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Build a bigger home deposit through shares

Photo of David Arnold By David Arnold

min read

Many young Australians are suffering from house “fomo”, the buzzword meaning “fear of missing out” that accurately describes the state of housing affordability among Gen Y – and the condition is spreading.

Australia must think seriously about alternative strategies for young people to achieve that prized first-home deposit. For many would-be home owners, it is not so much the property price rises that worry them, but the deposit needed.

To get off the rental roundabout the first step in most cases is to find a deposit of 20 per cent of the amount they want to borrow. If they want to borrow with a deposit of less than 20 per cent, the bank may charge them for the lender’s mortgage insurance premium.

Different generation, different approach

With the median house price across Australia close to $700,000, home buyers are looking at a deposit of at least $140,000 in some cases. That is what many of their parents’ generation would have paid for the house itself. Many young people are realising that how they save for a deposit also has to be different to what their parents did.

This is where a margin loan can enter the picture as a way of using gearing to accelerate house deposit savings, in a tax-effective manner.

The goal – the home loan deposit – is up to $140,000 today. Let’s assume it rises by 3 per cent a year. This is at the higher end of the Reserve Bank of Australia’s targeted inflation range, but a moderate rise compared to recent home price increases. Housing costs do not always rise and are subject to falls in value like any investment, but for the purposes of this example we will assume they rise 3 per cent a year.

Assume the borrower, Sarah, a 27-year-old lawyer earning $85,000 a year, starts with $10,000 savings and can save $1000 a month.

She can put 100 per cent of her savings in a term deposit, which we will assume earns a constant 2.51 per cent a year. In that case, it will take 11 years to reach her goal of a deposit, which by year 11 will be about $194,000.

Shares as an option for Sarah

Sarah keeps up with the news and so is aware of the sharemarket’s ability to generate a return through the combination of capital growth and dividends. She is on a marginal tax rate of 39 per cent, including the Medicare levy. She knows the sharemarket over the past 10 years has returned 11.32 per cent a year, made up of 5.92 per cent capital growth and dividend income of 5.4 per cent. She decides to invest all of her savings in shares. (Editor’s note: Be aware that an investment in the sharemarket is not a guarantee of a certain return – there is the potential for loss. Introducing leverage into your sharemarket strategy can amplify those losses.)

How a margin loan can help

Sarah investigates a margin loan. Using her initial savings of $10,000 she decides to borrow 50 per cent of an investment in a diversified portfolio of quality shares and managed funds.

Each month she invests an additional $2000, made up of $1000 of her own savings plus $1000 of borrowed funds. Sarah understands that gearing involves risk; investments can go up and down.

But Sarah feels that being in a relatively well-paid job, and given her age and ability to monitor her investments, she can afford to take on more risk. She buys a share portfolio of $20,000. In this scenario her $10,000 loan costs her 5.99 per cent a year – this may change over time. She may be able to claim this interest cost as a tax deduction.

Sarah should be able to claim the franking credits on the dividends she receives each year, (in this scenario, 57 per cent franked).

She regularly monitors her investments. In this scenario her portfolio continues to perform as expected and she doesn’t sell any investments until she has achieved her goal.

After paying capital gains tax, this strategy (with its underlying assumptions) has the potential to get Sarah to her goal in about eight years.

Further savings

Thinking about it a different way, by reaching her goal earlier than saving with a term deposit, Sarah actually needs about $16,500 less than she would have otherwise, because she has removed a year’s worth of house price inflation from the equation.

Sarah has also developed a great savings habit that will help her reach her goals, such as repaying her home loan and saving for retirement.

Here are the assumptions used in this example:

 

Field Source Calculation Value
Cash rate Bloomberg Bank Bill Index month end close 1yr average annual return 2.51%
Capital growth rate S&P/ASX 300 Index month end close 10yr average 5.92%
Dividend income rate S&P/ASX 300 Index month end close. S&P/ASX Accum Index month end close ASX 300 – ASX 300 Accum, annualised over 10yrs 5.40%
Franking levels Average ASX 300 franking Iress list 57%
Entry fees & brokerage Moneysmart Moneysmart 0.20%
Company tax rate ATO ATO 30%
Medicare levy ATO ATO 2%

Source: Leveraged

This scenario and others can be simulated here.
(Editor’s note: Leveraged provided ASX Investor Update with another article on Margin Lending in the September 2015 edition. In this article there is more detail on the issues that can arise when the market turns against you may be faced with a margin call.)

About the author

David Arnold is head of Leveraged, a leading provider of gearing solutions.

From ASX

ASX quoted instalment warrants are another option for geared investing. To learn about the features, benefits and risks of instalments, take the free online ASX Warrants and Instalments course.

The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2015 ASX Limited ABN 98 008 624 691. All rights reserved 2015.
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