The principles behind smart borrowing to invest

What makes a smart investor?

Australians are living longer and experiencing higher house-to-wage ratios. It makes good sense to consider how you can achieve a comfortable long term future.

Our recent webinar on borrowing to invest brought together financial advice commentator Noel Whittaker, REA Group’s Chief Economist Nerida Conisbee and NAB Equity Head of Sales Craig Saunders to explore what makes a smart investor.

Financial investment commentator Noel Whittaker summed up the panel’s attitude to moving forward financially: “I believe becoming wealthy is like a game of Monopoly. The aim is to get the most assets under your control as you can.”

The panel agreed on the importance of diversification and the basic steps to get a mix of performing assets. They also discussed the ins and outs of borrowing to invest in shares or property.

1. Define your goal

Most of us want extra money to create a better life for ourselves and our loved ones. Setting specific goals and a time frame for achieving them will help you build a realistic plan. The strategies you’d use to achieve each goal will probably look quite different, too.

Say your goal is that, in 10 years time, you’ll be receiving $100,000 p.a. in income from your investments so you can pay for your kids’ education and then give them a home deposit later on.

“Needless to say, if you don’t have the expertise to work this out for yourself and then put the investments in place, get the help of a financial planner,” NAB Equity Head of Sales Craig Saunders advises.

2. Compounding is everything

Compound growth means the more you invest early on, the greater your probable long-term return. Whittaker believes seven to 10 years is the minimum investment time frame because “property is going to have long flat times and shares will be volatile”.

3. Embrace good debt

When borrowing money, Whittaker urges us to remember the difference between good and bad debt. “Winners borrow money for things that will increase in value. This means buying or improving an asset that can grow in capital value. You also need to be aware of which investments are tax deductable and which aren’t.

“Losers pay high rates of interest to borrow for things that have no long-term value and no tax deductions – like clothes, a car or holiday” states Whittaker.

4. Shares or property?

REA Group’s Chief Economist Nerida Conisbee points out that every investment decision has good and bad points. “If you borrow to buy property, it’s tangible, you get rental income, you’ve got the potential of capital gain and it doesn’t have the volatility of shares.”

Whittaker points out that if you borrow for shares, you can start with $1,000 and very low entry and exit costs. “Shares are liquid, the income can have franking credits to make it highly effective for tax purposes and you can diversify easily.”

Both agree that when weighing up what will suit you best, you have to factor in set-up costs, regular fees and any costs associated with an investment class, as well as loan interest rates and the capital gains tax you’ll pay down the road.

Include all these factors into your calculations and Whittaker believes “long term, shares have greater potential capital gain than property”.

5. Tips for borrowing to invest in shares

Saunders reminds us that most people already have a substantial investment in property – their home. Drawing down on their mortgage to invest in diversified asset classes may be a practical solution.

“It can be an effective way to build your equity so you have more money working for you sooner,” he says.

Saunders explains that most lenders, including NAB, strongly recommend that you invest your loan in diversified funds. “To protect your investment, the approved vehicles are diversified assets like managed funds, EFTs and separately managed accounts.”

6. Tips for borrowing to invest in property

Conisbee says the vast majority of people buy property for capital gain rather than yield.

“Capital growth has been most prominent in capital cities, while the best yield tends to be in regional areas, so you have to know your goal before deciding where to invest,” she says.

Conisbee points out that another issue to consider is that capital growth has been highest for houses rather than units. “Houses have performed better simply because there are more units than houses being built.” She adds that REA’s search data reveals people still want to live in a big family home on a big block.

“People are willing to trade lifestyle to get it. And that’s behind the price rises in regional cities like Hobart and the Gold Coast.”

7. Maintain a safety net

The panel emphasised the need to maintain a safety net – or not to over-leverage. As Whittaker points out: “Borrowing magnifies whatever is going to happen.”

It’s also important to remember that, whichever asset class you choose, over time it will include dips as well as growth.