Building Offset vs Investing in Shares

Discussion in 'Investment Strategy' started by Bon_E, 27th Oct, 2020.

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  1. Bon_E

    Bon_E Well-Known Member

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    Hi everyone,

    I'm hoping you don't mind me using you all as a sounding board for my brain ramblings :D When thinking about our future financials, I had always pictured my partner and I getting to the end of acquisition phase and then just putting all of our surplus cash into our offset accounts, until all of our properties end up fully offset.

    Recently I had a thought as to whether it would be better to invest all/a portion of this money into shares instead as it may be possible to earn a return greater than what we are "earning" in our offset accounts. I've modeled the two different outcomes in my master spreadsheet and the results were quite significantly in favour of shares (even once tax implications are factored in).

    Basics:
    • We both earn a high income (circa $450k combined before tax)
    • In our early 30's (me) and early 40's (partner). No babies on the cards.
    • Currently have 5 investment properties between us... these are now positively geared with the low rates.
    • No PPOR as we move for work every 1-2 years. We have one of the IP's picked out as our PPOR for when we retire.
    • Happy to keep working for another 15-20 years
    • We have seen a financial advisor but it was early on in our journey, and they were heavily biased towards property. We'll go to see another one once we have done some more thinking about it ourselves.
    Current thoughts:
    • Build up a cash buffer in our offset of a nominal amount that makes us feel 'comfortable'
    • From then on start putting surplus cash into the share market (enter more research and financial advisor)
    • I've modeled this in my wealth projection spreadsheet based on a return of 6% which I'm hoping is conservative-ish
    • We do appreciate that obviously investing in shares carries more risk than hoarding cash

    I know a more tax effective strategy would be to purchase some quite heavily negatively geared property in the hopes of good capital gains over the years, however it's not something that we're comfortable with (our jobs, although high paying, can be pretty transient and we're not comfortable with the thought of being in a position with huge financial obligations each month and no income). We're happier at the thought of chipping in surplus monies to shares when we have it available... that way if the **** hits the fan we can stop the contributions and we have our buffer to fall back on.

    Any advice or thoughts? Things I may have missed in my calculations or assumptions?

    Thank you team!
     
    Last edited: 27th Oct, 2020
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  2. MB18

    MB18 Well-Known Member

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    If you have five properties and zero shares you have basically answered the question yourself.

    I'll put it to you that property (and cash depending on the circumstance) is far more risky than shares, albeit shares are more volatile as you would expect with instantaneous pricing vs that for property.

    It's a personal view point, but I don't believe that negative gearing in the hope of future capital gains is a sound investment strategy, and remeber too that shares can also have various tax benefits.

    I've mentioned it on here before but check out Motivated Money by Peter Thornhill (Australian author). The book is pretty light reading and wont take more than a couple of hours.
    It will go someway to dispell (or at least make you question) some of the myths around property vs shares.
     
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  3. Codie

    Codie Well-Known Member

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    When you say 5 properties do you have a PPOR or are they all IPs?

    Your both on great incomes, I personally see loading offsets as a waste and not very tax effective

    Very quickly if it was me id be looking to purchase a well located PPOR, pay it off & borrow against it, Deploying the funds into the share market into a mixture of growth and dividend paying shares. You also have the benefit of a tax free growth asset.

    Pretty common strategy I think a few on here do this type of setup, you can really super charge your wealth.
     
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  4. JasonC

    JasonC Well-Known Member

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    If I was you I would certainly be looking at diversifying investments into shares. Your plan sounds good (ie. building buffers, invest in shares).

    Are you putting any money into super above the compulsory employer amount? That is a tax efficient mechanism for additional investments. You could look at topping this up if you are not already doing this.

    Are you likely to need to upgrade your PPOR in the future? If so, you might want to use borrowed funds for the share investments (assuming you have equity and serviceability) and immediately offset it with the equivalent cash. That way if you ever need to redraw the cash for emergency expenses or to upgrade a PPOR then interest on the loan should still be tax deductible.

    One other thing you might want to run the sums on is the best structure to hold your share investments. If it is in personal names and you are both in the highest tax brackets then you'll be paying high tax rates on the income from the shares. If you setup a discretionary trust then you have a choice each year where to distribute the income - including potentially to a company which would pay a lower tax rate.

    If investing large sums it would be beneficial to get some proper tax/structure advice.

    Just my random thoughts (not advice etc etc).

    Regards,

    Jason
     
    Last edited: 27th Oct, 2020
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  5. Bon_E

    Bon_E Well-Known Member

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    Thanks MB18. I will definitely have a read! And I agree, I think it's time we should think about putting our eggs into a few different baskets :)
     
  6. Bon_E

    Bon_E Well-Known Member

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    Hey Codie!

    We don't technically have a PPOR at this stage as we move around for work every 18 months - 2 years, so we're forced "rentvesters". We are taking advantage of that in a way - our final PPOR will be one of the IP's, to be honest we would have a hard time choosing as there are a couple of good ones in there! So we luckily don't have to take on any non-deductible debt.

    Thanks for the tips.... I'll start doing some more research into what a good mix of growth/dividend shares would be!
     
  7. Bon_E

    Bon_E Well-Known Member

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    Hey Jason! Thanks for the comments.

    Unfortunately we are both being stung with Division 293 already (additional tax payable on super for high income earners), and there doesn't seem to be a way to avoid it. So I don't think in our case there is a tax benefit in contributing voluntarily pre-tax as the ATO still gets their hands on it anyway :(

    I should have mentioned in the post, we don't have a PPOR because we move for work every 1-2 years, but one of the IP's will be our final PPOR, but happily the interest on it is tax deducti ble at the moment :D

    Interesting thoughts on the equity I'll look into it...
     
