By MARY HOLM
Q: We recently repaid our mortgage. The repayments were $600 a month. We can borrow on this mortgage. Would you recommend we draw down, say, $50,000, buy a mix of international shares, and continue to use the $600 to repay the mortgage?
Would dividends cover the mortgage?
Would this be better than joining a scheme to buy the shares that we put $600 a month into?
Would you consider this similar to borrowing to buy a rental property, or much more risky? Maybe even too risky?
We are in our thirties and have two children.
How would you rate this in the short and long term?
A: I like the idea of your investing in international shares.
I'm not so sure if you should borrow to make that investment, or whether you should go with your less risky option, of putting $600 a month into a share fund.
Whenever you borrow to invest in anything - be it your home, shares or emus - you up the ante.
If you do well, you do really well. You start with more money so, if it grows, you'll end up with much more.
But if don't do well, you bomb. You can end up in debt with nothing to show for it.
And borrowing to invest in shares is generally regarded as riskier than borrowing for a rental property.
It's more likely, especially over the short term, that the value of your capital will fall - although that's certainly not unknown on rental property either, these days.
Despite the risks, you're not the only ones thinking about borrowing to make a share investment, as mortgage interest rates fall.
And you two seem to be in a strong position to take on risk.
This is especially true if you both have fairly secure employment, or could find other jobs if you lost yours.
Also, you're used to paying $600 a month, so you're not counting on the investment to bring in income to repay your loan.
At current mortgage rates, you could borrow $50,000, make monthly $600 repayments, and be out of debt in about ten years.
But have you got the right personalities for this game?
Picture this: You borrow $50,000 to invest. Six months later, that investment is worth $45,000. Six months after that, it has dropped to $35,000. But you're still paying off a $50,000 loan.
And you'll get very little help from dividends. While international share prices tend to grow faster than New Zealand ones, the companies tend to pay much lower dividends.
It's likely you'll get no dividend income if you invest through an international share fund, which I would recommend. The fees tend to swallow the dividends.
So what would you do when your investment hits $35,000? - A: Panic and sell the shares, repaying part of the mortgage but accepting the fact that you now have a $15,000 debt and no new assets? Or B: Shrug your shoulders, tell yourselves that downturns happen with share investments, and hang in there.
If you answered A, forget about borrowing and put $600 a month into a share fund.
You'll have less money at stake, so you should be less likely to bail out in the bad times.
And whatever you do, don't bail out. The share market has always come back.
Those who pull out during slumps live to regret it.
If you answered B, then perhaps you've got what it takes to borrow for long-term share investment.
But you'll gain only to the extent that your returns are above the mortgage interest you're paying.
You'll be able to deduct that interest on your tax return, which helps. If you're in the 33 per cent tax bracket, for instance, an 8 per cent mortgage will cost you about 5.4 per cent after tax.
Historically, returns on shares have averaged a fair bit more than that. In New Zealand, from 1961 to 2000, they averaged 10.8 per cent including dividends.
But many experts say average returns will be somewhat lower in future.
You could end up living through some worrying times, and not gaining vast amounts over all.
Perhaps you should start out with a $10,000 or $20,000 loan, and see how well you cope with it.
Q: I've followed your debate with the writer of the share newsletter with interest.
You say that if a third of a portfolio falls and two-thirds rises you will do well. But what if "the balance tips the other way for a while."
Surely this is just how it goes in share investing. Your preferred index funds will also "tip the other way" when the market does.
So what if some subscribers don't invest in "the lot." Some might do better - for example, by avoiding airlines and rural companies.
In the end it comes down to whatever you are comfortable with. And, ironically, the more people you convince to use index funds the easier it will be for others to outperform them.
As regards your comments on tax on New Zealand shares re the newsletter advice, please check your advice on this with your pet tax expert. Two accountants I spoke to say few people pay capital gains tax on shares.
I know only two - one a local sharebroker who has a separate account for trading; the other is a charitable trust.
The trust has $60 million. Of that, $50 million is invested so as not to attract capital gains tax and $10 million is traded by a sharebroker, and is therefore taxable. The non-taxed part has been audited by IRD and is okay.
So far the active part is outperforming the index, after tax and fees.
I fail to see how the newsletter advice would worry the IRD.
If you invest for the income then surely you can sell if:
the share goes up so much that you could get more income elsewhere; or the company does not do well and reduces dividends.
A: You certainly can sell your shares, whenever you like.
And if you're merely "rearranging your portfolio to enhance your dividend yield," Inland Revenue might well not tax your capital gains, says KPMG tax partner Craig Elliffe, the "pet tax expert" I rang.
But if you were audited, you would need to clearly demonstrate to the IRD that you bought the shares for the dividend income, rather than "for the purpose of resale," he says.
And that might be a bit tricky if you've got a history of buying and selling shares according to recommendations in a newsletter.
While the situation isn't quite the same, Mr Elliffe is reminded of the National Distributors case some years ago in the Court of Appeal.
"There weren't that many sales and purchases of shares, but the taxpayer lost," he says.
He agrees with you that few people actually pay tax on gains from share sales. But he also agrees with what I said a couple of weeks ago - that's mainly because the IRD doesn't know about them. And you never know when it might suddenly take an interest in you.
Mr Elliffe adds that he's a bit puzzled by your comments about a charitable trust. They don't pay any taxes, he says.
On your earlier point, that share portfolios rise and fall regardless of whether you're in individual shares or an index fund, you're right. But I've never said anything different.
You're also right that newsletter subscribers who avoid certain shares may do better than those who don't. They may also do worse. Airline shares might well be a great buy at the moment.
The main reason I favour index funds, and in particular worldwide ones, is that you get a broader spread of shares than anyone can get with their own portfolios. And a broader spread means lower risk.
Some of those who take the higher risk route will do better than the index. Your charitable trust's $10 million fund is just one example.
But research shows that not many investors keep outperforming the relevant indexes over the years.
I agree with you to some extent, that people should do what they're comfortable with.
But I wouldn't be comfortable expecting to stay among the outperformers indefinitely.
Nor would I feel too comfortable if I followed newsletter buy and sell recommendations and caught the eye of Inland Revenue.
Q: I can no longer remain silent about the rubbish that I have been reading lately in your column. Written by pompous people with sensitive egos.
I am left cheering at the literary dexterity with which you foil their barbs.
Your advice is quality. It is supported by other financial publications I consult, and it is always fun to read, especially when you are slaying dragons. Your column is 80 per cent of the reason I buy the Herald on Saturday, so please keep up the good work.
As that famous TV actor with the bald head and the lollipop used to say, "Love ya, baby."
A: Thanks, Dad!
Thanks, too, to the bloke who suggested I set up a comedy section for some of the material that has been in the column lately.
While I appreciated the idea, and your other thoughts, I decided not to publish your whole letter. It's time to let sleeping dogs lie.
* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.
<i>Money matters:</i> Borrowing to invest: a real test of nerves
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