Back to basics: Why property should be leveraged to a minimum of 70% with surplus capital diversified with NO EXCEPTIONS
Please do make any financial decisions based on the contents of this blog. My blogs are designed to be thought-provoking and introspective, not financial advice. Please do not act on any document unless it is titled “Statement of Advice.”
At risk of sounding like a broken record, I’m going to write this here and I’m going to refer you back to this page every time I hear you propose settling on a property with more than a 30% deposit.
As a property investor, and a share market investor, I’ve amassed a fortune for myself, and seen many others achieve the same, by following what I have coined as the Bisexual Investment Strategy.
Bisexual = ignoring the noise of the property tribe (usually real estate agents, property marketers and so-called “wealth strategists”) whilst simultaneously ignoring the pleas of the share market tribe (usually financial planners and stock brokers) as both tribes make it their mission to undermine each other, leading themselves and their followers into oblivion.
Check out this chart tracking the performance of the Aussie property market and the S&P500 share market index:
In case you didn’t notice, there’s a clear winner… it’s the share market!
The 30 year average capital growth rate for Aussie property is 6.6%*
*Let’s be realistic and assume that your average long-term performance, when you take into consideration the expensive buy and sell costs, is 5% p.a.
The performance of the S&P500 over the same period is 11.4%^
^Most managed portfolios are not going to be 100% invested in shares and will have allocations to stabilisers such as bonds, so let’s assume such portfolios will earn you 10% p.a. over long-term averages.
So, why would I invest in something earning 5% instead of 10%?
The answer lies in the leverage.
If you are using the bank’s money (via loan or LRBA) to acquire your property, you not only benefit from the capital growth on the entire value of the property, but you also get to invest the money that you did not tie up in the property, thereby enjoying the benefits of the Bisexual Investment Strategy.
To quantify this, I ran a bunch of scenarios on hypothetical SMSF strategies:
The above chart shows the 10 year projected net values of a superfund that starts with a value of $200,000.
No SMSF assumes the investor will leave their super in a managed fund and earn benchmark returns on their principal, plus ongoing contributions for 10 years.
0% Loan to Purchase Price Ratio assumes the investor will not have any leverage on the proposed investment property, and is the worst possible strategy to consider.
50% to 60% Loan to Purchase Price Ratio will leave the investor worse off compared with leaving their super where it was.
70% Loan to Purchase Price Ratio narrowly beats No SMSF, however for all the time, effort and responsibility, it is questionable as to whether it is really worth it.
80% Loan to Purchase Price Ratio starts generating some worthwhile outperformance, and as such should be the target LVR.
Okay, I get it Bryce, the property should be leveraged, but what about shares? I’ve heard of margin loans and derivatives that can amplify share market returns...
I’m glad you asked! Yes you can apply the same theory on shares, however I invite you to go up and have another look at the S&P500 performance over the last 30 years. Two observations can be made:
1) While the unleveraged returns on property are fairly lacklustre and barely outpace inflation, the unleveraged returns on shares are pretty darn good… do you really need to take the additional risk?
2) Shares are volatile enough as they are. Apply leverage and if they move in the wrong direction you can get wiped out very quickly! If interested, look into “margin calls” and have a very thorough read of the terms of derivatives contracts. You might find that your margin for fluctuations is smaller than you think. These are very complex instruments, tantamount to gambling. If you are going to leverage up your share portfolio, be prepared to lose enormous amounts of your capital if things don’t go your way. Real estate, on the other hand, has palatable volatility, even when leveraged heavily, and does not have margin calls, meaning that you can, and often should, ride out dips in the market.
If you follow the Bisexual Investment Strategy, investing sufficient capital and ongoing contributions in leveraged property and unleveraged managed portfolios, it will be enough to build a multi-million dollar portfolio whilst enabling you to sleep very well at night.
You really don’t need to go outside of this strategy.
Be very wary of anyone who tries to monopolise your portfolio.
Please do make any financial decisions based on the contents of this blog. My blogs are designed to be thought-provoking and introspective, not financial advice. Please do not act on any document unless it is titled “Statement of Advice.”
