Welcome to video 4 in our series about the 6 Building Blocks to Financial Success. In this video we’re going to talk about investing wisely and tax-effectively. So in the previous two videos, we talked about freeing up your cash flow, having surplus income each month that you can use to invest, and we also talked about freeing up some of the equity that you may have in a property, or tapping into those savings that you have, and really making sure that we are investing wisely and tax effectively.
Now we’ll talk about the sort of investments that you can look at putting your money into. Because essentially what you’re doing now is, you’re borrowing money at, say, 4% or thereabouts, and we want to make sure that when we’re investing, we’re getting a rate of return greater than that.
So there’s different assets, which are broken into growth and defensive assets. A defensive asset is an asset such as cash, fixed interest, or bonds, which essentially just paying you a rate of interest with very little or no capital fluctuation. Then there’s assets such as growth assets, which are your shares and your property. They’re the more traditional ones that we talk about. They’re assets that do fluctuate over the short term, but we do believe in the long term will be able to provide greater capital return.
The other asset that we do talk about, as well, is your business. So if you have a business, or are looking to start a business, you can borrow money relatively cheaply to invest in that business. I, myself, for instance, I believe that if I borrow money at 4%, I’ll be able to get a greater rate of return from that. So if you own a business and you think that you can buy a machine for your business that’ll be able to help you grow, and you can borrow the money very cheaply, say four, five or 6 percent, it probably makes sense for some of us to do that. Similarly, taking on an employee, or buying out another already established business, or expanding into new areas, they’re, again, ways that we can grow our own business, and using that equity and that cash flow to fund that.
What I’ll talk to you now is about doing the traditional methods, which is direct share portfolio, and also property. So if we look at a share portfolio, shares over the long term, if we just focused on an aggressive portfolio, where we’re just going 100% into shares, we might look at getting a rate of return over long term of around 8.5%, and that’s the growth rate. We’re not really relying on any dividends in that return. And 8.5% is therefore hopefully a better return than the cost of the borrowing, 4%, and so that’s a pretty good rate of return.
Also, we can look at investing in property. Now, property may give you a similar sort of rate of return over the long term, and you might say, again, 8.5%, but that rate of return is going to look very different. We’re going to say that it’s probably 5% growth, and that you might have it rented out, and then that might give you a 3.5% rental yield, or income yield, on that property. So, again, we want to be investing, long term, in those sort of growth assets, so they’re going to be giving us these sorts of rate of returns, instead of cash and fixed interest, which generally give a lower rate of return. So it’s about identifying if that is something more suitable for you.
In the previous videos, we talked about feeing up roughly about $160,000 in cash to be able to invest. Property is not necessarily going to get you very far with $160,000, so we may be, if we go down this path, we may be taking on additional debt. There’s obviously additional risks with that, which we’ll talk about in the next video, but $160,000 will certainly buy you a pretty well-diversified and high quality share portfolio, so that may be something that you’re more comfortable with. Again, it’s about finding out what you’re most comfortable investing in. Similarly, if it’s your business, $160,000 and/or freeing up of $550 a month in cash flow will go quite far in building up your business, or starting a business.
Again, if we’re going to look at investing in these things, or investing in our business, we want to make sure that we’re doing it in the most tax-effective manner. There’s a number of things that we want to talk about.
So having it in the right structure, for instance, if you’re going to be investing in a shared portfolio, are you going to be doing it in your name? In your partner’s name? Or are you going to be doing it in a family trust, in a company, or superannuation fund? There’s a whole bunch of different ways you can invest, and there’s different tax treatments for each of those things.
Similarly, there’s the benefits in property such as depreciation. If you’re buying a property, you can depreciate that asset over a period of time, and that can give some fairly significant tax advantages.
We also want to talk about franking credits, if you’ve got franked dividends coming through from those shares, which is essentially the company pays the company tax rate, it’s passing it through to you. If you have that in a pension account, or superannuation, you’re going to be able to get some tax credits back from that. So again, that’s a little bit more tax-effective for you.
Similarly, if you’re borrowing the $160,000, and maybe taking an additional loan to buy a better property, you’ve got the tax deductibility of the interest. So you’re borrowing money to invest. That means that interest is generally going to be tax-deductible. So we want to make sure that you’re doing that properly.
Hopefully this is all helping, and that we’re now kind of building up an idea of freeing up some cash flow, freeing up some assets, and then we’re going to start investing that, and where we’re going to invest that, and making sure that it’s tax-effective. In the next video, we’re going to talk about the risk management side of it, because as we’ve touched on, there are a number of risks associated with these sorts of strategies. So we’ll see you in the next video, but as always, please like us on Facebook. Please check out our YouTube channel and also our website, and please mention this video to friends and family who you think should be seeing this sort of content. Thanks very much for watching, and we’ll see you again soon. Thanks.
Okay let’s decide that we’re going to now get that property re-valued, so let’s just say property prices have gone up over the last few years, that property is now worth 800k. Again you still got the $490k loan, but we’re able to refinance that property at 80% quite easily, hopefully, with your lender. In which case we’ll take out the $480k loan over here and we may be able to get an additional loan of around about $160k. So we’re saying the new repayments over here are $1,950 a month. Now, $160k loan, if we say we’re going to do interest only because we’re going to use it for investment, we’re going to look to build our wealth and free up cash flow. Those repayments are about $550 a month.
Under this example, you’ve got the same repayments as you had on your original loan but you’ve got more debt now. So, we’ve got that existing loan over here which is partly interest only, partly principal and interest. We’ve done that…restructured that to free up our cash flow. We’ve now be able to get an additional loan of $160k, our total commitments a month haven’t changed from where we are originally, but now we can take that $160k and invest.
In our next video we’ll talk about where we’re going to invest that money and we want to make sure we are doing it wisely and tax effectively.
Again, hopefully, you’re enjoying this video content. If you do, please like us on Facebook, please also tag and comment with your friends, and we look forward to see you in the next video. Thanks very much. Bye.