Worry-free level of gear­ing

Money Magazine Australia - - ASK THE EXPERTS -

QBoth my­self and my wife are 32 this year and cur­rently have no kids. Our home is val­ued at around $400,000 with only $35,000 left to pay on the mort­gage. My in­come is $104,000 and my wife’s is $65,000 (both ex­clud­ing su­per­an­nu­a­tion). We both salary sac­ri­fice $100 to su­per each week.

We have $25,000 in a di­ver­si­fied num­ber of pas­sively in­vested shares. Our plan is to bor­row $25,000 against the eq­uity in our own home each year (this value will go up in line with our salaries) to in­vest in more shares/ETFs. Do you think this is a good plan or should we take on more risk and bor­row more to in­vest (in ei­ther the stock­mar­ket, real es­tate in­vest­ment trusts or a prop­erty)?

You have hit the nail on the head, Dun­can. It is all about your at­ti­tude to risk. Clearly, you could pay down your mort­gage, mean­ing you ef­fec­tively earn the in­ter­est rate on your mort­gage – I would sus­pect that is about 4.5%. So to make a de­ci­sion not to pay down the mort­gage, or to bor­row against your home, mean­ing your mort­gage goes up, you need to be­lieve you will earn more than the 4.5% in­ter­est charged by a com­pet­i­tive lender.

If we look at long-term in­vest­ment re­turns, both shares and well-lo­cated prop­erty have cer­tainly done much bet­ter than this. So over time it is rea­son­able to ex­pect that good in­vest­ments should re­turn more than the in­ter­est you are pay­ing. This could lead to the view that “the more you bor­row the bet­ter”. This is likely, but not guar­an­teed, to hap­pen in the long term. The prob­lem is, of course, if you bor­row large amounts and mar­kets fall sharply, as they can, and of course in­ter­est rates could go up.

If you were to sell in a down­turn, your gear­ing will lead to large losses. The right amount to bor­row is based on your and your wife’s per­son­al­ity and at­ti­tude to risk. Make an as­sump­tion that in­ter­est rates go up and the mar­ket falls sig­nif­i­cantly, say 50%. If in that sit­u­a­tion you would hold onto your in­vest­ments and not be con­cerned, then you have found the right level of bor­row­ings for you.

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