Sitting Down with Strong Money – Your Questions Answered #9

Welcome to the latest Strong Money Q&A – where I answer a bunch of juicy questions sent in by readers.  

The aim of these posts is simply for me to provide more thoughts on certain topics or situations that don’t really require a whole blog post.

And by sharing my answers with all of you, instead of one-by-one, it’s better value for everyone! 

In today’s post we cover:

—  Leveraging with NAB’s Equity Builder. 
—  Investing sizeable sums for grandchildren. 
—  The trade-off between investing and home ownership. 
—  Lump sum investing in the sharemarket. 
—  P2P Lending vs The Sharemarket. 
—  Geared share funds. 
—  And more!

(Remember, nothing on this blog is personal advice.  Please do your own research before making financial or investment decisions) 🙂

 

Question #1

G’day Dave.  I’m a 75 year-old retiree.  I have 2 grandsons, aged 6 and 8.

I’d like to build a portfolio for each which will enable them to be FI ($100k per year) right from the get go.  How would YOU achieve this?

I have access to fairly sizeable amounts of capital to inject to get things off the ground.  I have ideas, but it would be interesting to see if they align with what you would do.  Looking forward to your response.  Rob.

 

Strong Money’s Answer:

This is actually a tricky one.  I can see there’s an income target in mind, but I’m not sure the amount of funds available to build this ‘cash machine’.

The timeframe we’re working with is roughly 10-15 years.  So first I’d divide the capital up into two accounts and then invest in whatever you’re most comfortable with – whether index funds or low-cost LICs.

Unless I was working with huge amounts, I’d personally invest mostly in Aussie shares for the higher income stream.  To get $100k of income would require $2.5m per kid (not including franking credits).

If you are working with huge amounts, and are keen on being more diversified, then you could definitely set it up as 50/50 Aussie/international, with something as simple as VAS and VGS. 

But this means lower dividend income for greater diversification.  So depending on your numbers, and how you like to invest, the higher income Oz shares might be preferred to establish the income stream desired.

(Yes, I’m aware international shares can be sold to create more ‘income’.  But that’s probably not what this reader has in mind when handing over a large portfolio to future 20 year-olds with no investing experience!)

Basically, I’d probably go with Oz shares unless the numbers were huge then of course the international shares can be added and income target still achieved.

As for setting it up, the most tax-effective setup is probably inside super for the next 10-15 years.  But that makes it difficult to handover.  If this isn’t an option the next way could be to invest in your personal name and then pay the CGT to hand to them later. 

Or, it could even go in their personal name if you use the Bonus Share Plans (BSP) from AFIC or Whitefield so that tax is effectively capped at 30%.  Then, when they want the income, they can simply elect to start receiving the dividend income.

Keep in mind, I’m certainly no expert in tax/super/estate planning so there could easily be better ways of doing this!  I’m just guesstimating from what I’m aware of right now.

 

Question #2

Hi SMA.  I read your post about debt recycling and that got me tempted to try to buy a property for myself while Perth housing prices are fairly low, and later on use the equity as dry powder for investments.

On the other hand, I also thought I could rent a few more years, get as big of a NAB Equity Builder loan as I can to benefit from leverage over the next 5-10 years and then buy a house almost debt free.

With my savings rate I could see myself becoming financially independent in 6-8 years.  But I can’t help think that if I used leverage (either through a mortgage or equity builder), I could reach FI much sooner.  I have a pretty good risk tolerance overall.  Thoughts?

 

Strong Money’s Answer:

Hmm, interesting.  First, if going the NAB Equity Builder route, the excess return after your interest cost won’t be huge (future post on NAB Equity Builder is planned).  Therefore, it won’t have a huge impact on your FI timeframe. 

If the interest rate is 4% and your annual return is 7%, you’re really only pocketing 3%.  On $200k of debt this is $6k per year.

Over 10 years this may be around $70k-$100k or so, assuming interest rates don’t increase.  A nice outcome, but hardly a huge benefit for taking on that debt and uncertainty of cashflow. 

