Enhancing Those Investment Returns

Written By Russell Tym, Authorised Representative of MoneyLink Financial Planning, AFSL No 247360

The dramatic changes to superannuation rules have dominated discussion of investment planning issues since their announcement in the Budget. Yet with one exception they don’t come into effect until July 2007.

With June 30 closing in fast, tax reduction strategies for this financial year should be top of the agenda. Borrowing to invest and pre-paying the next year’s interest now is one of the most effective.

Interest on loans taken for private purposes is not tax deductible, but interest on loans for business or investment purposes usually is a tax deduction.

The Tax Office will also allow prepayment of expenses for up to thirteen months, so interest prepaid now for the next year is a tax deduction in this current tax year.

Investment gearing is fundamentally a wealth accumulation strategy. Tax deductions can be earned with a donation to charity but investment gearing has the potential to build savings and investments more quickly.

It enables the investor to earn returns on someone else’s money greater than the cost of borrowing it.

The success of the strategy depends on the investments chosen. Property is commonly used. Share based investments have done best over the last year with capital gains of more than 20 per cent. They should continue to do quite well over the coming years.

Investors can use borrowings for managed funds or direct shares. Because the borrowed money must be repaid in full even if the investments lose value it is important to consider the volatility of the investments.

Funds with sound growth potential and moderate volatility are a good choice. These also tend to pay a low income with tax advantages including franking credits, thereby maximising the tax benefits.

It could be argued that the reductions in the income tax rates announced in the Budget make investment gearing less attractive.

The annual tax savings will be reduced for higher earners who drop back a notch on the tax scale, but so too should the capital gains tax when the investments are sold.

Borrowing against a home or investment property provides the cheapest source of finance, at home loan rates. Loans can also be arranged against existing shares and funds or using a cash deposit.

Margin loans usually charge about 1 per cent more than property loans but using them avoids the need to mortgage a property. Margin loan lending ratio’s are up to 75 per cent on many shares and funds.

This means the financier will lend up to $3 for each $1 the investor puts in. This is plenty high enough to make the gearing effective. If the investments fall in value the loan to value ratio will rise. If it moves more than 10 per cent the lender will make a margin call.

Extra money must be invested to restore the previous ratio. Margin calls can usually be avoided by borrowing less than the maximum allowed against the chosen investments. There are no margin calls when borrowing against property.

Protected equity loans will finance 100 per cent of an investment and guarantee there will be no losses over a specified time period such as five years. This sounds very attractive but the interest rates are very high, typically 13 to 17 per cent.

One 100 per cent loan seen recently lends against a range of well-performed funds, and is managed to ensure no losses over five years. The interest rate is under 9 per cent. This looks an attractive package.

If geared investments earn 9 to 10 per cent per annum on average over the long term with the returns partly tax free, and the interest cost is lower and fully tax deductible, gearing can accumulate wealth much faster than simply investing cash amounts.

Gearing plans take some time to set up so those considering doing so before June 30 should speak to their advisers now.

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No investment advice provided to you.
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