  8. Codie

    Codie Well-Known Member

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    You might be interested in reading through Terry's tax tips on this site, it may help you understand timing in regards to moving back into an IP eventually, IE the 6yr rule etc - Keeping 1 property CGT free is always a great idea in my view.

    The share page on here is great, ETFs vs LIC's etc Im personally only going to stick with 4-5 properties myself and am fully focused on building a substantial share portfolio over the next decade. (targeting growth share's first) On your incomes id say you have many many options.

    Keep us posted.
     
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  9. Bon_E

    Bon_E Well-Known Member

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    Will do! I'm a bit surprised that the thought of shares hadn't crossed my mind earlier, but better late than never! Heading over to sus out the share pages now thanks for the heads up.

    I agree, I don't think we're going to want to buy/hold more than these 5. We might do an occasional flip though as we both love renovating!
     
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  10. Fargo

    Fargo Well-Known Member

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    I dont think you need dividend paying shares if you are earning such a high income. I would buy shares so you can grow your asett base . I consider them more tax efficient and much less risky than the large opportunity cost risk you have with cash and just as liquid. Have some defensive stocks which will probably be good dividend payers you can sell in a down turn if you need funds . For example. I have 25% RFF in the account I draw on and they have risen by nearly as much in the last 2 days as the market has fallen. With shares you can keep your gains and let them compound away, while you can sell ones that have little gain, or a loss, which offsets gains for tax free income, or you can get a 50% CG tax discount. Then if you wish you can put chunks of Tax free money in your offset which may then give you cash flow from your property if you dont want them negative geared. Or even enable you to buy a cash flow property, while the value of the shares you keep continue increasing by as much as the loan perhaps every 3 or 5 years.
     
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  11. Bon_E

    Bon_E Well-Known Member

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    Thanks Fargo. Lots for me to think about! Definitely need to do some research regarding the most tax effective strategy to set up a portfolio. Luckily we're still in the process of building up a comfortable buffer, so I have another 12 months to do lots of reading and talk to some professionals about it.
     
  12. Squirrell

    Squirrell Well-Known Member

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    Question. If you use money from the offset account, is it tax deductible? In practical terms you are borrowing the money so maybe yes, but technically you are taking it from a transactional/savings account that is in credit so maybe no?
     
  13. Bon_E

    Bon_E Well-Known Member

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    I wouldn't have thought so since offset accounts are savings not borrowings. Maybe if it was in redraw? Not sure :confused:
     
  14. Propagate

    Propagate Well-Known Member

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    I’ve gone through this scenario myself many times and always came back to the same thing, offset money is safe and easy, though not as exciting as shares.

    Shares need to perform much better than your current loan rate to put you ahead of just saving money in your offset account.

    I.E. lets say your loan rate is 4% and you put $1,000 into your offset you’ve effectively locked in a guaranteed return of 4% on that $1,000 (tax free effectively)

    If you put the same $1,000 into shares those shares would need to return 4% PLUS your marginal tax rate, i.e. on your incomes you’re in the 45c bracket? So if you had a share that gave say a 7% dividend you’d lose 4.5% of that in tax each year and end up roughly about the same as just putting the money n the offset. Sure, there’d hopefully be capital growth accumulating in the shares too, but effectively you’d need to be making a 6.5-7% return on your shares to get the same result as just saving in the offset (plus shares can also obviously go down too).

    I’m no expert so I may be looking at that wrong? Perhaps someone that knows tax & shares better can clarify my thinking? Last time I looked at it properly was several years ago when our loan rates were over 5% and I worked out we’d need shares to return 10% to get the same result as just safely banging cash in the offsets.

    Oh, I should say that’s in a PPOR offset, the calcs would be different in an IP offset if you have no PPORS as you’d be losing some tax deructibility from essentially paying down the IP loan in effect.

    For me, we decided we'd smash the PPOR down ASAP then start funneling any surplus in to shares, meanwhile max out the super contributions so we're diversified into shares somewhat that way.
     
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  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You are not borrowing money.
    But the offset is linked to a loan which was used to buy property - from what has been said here - and the interest on this loan will increase and be deductible against the property income.
     
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  16. Bon_E

    Bon_E Well-Known Member

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    I thought the same but when I modelled it out that wasn't the case. Mostly because the properties are positively geared now, so any reduction in interest paid (from offset balance increasing) means I pay more tax anyway, so it's not a tax free return of say 4%. If the properties were negatively geared I'd totally agree, and it would make sense to keep paying money into the offset until they became positive. But at that point to me it seems like the money is better spent invested elsewhere...

    By my maths... 4% loan rate and the property is positively geared, means that for each extra dollar that goes into the offset I'm only "earning" 4% less 45c/dollar = about 2.2%

    If I invest in shares that would say show a return of 7% per above, then I'd still show a return of 3.85% after the worst possible tax scenario which might be worth considering? Especially since there may be some ways to minimise tax paid on the shares...
     
    Last edited: 28th Oct, 2020
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  17. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    There is another strategy post that I wrote which I now cannot find. But if you remove cash from an offset and onlend it interest free to another entity you can shift profits to a more tax effective structure which can save the family group additional tax, plus all the extra income.
     
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  19. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  20. Bon_E

    Bon_E Well-Known Member

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