Plus, NAB are the only bank that offers this type of loan.  This means NAB could change the rate or rules at any time and nobody could do a thing about it.  So for that reason alone, I’m a bit cautious on this product.

This also assumes healthy market returns over that time… which is far from guaranteed.  We could have a downturn towards the end of your timeframe and it’ll leave you underwater on your debt. 

Psychologically, this would suck big time and may cause you to question your approach and sell to get rid of the debt.  A debt-free portfolio will still be in the green, providing positive income. 

Of course, it could also work out great.  But it’s worth thinking about the downside!  Given your already-short timeframe to FI, there’s really no need to push harder by using debt.

 

Question #3

Hey Strong Money.  I’ve been interested in Financial Independence for a while, and just came across your blog… so much great information you’ve got here.

I’ve got a portfolio of Aussie ETFs, plus a couple of US dividend growth stocks.  I’m wondering if investing in the US for dividend growth is worth it.  I came across your blog on international shares and found it to be a great read.

My concerns with the US stocks is the currency conversion and potential tax implications once I’m getting larger dividend payments (I’ve filled out a W8-BEN form). 

The biggest reason I’m interested in the US is because there’s some companies over there that have a consistent history of raising their dividends every year like clockwork (I’m sure you’ve heard of the dividend aristocrats).

My thinking is holding these companies for 10+ years will negate the currency conversion and tax problem with such large dividend growth.  I know that’s a lot to answer, but I can’t find anything online about this so hopefully you can help me out.  Keep up the great work.  Mick.

 

Strong Money’s Answer:

Thanks for the kind words Mick!

The currency stuff tends to mostly even out over time.  But annoying in terms of having a fluctuating income, even though your US companies might be regularly increasing dividends.

I think you’re right that a long term view negates most issues.  There is still the tax issue though.  What I mean is a US dividend yield of say 4%, becomes 2.8% after paying 30% Aussie income tax. 

As you know, an Aussie dividend yield of 4% fully franked, will also be 4% after the same 30% tax, because the franking credit basically takes care of the tax.  

That’s not to say don’t invest overseas.  But investing overseas for the primary purpose of an income stream is less efficient than it is here – that’s all. 

So the main question is whether you expect your US dividend-payers to outperform Aussie shares to make up for the tax drag?

It’s a little tricky but that’s how I’d think about it.  Hope that’s helpful.

 

Question #4

Hi Dave.  Thanks for all the A-grade content you are providing to all us future Aussie FIREees. 

We have recently sold our home and will soon have $1m to invest in the sharemarket.  I feel confident in where to allocate the money, but I’m not sure what timeframe to invest it over. 

I know the research says that investing the whole lot straight up is best for returns on average.  But… damn, its going to be hard to actually do it! 

I’m considering 12 monthly investments instead.  Really interested in how you would approach this situation.  Thanks again.

 

Strong Money’s Answer:

Thanks for your support – much appreciated!

Like you, I wouldn’t feel super comfortable going all-in on one day either, despite the research saying lump-sum wins most of the time. 

So I don’t blame you for wanting to stretch it out – especially such a giant sum!  To be honest, I think I would go with a 12 month time frame as well. 

Longer than this and it really becomes a drag on returns.  Shorter than this and it’ll probably be quite scary or feel rushed.  I think your plan is very sensible!

Another approach that I like is to invest a percentage straight away – say 50% – and the rest over time as above.  

As you know, there’s no guaranteed outcome no matter which approach you take.  So picking one that you feel comfortable with and which won’t be a huge drag makes sense to me.  Hope that helps!

 

Question #5

My question is around investing in shares vs peer-to-peer lending.  I have over $100k in A200 (40%), VTS (30%), and VEU (30%).  I also have $10k in RateSetter earning 8% and $7k in True Pillars at 13%.

I’d like to keep adding to these.  It’s tempting to put more into True Pillars where I can get a
great return which beats any of the ETFs even with dividends taken into account. 

