BORROWING to invest has fallen from favour, despite the numbers surrounding it now stacking up better than ever.
Horror stories from the global financial crisis – where retirees lost their houses after dodgy advisers told them to use aggressive home equity loan strategies to buy shares – have haunted the psyche of many Australians.
Reserve Bank data shows that margin lending – once popular among investors – is still at less than one third of the levels achieved during the sharemarket’s peak in 2007.
Indeed borrowing to invest is not for the faint-hearted and you will need to do your research or talk to a financial adviser. However, today’s low interest rates and high share dividends present a compelling argument for borrowing.
When you can borrow money at less than 5 per cent to buy a blue-chip share that is effectively paying 8 or 9 per cent a year in income, some investors see it as a no-brainer.
‘I can’t see why you wouldn’t do it, as long as you are not going to be a forced seller,’ says Middletons Securities adviser David Middleton.
‘Borrowing improves your cash flow – it doesn’t make it worse,’ he says. You can’t claim for negative gearing, but it’s better to pay tax on a profit rather than get a tax deduction for a loss.
Borrowing magnifies investment losses and investment gains, so it must be a long-term investment. For investors who borrowed before the GFC, that ‘long-term’ is stretching towards a decade because the overall market’s value is still well below its 2007 peak. If you can stomach the volatility and look long term, here are some options:
Borrowing against your home gives you the lowest interest rate and the most secure loan. As long as you pay the interest it’s all good.
People who lost their homes in the GFC typically borrowed against their home and then borrowed again through a margin loan, coming unstuck by this double-gearing strategy when share prices halved.
You’ll pay higher interest than a mortgage and your shares are used as security, so if they fall too low you get a margin call – where you have to stump up extra cash or your shares get sold from under you.
Margin lenders generally allow borrowings up to 70 per cent of a share’s value, but Middleton says it’s best to limit your debt to no more than 30 per cent of the value so you can withstand a significant downturn without suffering a margin call.
Geared share funds take your money and typically borrow against that so you own twice the shares you could otherwise buy. This means you can win big and lose big.
‘You can get very volatile valuations from these because they amplify returns,’ Middleton says.