Risk brings reward over time

QWhat’s the better use of investment funds out of the following two options over a long-term strategy? Put it an offset account that saves 5% interest (for example) against an investment property mortgage or buy a share portfolio that makes 5% (again for example). Will the answer change depending on whether the investment property is negatively or positively geared?

I can’t get my head around how each strategy, including tax implications, will ultimately impact the performance of the investment capital. Hopefully you can get to this one.

Now this is a bit of fun, Richard, and very practical fun!

Yes, 5% in an offset account, if it was saving you that amount in interest, is 5% risk free and tax free. Not bad.

If you borrowed, say, $100,000 at 5% and earned 5% in income on your property or shares, it would be a zero sum games. But the gearing game is not so simple. You simply would not borrow to invest if you thought it was a 5% cost of money and a 5% return. Property and shares are riskier than cash and you would expect a higher return.

So a more likely scenario is that the interest on your $100,000 is 5% and your property returns, say, 4% in income. But with depreciation and other taxdeductible costs, this might be lowered to 3%. Then the 2% difference between the 5% you pay and the 3% taxable you earn is tax deductible. Then the property is likely to grow in value at 3% to 4% a year. This growth is a capital gain and is taxed with a 50% break on your normal rate of tax.

It is no surprise to me that this sounds complex. It is! Our tax system is not simple. But the key here is not really tax. Sure, the tax breaks help but the simple bit is that over time riskier assets like shares and property should outperform the interest payable on an investment loan. If not, none of us would ever invest.