But are ETFs better in the long run because of cumulative capital growth?  Thanks!

 

Strong Money’s Answer:

The issue with P2P lending is the risk involved.  If we have a recession and a bunch of loans default, all of a sudden the return drops and there may be losses. 

The reason I like Ratesetter is because it has a provision fund to help cover against losses.  Sure, interest rates are lower than some other P2P lending platforms, so the returns appear lower.  But the risk is also lower.

While there are no guarantees, Ratesetter has returned every dollar of principal & interest to investors since starting 10 years ago, because of this provision fund.  Here is a recent Q&A with the Chief Risk Officer, talking about loan performance, defaults, and risk management for the Ratesetter platform.

I doubt the other providers offering very high rates have this sort of loss protection in place.  And I’m not sure if they have a credit risk team in place or the track record that Ratesetter does. 

I’m probably biased because I use Ratesetter, but I’m just cautious towards other P2P lenders for the above reasons. 

Also, without a provision fund, the other platforms need to have higher rates, to cover against future expected losses.  It might be okay over time, but I prefer a bit more certainty.

As for shares vs P2P lending:  Generally, I put more money into shares than into P2P for the reason you said, compounding long term returns.  I expect shares to beat other investment choices over the long term, after tax, when both growth and income are included.

While I like P2P lending for something interesting and different, it’s still not clear how these platforms will fare if the economy really goes off the rails (not that shares will hold up well either, mind you!). 

Plus, income from Aussie shares is tax-effective due to franking credits, and compound capital growth obviously goes untaxed until shares are sold.

As a final philosophical point, investing most of our long-term savings into productive enterprise (businesses), to benefit from increasing innovation and human endeavour makes the most sense to me. 

 

Question #6

Hi Dave!  Thanks again for all of your awesome contributions to the FIRE community!

I have quick question regarding franking credits.  To receive the franking credit refund, do I have to specifically claim the franking credits to receive an additional return on top of my normal tax return?

Or, is simply declaring my dividends and the relevant franked amounts (as provided on Vanguard’s statement, for example), sufficient to receive the full benefit of the franking credit?

Apologies for the rather nooby question.  I just want to ensure I learn everything from a young age and make sure I’m not missing something when it comes to getting a franking credit refund.  Jack.

 

Strong Money’s Answer:

Really appreciate the feedback Jack!  You pretty much nailed it.  As long as your dividends and franking are filled out in your tax return, that’s all you need to do.

The dividends will add to your income total.  The franking adds to your income total and also to your total tax paid.  The tax office then works out your overall income level and overall tax paid and see whether you’re entitled to a tax refund or not.

Basically, if you’re on a tax rate higher than 30%, you won’t be getting a refund (since 30% is the company tax rate and the value of the franking credit).  The franking credits will just reduce tax on your dividends.  If your tax rate is under 30%, you’ll get the difference as a refund.  Hope that helps.

 

Question #7

Hi Dave.  Just wondering what your thoughts are on dollar cost averaging into the geared share fund by Betashares ‘GEAR’?

As an alternative to debt recycling or using NAB Equity Builder?  Thanks mate.

 

Strong Money’s Answer:

Hmm, I’m not really a fan of GEAR to be honest.  For a few reasons.  First, the gearing is very high.  Looking at the fund, it is very volatile for obvious reasons.  And management fees are 0.8%. 

I think in a nasty market fall of 40% or more, this one will be extremely hard to hold onto as it could be down 60-70% or more, depending on the leverage/margin call situation.  

As I write this article on the 9th of March, the Aussie sharemarket is down a whopping 6% today.  This fund is down over 16%.  That’s just for one day! 

In fact, since the 21st of Feb, this fund is down 37%.  Sure, the market is down about 17% or so.  But GEAR is another level of volatile.  Almost nobody has the stomach for that!

UPDATE:  GEAR is now down almost 50% in the last month alone! 

Amplified long term returns might look great on a spreadsheet, but I don’t think many investors can stick with this one through the bad times, compared to a plain vanilla index fund.

