To create wealth, you need a dollar to make a dollar. $5000 is a small amount to start with. However, it’s a start. Here are some of the options that I would look at:
1 Invest in an Australian equity ETF
$5000 is too small in my opinion for individual share trading and stock selection. Also, the track record of most active equity managers is now something to question. Over the past five years, 69.88% of Australian equity general managers have underperformed the ASX 200. For international equity managers a staggering 93.15% underperform the index. Ouch! I used to rely solely on stock-picking for my clients. I don’t rely on it as the sole equity strategy any more.
The most appropriate way to get exposure to the equity market with a small amount of cash is via an exchange traded fund. With an ETF you gain a broad basket of direct shareholdings that mimic a chosen index. The fees are substantially lower than those of a traditional managed fund and there is the benefit of daily liquidity on the securities exchange.
One of my favourite ETFs is iShares Core S&P/ASX 200 (ASX: IOZ). It invests in the top 200 companies on the Australian stockmarket. The dividend yield is currently 3.22% (or 4.33% fully franked). The management fee is 0.15%, so your only other cost would be brokerage.
Since the ETF’s inception in October 2010, it has provided a total annualised return of 7.42%. Thus in 32 years you will make your $50,000 target. I am currently using an 8.5% total return forecast for the Australian market over the long term, so based on that assumption we would expect to achieve our $50,000 target in 25 years instead. Will you still be working then?
In short, without additional contributions to an equity portfolio you can see it will take a long time to get to $50,000. Pure equity strategies work when you make regular contributions as part of a savings plan. The rate of return on equities is higher than cash and that is where you will achieve a better outcome than simply having your cash in a high-interest account. However, I recommend that my clients commit their capital for a minimum of five years when embarking on any equity strategy.
2 Invest in a geared fund
Have pure equities got you excited? How about we add some gearing. This is where you contribute a dollar and borrow some money against that. Some options that are available on the market are geared managed funds and geared ETFs.
The graph (below left) shows the returns of one geared managed fund I have looked at: BT Geared Imputation. You can see that a direct ETF in the Australian market would have performed better. The graph shows the price changes over 10 years and if we include the distributions the return for the BT fund has been 3.47%pa. Thus our $5000 would take 67 years to reach $50,000. To be fair, this was during the GFC but it is a good example of how gearing can magnify your losses in an equity portfolio.
Based on a long-term assumption of 9.5%pa total return for a portfolio with 40% gearing, with a fee of 1.95% for the managed fund option, it would still take us 41 years to reach $50,000. Unfortunately, half the returns would be eaten up by interest costs and management fees. A geared ETF such as the BetaShares Geared Australian Equity Fund (ASX: GEAR), which has a management fee of 0.80%, would fare slightly better.
3 Fractional property investing
Property has given great returns and prospects of capital growth due to gearing. However, we know $5000 is too small to buy a property on your own. In recent times we have seen the emergence of fractional property investing. This is where a syndicate of investors come together and purchase a share in a direct investment property. Firms such as Domacom provide the ability for a pool of investors to make a contribution to the purchase of a direct investment property. The gearing in a Domacom fund is limited to a maximum of 50%.
In my calculations, I looked at a $650,000 property purchased with a 40% loan-to-value ratio. A $5000 contribution to the syndicate would equate to a share of around 1.2% of the equity in that property. With principle and interest loan repayments, in 32 years your 1.2% share, based on a property valuation of $4.195 million (assuming 6%pa capital growth rate) would achieve our target of $50,340.
4 Private equity and currency
These are some assets that can provide returns greater than the traditional equities and property. Investments in fintech, private equity and private business can provide returns of up to 20%pa. With a 20%pa return we would reach our $50,000 target in 13 years. Now this is looking better.
The problem is for most investors is that to access these opportunities you need to be considered a “sophisticated investor”. A sophisticated investor is a person who has a net wealth of at least $2.5 million and/or has derived a personal income of at least $250,000pa over the past two financial years. I don’t think too many people looking to start with investing $5000 are in this situation. Most of the private equity funds and fintech funds we have recommended to our clients have been for sophisticated investors.
Investing in currency is hard. A report by BIS shows that up to 60% to 80% of trade in the Australian dollar is speculative. I accept that my expertise does not cross over to foreign exchange. (My professional
qualifications include a law degree, business admin degree, financial planning qualifications and real estate qualifications.) Currency trading is an area for specialists and I am yet to come across a retail investor who has made money from currency trading. Investing is partly about knowing your limits.
As you can see, aiming for a tenfold increase in your capital in the short term is a big ask. If it were that easy everyone would have done it. And, frankly, I would not be sitting here as a financial planner because if I had enjoyed a tenfold increase in my investments over the past five years I would not be writing this article for you.
If you are not fortunate yet to be a sophisticated investor or business owner, I recommend a strategy of starting with a small capital base and making regular contributions to that asset.
For example, if you had started with $5000 in the iShares Core S&P/ASX 200 ETF two years ago and made a $1000 contribution every month, your portfolio would be valued at just under $30,000 today. Your profit so far would be $1284 or 4.47%. This result is in a market that dropped by almost 20% in the period and then recovered.
Investing is a long-term project.
Andrew Zbik is senior financial planner at Omniwealth. omniwealth.com.au