The Australian Business Network
Shares, exchange-traded funds and other equity investments escaped Labor’s budget ban on negative gearing. But it may matter little, with several factors conspiring to make borrowing to invest in these assets unattractive.
For years Australians have used debt to grow their wealth, most prominently through taking out mortgages for investment properties, and many have used home equity loans or margin lending to grow share portfolios too.
However, sharp rises in interest rates, falling dividend yields and uncertainty clouding financial markets mean it may not be a good time to gear into shares and other assets that were untouched by the Treasurer’s negative gearing ban for established rental properties.
The looming changes to capital gains tax throw another spanner in the works. From July next year, share investors will lose the ability to claim the 50 per cent CGT discount on assets held for more than a year, and will also be slugged with a minimum CGT rate of 30 per cent.
Borrowing to invest needs the numbers to stack up, and Baker Young managed portfolio analyst Toby Grimm said the interest rate was critical to the strategy.
“At the end of the day, you make money out of borrowing to invest as long as your returns are greater than the cost of borrowing,” he said.
“With interest rates going up, it has narrowed that gap.”
The Reserve Bank cash rate has jumped from 0.1 per cent to 4.35 per cent in the past four years, pushing many interest rates for home equity investment loans above 7 per cent. Average margin lending interest rates are higher still, often between 9 and 11 per cent.
Margin lending, where investors use their existing portfolio as loan security, has plummeted in popularity over the past 20 years. There were almost 250,000 margin loan accounts in Australia in December 2007, right before the global financial crisis, and today there are fewer than 75,000, according to RBA data.
Mr Grimm said borrowers should understand that investment returns for Australian shares had averaged 8-9 per cent over the past decade, and “the equation really only works if you can borrow at rates lower than that”.
Dividend income helps investors cover their loan costs. The long-term average yield for Australian stocks has been just above 4 per cent, while average yields for global shares have been below 2.5 per cent.
Four years ago, Australian dividend yields were above 4.5 per cent but today they are closer to 3.5 per cent.
IG market analyst Tony Sycamore said yields were higher years ago when mining giants BHP, Rio Tinto and Fortescue were pocketing big profits from high iron ore prices.
“We were one of the highest dividend-yielding stockmarkets in the world, and we are still probably not far away from it, but our dividend yield used to be up around 4.8 per cent and it’s dropped away since then,” he said.
Mr Sycamore said margin lending was “huge” before the global financial crisis delivered a painful reality check to many investors.
“The GFC broke the back of that (margin lending). A lot of people whose portfolios were leveraged were wiped out,” he said.
Mr Sycamore said uncertainty in sharemarkets was another factor.
“Domestically, you have consumer confidence in the doldrums, you have business confidence in the doldrums, you’ve got the RBA hiking rates three times with probably another one or two more rate hikes, so you are not feeling particularly confident about the overall health of the economy,” he said.
Caveo Partners chief economist Theo Marinis said investors were dealing with rising interest rates and the increasing likelihood of a recession.
“We’re almost certainly going to hit a recession, and it might be the deepest recession since the recession we had to have back in the 1990s,” he said.
“We’re deep in debt, we haven’t got many levers to pull, the price of oil is going to play out over the next 6-12 months.”
Mr Sycamore said cautious investors would be thinking that now was not the time to add leverage to a share portfolio using borrowed money.
“If you were going to borrow to build a share portfolio, you would want to be fairly bullish on the outlook for both the global economy and the domestic economy,” he said.
“Right now, to think that this is a particularly good time to borrow, you would have to be the ultimate contrarian.”
Mr Grimm said many modern financial products, including ETFs, had built-in leverage that used borrowed money to buy more equities. “You can get leverage exposure without necessarily having to do the borrowing yourself but, again, they’re higher-risk and the volatility is magnified by the leverage.
“We’ve evolved a little bit and the way that people are gearing is slightly different.”
Read related topics:FundsSharesWealth
Anthony KeanePersonal finance writer