And I don’t know what the structure of that debt is, but I’d bet it’s much less controllable than having a basic residential home loan. 

Plus, the distributions are also all over the place.  They’re saying it returned 12% in income in the last year.  Dunno how that works but that won’t be tax effective at all.

I’d rather keep it simple with a cash portfolio or using some debt attached to property if one wants to be more aggressive.  The market is volatile enough for most people without adding a fund like this. 

 

Notes

I hope you enjoyed this Q&A session!  We certainly had some fantastic questions to discuss. 

After the sharemarket’s brutal month, I have a feeling there won’t be many questions about using leverage to “boost returns” for a while 😉

Feel free to share how YOU would answer these questions in the comments below!

And if you have a question you’d like me to answer, you can get in touch through my Contact page and I’ll do my best to get back to you.

 Thanks for reading!  If you’d like to receive future articles and updates, you can sign up here.

27 comments

  1. NAB Equity Builder question was interesting. Nearly pulled the trigger on this product but recently ended out going with State Custodians for a LOC against our PPOR as has much more flexibility, better interest rate and lower fees.

      1. Just FYI, I called NAB for an equity builder application pack Fri 20 June and the friendly guy told me that they’d receive 9 mths worth of applications in the last 3 weeks. Read into that what you like, but I decided not to leverage.

        1. Thanks for the info Giles. Very interesting. I’ve actually heard they’re not taking new applications at the moment (perhaps because they’re running behind with processing as it sounds like from your comment?).

          1. Fair point, I should have read all the comments on this post before adding. So the online application is down, because they are trying to process the backlog before the end of June, but I was told that if I posted in an application from soon, they should get it done by the same time. The NAB guy also expressed doubt re the optimism in the sharemarket, particularly since many companies haven’t reported earnings yet?

  2. I Love this topic. Thank you. Here is another question for you. My son is eligible to receive the 750 dollars to help boost the economy. He has just finished a uni degree and is on newstart while applying for graduate positions. We have discussed spending it in the local community and supporting local business beer , cafes restaurants,etc. We live in the yarra valley, not a lot is manufactured here, other than wine and some craft beer, oh and gin! Do you have any advice how best to spend or invest this cash that would help the economy the most. Will buying Australian shares help boost the economy? He has just started a ratesetter account.

    1. Hi Dave

      Enjoyed your insights once again. I just wanted your further thoughts on DCA vs lump sum investing. If someone had 1 mil and bought MLT this past week for $3.90 they would be a lot better off than someone who has been doing DCA monthly for the past 12 months where every entry price would have been much higher. Sometimes I think timing the market is also important

      1. Hey Ken. Sounds like a fantastic plan, but the problem is nobody had any idea the coronavirus was going to derail markets this year! So how could you possibly hold off the last 12 months of purchases because you imagined this scenario happening? That’s fantastyland stuff.

        There are always cases where we can look back and see what option would’ve been better, but unless we have a crystal ball, we’ll never get it right and regular buying makes the most sense to me. Especially true for those who are trying to build a portfolio for FI.

    2. Interesting question! Given he’s just starting out in the world, I think saving at least some of this windfall makes sense – an economy is more fundamentally sound when its people are in good financial positions themselves. And if the goal is boosting local business, then I think some purchases of craft beer and the like might be in order 😉 Other local shops and businesses also benefit from using their services, even if their products aren’t necessarily manufactured locally.

    3. RetroMum treat that one off windfall as a gift to mark a turning point in his young life.

      Spend it on developing a life long skill such as public speaking, job preparation course or a foundation financial life plan on how he can achieve his future life & financial dreams. (ie Global Travel, marriage, children, home ownership, Overseas work, post graduate studies, career change, philanthropy, financial security, early retirement.)

      Don’t squander the money on a new LCD TV or nextgen game console that has no lasting value like the $1K handout by Labour Government during the last crisis.

