holdings are about 85% of the fund. Retail REITs are a large part of that (not sure they have a great outlook as a group).
3. It contains property developers as well, not just rent-collecting landlord REITs. These earnings/dividends are more volatile than a simple rent-collecting REIT.
It’s not a bad choice and the returns will probably be fine over the long term. But it’s just not appealing to me. I prefer to buy individual REITs (which is a higher risk approach/less diversification) so I can be more selective about the income stream I’m buying and get more attractive yields.
REITs already make up about 8% of the Aussie market, so if you buy VAS (Vanguard Australian Shares) there is already a decent exposure to REITs. I just buy a few individual ones out of interest and because we’re in a zero tax environment so the higher income is attractive. So it suits our personal situation and what I’m personally comfortable with, not saying it’s right for anyone else. Not advice, do your own research etc. 🙂
Hi Dave,
I hope this message finds you well. Would you be so kind as to help me with my thinking regarding investment using cash vs affordable loan with the following assumptions: I am still working with annual salary of $80K, bank savings of $100K, nearly paid off home loan of which I can redraw 100K (interest rate 4.7%) to make things simple.
My options are:
1.
Simple and straight forward: use the $100K cash for investment (this is after tax dollars).
2.
Redraw (no redraw fee) $100K for investment and repay principal and interest (say, $1800 per month). The $100K cash from savings used for backup parked in an interest account of say 2% (interest taxable). This way, the interest expense of the investment capital (tax deductible) will lower the annual income (assuming personal tax rate of about 30%).
My thinking is that I should use option 2 because I am using before tax dollars for investment. So for that $100K, I am paying 4.7% interest which is tax deductible (it would lower my taxable income by 4.7% of $100K = $4700 to $75300) rather than paying 30% tax on that $4700. Even though I would still be taxed on the interest from the parked cash, it is 30% of the 2% interest.
Is there any flaw with my thinking? My confusion is this: normally we would want to reduce expenses; after all, savings from tax deduction is only a percentage of the expense. So it would make sense to focus on reducing expense rather than tax, but option 2 seems to make sense as well. I’m totally confused and thinking in circle. The fact that loan tends to depreciate (eg $10k debt 30 years ago would not be considered much in today’s term due to inflation) also adds to the complication.
Thank you.
Regards,
Michael Lim
Hi Michael, sorry for the slow reply.
A few thoughts on a scenario like that…
– That interest rate is too high. You should be able to get a mortgage for well under 4% if you can meet serviceability.
– If you have $100k in cash and keep a $100k loan, make sure you get an offset account to put your cash in. This will mean the spare cash is earning higher than a separate savings account.
– You’re misunderstanding the consquence of the debt being deductible. Read this article on debt recycling to see how it works in practice. It’s not immediately tax deductible from your income, this is a common misconception.
In general, you’re probably overthinking this. Bottom line, you have $100k cash to invest in shares and an almost paid off house. That’s fantastic! If you want to keep the $100k in cash then you can use $100k of debt to buy shares instead and this will be a bit more tax efficient, but it adds complexity and possibly stress, so it comes at a cost. If you go this route, make sure this $100k loan is separate from your regular mortgage, making it cleaner for tax purposes.
If it’s all a bit confusing, the best option is probably to decide how much cash to keep and invest the rest in shares, while getting rid of your loan. That’s the simplest and most stress free option! Hope that helps mate 🙂
Thank you for taking the time to comment, Dave, I really appreciate it. I have read the links a few times. I’ll read them a couple more to digest it further. The thing is the house is pretty much paid off. I am just keeping the redraw facility in case i need quick cash for bargains 🙂 My monthly interest is less than a dollar and the loan still has 20 years of life. I tried calling the bank to reduce the interest rate but they refused, and said that I’d have to reapply for a loan etc and have to pay a few hundred dollars in fees etc. So I thought I’d leave it for the time being. It is the cash I have in savings that I kind of want to use, and the options are 1. use the cash directly or 2. redraw from the loan, pay interest and claim back the interest as tax deduction (but apparently from your link, it is not that straightforward), and use the spare cash to service principal and interest repayment. I much prefer simplicity but I also don’t like to waste leverage as a tool, as well as to leave cash idling around. Any other ideas? I don’t think I qualify for an offset account at the moment as I am currently in casual status work-wise. I will have to wait until next year before I have my regular income back. Thank you.
It’s a good position to be in whichever way you take it Michael!
An offset account is simply a transaction account that you can link to your home loan, and any cash in the offset will reduce interest payable. You don’t need to qualify for one of these it’s essentially the same as any other transaction account.
My thoughts are basically this: you can pay off your house and the invest every month with the spare cash you have saved, keep it simple and be completely debt free. Or you can redraw the funds from the loan, put it in the market over time, and have a larger portfolio faster, accepting the risk that the market may crash and you’ll have a large lump of debt for investments that aren’t worth as much anymore. Over the long term, this strategy may provide higher returns, but it comes with some extra complexity and risk. That’s the trade-off.
Using debt for shares is not that complicated in truth, but some people make the wrong assumptions tax wise. To keep it simple, if you are paying 4% in interest, and earning 4% in dividends, you deduct your interest costs from your dividends and you’re left with $0 income, so pay zero tax on it. But you also don’t get a tax refund, because there’s no taxable loss. Your profit above the interest costs are the growth over time in the portfolio (maybe 3-4% per annum). Hope this makes sense.
