Borrowed cash makes for scary investments

By MARY HOLM

Q. I am 38 years old, married with one small child and another on the way. We returned from Australia to live in New Zealand two years ago.

We have never earned a lot of money. I now earn $40,000 a year.

But my wife and I are good savers and by profiting on the Sydney housing market have done reasonably well. Our house is worth $300,000 mortgage-free.

We have about $60,000 in international share funds, $10,000 in 90-day term deposits and $12,000 in shares.

We are debt-free and investing $700 a month into the international share fund.

My future income is unlikely to increase much, and I don't think we are saving enough to achieve our dream of being, well, wealthy.

Do you think it would be wise to borrow, interest only, to invest in, say, three or four managed funds - mainly international equities to start, then switch to lower-risk products as we approach retirement?

The past two years have been dreadful for the sharemarkets and, with prices being low, it may be a good time to implement this type of strategy.

A. You two are young and in a pretty strong financial position. But how gutsy are you?

Picture this: you've borrowed $100,000 to invest in an international share fund.

Each month, you're no longer saving but spending on interest. True, you can deduct the interest on your tax return. But beyond that it's "dead" money.

Share prices are low and keep falling. A year from now, even after reinvesting dividends, your investment is worth $60,000.

What will you do?

Panic and sell the shares, leaving you with a $40,000 mortgage? Or stay the course?

Such a scenario is unlikely. But it could happen. And I can promise you that there will be some years when the value of your investment will fall.

When that happens, paying interest will feel like pouring more money into a bottomless pit.

Over several decades, though, your investment will almost certainly grow. And history suggests it will grow faster than alternatives.

The big question is whether you will be better off than if you had just continued to save $700 a month.

Borrowing to invest in anything - whether it's shares, property or emus - makes sense only if your after-tax return is higher than the after-tax interest you're paying.

And if the return is only a few percentage points higher, your gain from borrowing will be only that small amount. You've got to wonder whether it's worth the hassle and worry.

What will be the future gap between interest rates and long-run share returns? Maybe enough to make it all worthwhile; maybe not.

One thing is clear, if you decide to switch to lower-risk investments near retirement, it won't make sense to continue borrowing to invest in those.

A better way to reduce risk towards retirement might be to start out with a mortgage that you pay off over, say, 25 years. By the time you retire, the debt will be gone.

Q. I am a 52-year-old widow without dependants. I have a mortgage-free home in trust, and $263,000 in a mixed fund of shares and fixed interest with a money manager, which has not performed that well over the last three years, but I am in for the long haul. I add $100 a month to this fund.

I also have a rental property, which will be mortgage-free in eight months. It is valued at $220,000 and I get $310 a week from it. I bought it for $181,500 seven years ago, with a $60,000 mortgage.

I am one of the lucky landlords who has never been without a tenant and has had no damage or bad payer problems. I earn $35,000, which is more than enough for my lifestyle. I intend to work another five to six years.

My problem is what to do with the income from the rental once I no longer have a mortgage on it.

Do I buy another one and put both lots of rent into one mortgage, or what?

The only thing my money manager has come up with is to borrow money against the rental to invest more in shares etc, and get a tax write-off on the interest I would have to pay. I suppose I could just put the rental income into my share fund and pay the tax.

A. Fire your money manager.

Your investments suggest you are more conservative than the couple above. I think you'll agree that borrowing to invest in shares is not for you.

Your money manager seems driven by tax issues. That's usually silly.

In the 33 per cent tax bracket, every dollar you spend on interest - or any other tax-deductible expense - still costs you 67 cents.

I can't help wondering, too, if your money manager is also driven by the fees she or he would get if you invested a large sum through him or her.

You seem content being a landlord. But two residential properties is more than enough in that sector.

What about your last idea, of putting your rental income into a share fund?

If you do it without borrowing, it's much less risky. Even so, with just five or six years to go until retirement, many would argue that a share fund is unsuitable for you.

There's some chance that you would come out after six years with less than you put in.

Then again, you don't have to get out of the share fund on the day you retire.

You've got a good attitude to the ups and downs of your current balanced fund. You're in for the long haul. A share fund will wobble around even more. Will you hang in through that, too?

If yes, go for it. But if that worries you, perhaps you should stick to putting more in another balanced fund. I wouldn't do it via your current adviser, though.

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