  3. Hi Dave, great content as usual. Just a comment for the gent that’s looking into estate planning. It is really worth seeing a professional accountant here as there are some very effective ways to achieve your goals. For example having a discretionary trust set up with the kids as beneficiaries can avoid any cgt events on succession because the trust just continues to operate after death. It is also more tax effective as income can be distributed with discretion between the beneficiaries to equalize tax brackets in the most efficient way.

    Thanks
    Mike

  4. I just read the first question. I really don’t think you should be advising people to put all their money in Australian dividend stocks. Many of them have a ‘yield’ but little capital growth. Many have in fact fallen. Compare businesses which reinvest in R and D and those that churn out dividends. Eg CSL v the banks.
    Plus you can question the need for a 100K per year portfolio in the first place.

    1. Hi David. I’m not sure you read it properly. I didn’t ‘advise’ anything. The question was about creating a hand-me-down portfolio with an income target in mind, saying “I have some ideas already, but I’m curious, how would YOU do it?” So I told him how I would do it. That’s it.

      Of course, we can question the need for $100k per year, but that wasn’t the question so I left that alone.

      Yes, most Aussie stocks have fallen this year… so have most stocks globally. CSL is an Aussie stock, so if he was buying Aussie stocks, he’d get both. I get what you’re trying to say, but I wasn’t saying avoid CSL/growth stocks. I simply stated if I had an income target in mind to hand down a simple portfolio, then I’d probably invest mostly in Aussie shares because the MARKET has a higher income overall (all stocks included). But if I was working with larger amounts of money, then the lower income yield from international shares wouldn’t be a concern at all. Others may decide differently and that’s okay!

  5. Enjoyed the article again mate. Especially anything to do with the NAB EB.

    I use this facility and I have got to tell you so far so good. I have great flexibility with the account and any extra money I pay off I can have back in my account within a day (which I had to do recently). I have a high tolerance for what a lot of people think is risk (I personally don’t think shares are risky because I am comfortable with how businesses work. I also have a high salary which makes things obviously easier.)

    The NAB EB allows you to leverage and get your hands on a larger amount of shares earlier on and make better use of the dividends and franking credits (now is a great time to buy and leverage). You can use the shares you already have or a cash deposit as collateral and no margin calls which is obviously the main reason to use it. Easy to set up and no account fees.

    The only problem I can see with it is with investors with a low tolerance to risk and market moves and someone sells at the wrong time (this could happen anyway with unleveraged shares). The main problem I am having at this stage is that since the market value of the shares has gone down I can’t use that equity anymore to leverage and buy a lot more when the market is down. The way I am getting through that is by pulling my extra capital I have paid off the loan, putting it into my Selfwealth account, waiting until I have a decent parcel and then I can use that money to leverage again through NAB without the capital diminishing in the meantime while I wait for a large enough parcel before pulling the trigger. In the early years of a portfolio your savings rate will have a larger impact than investment returns anyway so the quicker you can get your hands on a decent sized portfolio and pay it down as quick as you can the quicker compounding will start working for you. At the end of the day people around the country take out huge loans to buy a property (all eggs in 1 basket, high maintenance costs & not tax effective at all), why not just do the same but with shares instead (more diversified, tax effective which helps pay the loan down quicker & once bought has no extra overheads to worry about ever again. I would never buy property again knowing that I can do this instead. I’ll just wait 20 years and buy one with cash if it means that much to me to own a house, however I can’t see that happening. I understand everyone has a different tolerance to risk though and obviously different savings rates that they can achieve but I thought I would just add my 2 cents from my experience using the facility. Also if I continue to work full time this allows me to achieve FI in 4 years instead of 10 just saving the regular FIRE way. However I’m going to do COAST FI (because life is more important) and work 12 weeks per year and achieve it in 6 years instead. If I get stuck financially I have the option of going back full time.

    Look forward to your NAB EB blog post. I hope you use a few examples of how powerful this facility can be if used correctly.

