LIC & LIT Money Offsetting IP Loan or Invest in LICs

Looking to throw one out there if someone is keen to do some hypothetical modelling:

What is the tipping point, to take savings offsetting a loan on an IP, and using these funds to invest in LIC's (e.g., ARG, AFI, BKI, MLT, WHF)?

Assumptions:
$500,000 IP Loan
$100,000 in Offset
4.0% or 4.5% Interest Rate
Nil non-deductable debt

LIC's yielding 5.7% (inclusive of franking)

How might this pan out for each respective tax bracket?
35%
39%
47%

Simplistically, without taking into consideration an individual's tax bracket, it'd make immediate sense to use the offset funds as the income from yield > interest... however when you throw in:

• Tax Deductible Debt
• Different Tax Brackets

The decision-tree to place offset funds into LICs is a bit blurred.

On the flipside, what would be the point of diminishing returns if you were to take a loan out to invest in LICs?

 

The money in the offset is a guaranteed after tax return vs the LICs which are a before tax return with some risk.

Oops, just realised this is for an IP:

I'd keep the IP neutrally geared and invest in LICs with spare cash.

 

It doesn't have to be all or nothing.

You can invest any amount into LICs or other shares for that matter. If unsure, start by putting some of the offset money into the share market, even just $5K to start or whatever amount you are comfortable with. See how you go. You can add to it as you want.
Marg

 

Is this the scenario you are contemplating? I've assumed the LIC income is fully franked and therefore that tax payable is the marginal rate selected minus the company tax rate.



If I've worked this out correctly the return from the LIC investment more than offsets the additional interest paid.

 

I try to think about it in a simplistic way.

With interest rate of 4% and gross dividend of 5.7%.

Your cashflow profit is basically 1.7%. This is what you'll pay tax on.

So then deduct tax for each scenario.
35% bracket means after-tax positive cashflow of 1.10%, plus growth
39% bracket means after-tax positive cashflow of 1.03% plus growth
47% bracket means after-tax positive cashflow of 0.90% plus growth

If you assume earnings/dividend growth of 3%, you reach positive returns of roughly 4% above current cost of the loan for each scenario.

What the share prices do is anyone's guess. But eventually they will follow earnings/dividend growth.

That's how I look at it. Hope that helps

 

Thank you @Martin73 and @Snowball in particular for working these scenarios through. It gives me something to work in re: tipping more into the share portfolio

 

All good - I needed to work through a similar scenario in 2017 and ended up (with assistance and advice from others on this forum along the way) converting an IP into a mix of LIC/ETFs. Don't get me wrong I'm still a fan of property investment but there are other investment classes which can be low risk and deliver stable returns without the hassles of a managing agent ringing me to say they spent $200 on a plumber to change a tap washer.

 

The problem with the scenarios modelled is that they make no allowance for share market fluctuations. You must take into account the very real possibility that your capital will be eroded in a share market fall. Equally, you may get lucky and enjoy a rising market.

Just be aware that you are taking that risk.
Marg

 

Being conservative I generally only tend to use leverage for equities when their a screaming bargain not for general Accumulation. And even then I like to keep the leverage conservative. Much greater margin of safety then if things go pear shaped.

Very hard to model these scenarios which is why I take a very conservative approach to leverage.

 

Nodrog - how do you define conservative leverage?
You have done well in your journey and I am wondering what your use of leverage has been. Did you ever get into property & borrow 80% or have you just slowly chipped away through the use of savings and limited leverage.
As always, thanks for your insights

 

I don’t know about @Nodrog but I consider 30% to 50% as conservative; up to 80% as aggressive and 80+% as stupidity.

But I am conservative .

 

Do people generally count their PPOR when quoting individual leverage or just leverage on investments?

I’m aware it’s certainly used by lenders to determine security and borrowing capacity, just wondering how people benchmark themselves individually. For example, I am at 75% on investments but 50% if I include PPOR.

 

Personally, I have always separated my PPOR from my IP's in relation to leverage. This gave a more honest and realistic measure of where I was in my investment journey. In saying this, putting down 30 per cent as a deposit has been mandatory for me. Conservative I guess in some peoples eyes, however, it has worked for me and given me the SANF.

Cheers.

 

Like it. I do the same. The only way to truly understand if the IPs are performing.

Also keeps your PPOR one step out of the IP risks.