I guess you have to decide what your priority is; stable finances, less risk, paid off house etc. Or building your portfolio faster using leverage and accepting a bit more uncertainty and risk.
Hi Dave, you don’t know how much I appreciate you comments. Thank you. 🙂 I know the dangers of using leverage. And I always remind myself not to ever use leverage unless the risk reward ratio is good. So the premise of me using leverage is to prepare for times of market crash or uncertainty. I need to get the setup up so I can use it when the time comes. And now I am in a good financial situation to request the bank to increase my loan amount, even thought the mortgage is only $32 left. If something happens if I lose my job or there is a decrease in salary, the bank will refuse to up the loan. I am basically increasing my spare loan capacity given the current opportunity exists for me to do so. For now I will be using cash. When market crashes, I will use cash and half to a third of the leverage. And if the market crashes further, I will use the rest of the leverage. All this to end up with: luck is a case of preparation meeting opportunity. I will always make sure I can service the debt.
With reference to your above (quote: – You’re misunderstanding the consequence of the debt being deductible. Read this article on debt recycling to see how it works in practice. It’s not immediately tax deductible from your income, this is a common misconception.) I thought this was a case of claiming a capital loss against a capital gain. But with interest, shouldn’t it be considered an expense in the process of gaining an income (dividend, not capital gains as the security is not sold), just like claiming other expenses. Are you able to please confirm.
The other quote (To keep it simple, if you are paying 4% in interest, and earning 4% in dividends, you deduct your interest costs from your dividends and you’re left with $0 income, so pay zero tax on it. But you also don’t get a tax refund, because there’s no taxable loss.), are you saying that if I don’t claim the interest expense I’d get a refund? How and from where?
The last question is the MER expense. I presume that is claimable but from the statements that I received, I don’t recall the funds itemising the MER costs. Do I need to calculate it myself and claim on the tax? Any ideas. I used an accountant last financial year hoping to reduce the tax but it didn’t help much. They just key in the numbers into the system. I was thinking I might as well do it myself and learn something along the way and save on the expense although it is claimable. In general I much prefer reducing expense to claiming tax, but for the leverage situation above, it is different due to the very favourable risk reward at the right time.
Hope you are enjoying your weekend.
Regards,
Michael
Thank you so much for your time and sharing.
Hi Michael, thanks for reading.
In regards to using debt for shares, I’m not sure how to explain it any differently. It’s like property investing. If your rent is less than your expenses (interest plus other costs) you have a cashflow loss and this is a tax deduction. Same with shares. If your dividends are less than your interest payments, you have a cashflow loss and this is a tax deduction. In simple terms, 4% dividends and 4% interest costs means $0 positive/negative cashflow. No tax deduction.
The MER automatically deducted from the fund you’re invested in. You do not get a separate tax deduction for this.
There is no secret to tax deductions, if you make more money you pay more tax. If you want to pay less tax, make less money. I do our tax myself and can say it’s not that difficult, just a matter of keying in the details, and it gets easier each time you do it 🙂
Hope that helps mate!
Thanks, Dave. Your first paragraph makes it much clearer now. 🙂 Now I think if I buy securities during market turmoil, and they cut dividend, then I can also claim more back. so it is like an insurance against dividend cut. :))
Regards,
Michael
Hi Dave,
I’ve Just very recently begun investing, I own my own home with a mortgage of 130k. Not including mys super I’m currently invested in a 50/50 split of WDIV & VHY. I know you’re not a fan of VHY and prefer broad market indexes and old-school LICS.
My basic plan is to build long term passive income, I would like this income and my capital to increase overtime. I’m not a fan of selling off assets and like to keep things simple.
My questions are:
Not looking for specific LIC or ETF suggestions. Would you recommend I sell off my Smart Beta ETFs & focus on broad market Index Funds?
Do you have any suggestions for achieving decent yield through international exposure?
Best regards
Chris
Hey Chris. You’ve done a great job so far keeping it simple and having a small mortgage.
You guessed right – I would probably switch those for broad market indexes or diversified LICs and accept the slightly lower yield than you currently get. There’s no magic in getting higher yield from international shares, it’s hard. Your WDIV fund is one way to do it. There are other funds including international LICs, but I’m not a huge fan of them either.
If you’re happy with WDIV then by all means you can keep it. Other than that I’d probably just accept the lower yield from international while acknowledging it will have stronger growth over time. The other solution is obviously to have less in international so you’ll achieve a higher income stream, which is the approach I take (having only international in super). Hope that helps.
Thanks Dave,
I’ve been playing around with the idea of swaping out VHY with something along the lines of VAS, A200 or BKI. I’ll be looking into it further and deciding what to swap out VHY with.
At this point I may or may not Keep WDIV. If I go for something like VGS, I may go the route of allocating more to Australian shares. I will be holding on to WDIV until I am certain about what I want to, in in regards to international exposure.
Hi Dave,
I get some fresh advice out of your blogposts. Continue the fantastic work.
1 question concerning REIT investment. You recorded the amount of REITs you’re investing. However, like indicator investing, will not it be a fantastic idea simply to purchase REIT indicator like VAP?
Hey there, glad you’ve gotten some value from the blog! It depends on how you want to approach it. I actually wrote a whole article about REITs here – The Aussie Guide to Real Estate Investment Trusts (REITs) – you might find it useful. Since then I have sold out of the REITs I held as they had become overvalued in my view and I was able to recognise some decent gains.