    1. Thanks for your thoughts Ben! Good to hear about your experience with it. Like anything, there are pros and cons, so I’ll do my best to give a balanced view, while also giving my opinion 🙂

    2. Hi Ben, very interested to hear your experience with NAB EB. I was all ready to sign up for this, then they withdrew accepting new applications. Apparently their team that processes the applications has been stood down and they won’t accept new applications for at least 4 weeks (I believe this will be longer). Just wondering what your application process was like, how much could you borrow? Did you just ask for the max amount possible? TIA, Andy

  6. Thanks for a great post as usual Dave. I’m also looking forward to the NAB Equity Builder Post. Noel Wittaker likes the product: https://www.noelwhittaker.com.au/essential_grid/borrowing-for-shares/
    I feel it works for me as it allows me to take advantage of cheaper shares now (and maybe they’ll get a bit cheaper!) rather than using only my limited cash dry powder. Even in a normal market environment it seems to make sense as how can it be worse than buying property with a 2% yield (if you’re lucky) compared to say a 4% yield on shares (not including franking), since in both cases the interest is tax deductible? Of course the big issue is volatility and I guess this what you mention above. Looking forward to the review!

    1. Cheers Greg! You’re right, it definitely lets you bring forward a decent amount of purchasing vs using cash.

      The property ppl would likely argue that with property you’re easily leveraging 5×1 or 10×1 since you can comfortably get a $500k investment loan. Cashflow is horrible obviously, but the higher leveraged capital growth (ideally) makes up for that. I’m not arguing either way, but that’d be their comparison rather than looking at yield.

    1. I’m not. I don’t think that makes sense at all. That assumes we know when the market is going to recover – we don’t. The market may continue to fall, or it may start recovering from here, nobody knows. By selling now, you’re locking in losses and guaranteeing to lose money by staying in cash and earning nothing, losing to inflation every year.

  7. Hi Dave,

    Another excellent post as always. Please keep the good stuffs coming!!

    I very much look forward to your upcoming post of NAB EB. I was actually contemplating in using it. Now thanks to you, I don’t need to do all the hard yard work lol

    My plan was to keep one IP and use its equity to buy shares. So I can’t wait for the release of this post!

    Take care!
    Gordon

  8. Hi Dave,
    Late last year I found your website, around this time I also started to read up on Peter Thornhill a little bit. I’m that guy who had a 50/50 split between just WDIV and VHY, from memory “Your Questions Answered #3” was the last and only post of yours I’ve commented on. I’ve ended up swapping out VHY for BKI and now hold equal weighting between WDIV & BKI, this was done Pre Corona virus saga. I still hold WDIV, I just can’t bring myself to ditch WDIV I’m someone who feels most comfortable with some international diversification, this fund still offers both yield and some growth with an acceptable MER. It’s far from perfect but for my piece of mind it does the job.
    Recently I’ve been considering diversifying between different fund managers as well as tilting my portfolio more towards Australian shares. The two funds I’ve been trying to decide on are DUI and ARGO, to me these both have different benefits.

    DUI Pros,
    • International diversification in a different way to WDIV, more growth focused and doesn’t just allocated based on a set of rules.

    • Although still dividend orientated I believe DUI to focus on growth more than WDIV and BKI, to me this seems like a nice counter balance to these two funds.

    • Can regulary be brought at a discount to it’s NAV.

    ARGO Pros,
    • From a diversification view point this LIC has less exposure to the big 4 banks than BKI, to me this is good from a diversification view point.

    • Argo has a larger amount of holdings compared to the more concentrated BKI, to me this is also good from a diversification view point.

    • Although not quite to the extent of DUI, ARGO still seems to be more growth orientated than WDIV and BKI.

    I’m also waiting until I think the market has bottomed out enough, I’m not going to stop my DRP setup or sell anything to buy at a lower price. Regardless I still feel the need to hold out for longer until I put anymore money into the market. This should give me plenty of time to decide. On the off chance you feel comfortable enough to give out and opinion on such a specif question. What are your thoughts on WDIV, BKI, DUI vs WDIV, BKI, ARG in equal weightings?

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