March 14, 2020
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)
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.
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).
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.
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?
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.
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.
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.
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.
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!
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!
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.
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.
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.
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.
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.
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!