Gearing Strategy

Hi All,
I'm thinking about gearing into shares and would like opinions on my strategy.
I've been in shares before including geared share funds but got out of shares completely prior to the GFC and haven't held any outside SMSF since then.

At present, I'm thinking-

40k of own funds
60k borrowed funds secured against property
Split between 3 LICS (ARG,MLT,AFI)

Reasoning is-
- the biggest share market crashes have been circa 40%, so with 60%LVR you'd still be able to repay the loan in the event of such a crash.
-total dividends would cover P&I repayments so it could look after itself if need be.
-solid yield and reduced volatility of LIC's

Would probably average into the market at say 5k a month and dump more in if there was a big drop.

What could possibly go wrong?

Thoughts?

Thks

Willy

 

There is no rule to say the market can’t fall 60% or more.

Even with a 40% fall, you’d essentially be left with zero money if planning to sell and repay debt. (100k portfolio drops to 40k, repay debt, balance zero)

But in real time you’d get a margin call (if using margin loan) way before then so you’ll need to hold a decent amount of cash just in case.

And this cash itself is a drag on returns.

In a scenario like this dividends will likely fall quite a bit so will not cover P&I loan repayments.

Keeping it simple you’ll basically earn a profit between your interest rate and long term return. With a 4-5% interest rate you might get 3% after costs.

So for 100k of debt you’re maybe clearing 3k pa compounded. Not nothing but hardly a huge payoff.

Also likely some additional stress that could come with a leveraged strategy vs cash only, even if using home loan.

Not saying it’s a bad idea just some things to consider.

 

Why not just go 100% using loans secured against property and keep the 40% in an offset? Generally property loans dont have margin calls. Offset gives you a buffer for loan repayments. If your shares fall 50%, assuming theyre not speculative shares, selling is the last thing you want to do.

 

Or use the NAB equity builder cash funded which has no margin call & P&I ;-) Still end ahead ahead than using just cash.

 

Why would you sell if they crash? It is better to sell some if they rise, In a crash you get better yields, In a crash you should buy more shares, that's is when you could take out an equity loan or margin loan. If you are concerned about a crash and an irrational response consider getting a non recourse loan for 100k exposure to something like BRK . Not sure of the interest rates now but in the past 28k for interest, put options and fees ( only about 17k after tax) would give me 100k exposure to BRK. You could use your cash for that, and have some cash and the 60k borrowed against the property to buy in during a crash Buying in every 3 months might be more prudent then buying in every month. I wouldn't invest in ARG MLT or AFI . They are all the much the same with little diversity. they only have a yield of 4% wont even cover interest costs and they have little growth the price don't fluctuate by more than a $1 and are still the same price as 5 years ago. They hold too many financial stocks , what happens if jnterest rates go down or even negative. Negative growth and poor yield. If interest rates go up servicing your loans will increase and be more than dividend.. It would be better to invest in 5 of the best business's they hold off the top of my head SOL, NWL, RWC, CSL SHL and if you must be invested in banks MQG. There is a lot of crap in the LIC you mentioned if you dont want a market crash don't invest in the market, Invest in sound businesses.

 

I wouldn't plan to sell in a crash, but you have to have a plan for what you would do in the worst case scenario and that is that you end up owing more than the shares are worth.
The choice of LIC's isn't set in stone. If you can pick the 5 best companies out of hundreds (that will always be the 5 best companies) you need to become a fund manager.

Willy

 

The worst case scenario would be that you are forced to sell. Which you avoid by using property loans and keeping money in the offset.

 

I think you could do a lot worse. No margin call as loan is secured by property, diversified between three of the oldest safest LICs out there. Just follow your strategy of buying more and not panic selling if here is a downturn.

Also I wouldn’t think your dividends would fully cover P&I as you suggested? Those LICs are around 4% yield at the moment, that would cover the interest repayments but not the principal (depending on the rate you are borrowing at)

Also make sure you set up your loan as a separate split for easier calculating of interest deductions come tax time.

 

Best time to leverage up would be following a big downturn. Seems like you’re just getting interested as ASX is around GFC highs again..

 

Agree, leveraging would be a good way to find the extra cash to take advantage of a downturn.

Willy

 

I've been using leverage for my investment portfolio for some time but only the portion that's held directly (individual ownership)

I've been doing some comparative analysis on gearing a diversified share portfolio held directly vs an held in an SMSF.

Assuming both are structured with term loans, no risk of margin calls, serviceability, adhering to super safe harbour rules and other superannuation compliance rules and top marginal tax rate for direct holdings, SMSF wins (at least in spreadsheet land)

Lots and lots of factors to consider, but it's been an interesting exersise, basically comes down to tax rate (including franking credit rebates). CGT advantages in super would potentially juice the returns even further once accumulation stage completed.