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Alternatives to income funds

Discussion in 'Investing Strategies' started by coopranos, 28th Sep, 2007.

  1. coopranos

    coopranos Well-Known Member

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    To follow on from previous discussions in MW's Navra Performance Tracking thread, I thought it would be interesting to get people's ideas and discuss some alternatives to what seems to be a big area of investment demand - the income managed fund. Although the main fund we discuss and compare on this forum is Navra, it is not meant to be a negative against that fund, just simply a brainstorming and discussion exercise.
    As far as I can tell, the major reasons people would invest in an income style fund are:
    - Serviceability (ie increasing income so the banks will lend more)
    - Debt Recycling (plugging the distributions into a non-deductible loan, presumeably with the intention of paying the loan off then redrawing it for investment activities once paid off, making it fully deductible)
    - Fund shortfall amounts on other negatively geared investments
    - A belief that the total return on the income fund will actually be more secure/more competitive/less volatile over a more growth oriented fund

    If there are any more please feel free to add them. If anyone has any ideas on other options for addressing any of the above, hopefully we can discuss them and nut them out here. I think including some numbers and model comparisons would be of benefit as well.
     
  2. AsxBroker

    AsxBroker Well-Known Member

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    Alternatives I have heard of are Zurich Income Fund and Challenger Australian Share Income Fund. Don't know much about the Zurich fund apart that it exists. The Challenger fund looks for strong yielding companies paying franked dividends, ie, they would rather buy shares than property plays, eg, GPT, as the shares distributions are franked and property share distributions are usually unfranked.

    Very good if your going to give it to a low income earner, super or pensions.

    If you want fixed interest, the AMP Enhanced Yield fund is pretty good and there is also a Challenger High Yield fund.

    Cheers,

    Dan

    The above information is factual information and not an inducement to invest in any investments. Speak to your FPA registered Financial Planner, Accountant or Tax Adviser before making an investment decision.
     
  3. coopranos

    coopranos Well-Known Member

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    So to kick it off in response to the query above, here is an alternative method for addressing the "Fund shortfall amounts" reason mentioned above.
    The theory behind this reason is that you have a negatively geared property to the tune of -$10,000 per annum. You invest in the income fund returning 10%, using the difference between the interest on the income fund and the actual income to fund your shortfall. Example:
    Annual shortfall from negatively geared property: $10,000
    Income from income fund investment: 10%
    Interest Rate on income fund Loan (will be a mix of perhaps a LOC and margin loan, so ave rate used): 8%
    Therefore, to fund your $10,000 shortfall you need $500,000 invested in the income fund returning 2% above your interest costs.
    These will net each other out, so you have no taxable income, and no deduction either. Also we assume your LVR on your margin loan remains the same, because you are paying your interest bill. So in the end you have your same $500,000 investment, but you have been able to hold another negatively geared growth asset you may not have otherwise been able to hold.

    An alternative to this approach is to invest in growth oriented funds, capitalize your interest, and withdrawm funds from your margin loan to fund your shortfall:
    Growth on growth fund: 15%
    Interest rate on growth fund loan: 8%
    At the end of a year, your loan is $40k higher than at the start, you have taken out your $10k shortfall (with a cash withdrawal from the margin lending account), but your portfolio is actually $65k higher than when you started, and your LVR is actually lower as well. Plus, because it is a growth fund and you havent actually sold any units, you keep your $10k deduction on your negatively geared property, you have a $40,000 deduction on your interest on your margin loan. So you are not only $65k better off from the growth, you are potentially $21,000 better off because of the higher deductions/lower taxable income (assuming top marginal rate). With compounding, not only does the growth side of things get better each year (and thus your overall LVR comes down as opposed to staying the same with the income fund), you whack your $21k tax refund back onto your margin loan or buy more units in your growth fund, and it gets even better again.
    Hopefully this explains the idea, look forward to any discussion on it, and pointing out any errors etc.
     
  4. crc_error

    crc_error The Rule of 72

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    I don't see the point in having a negatively geared investment, only to try to make it neutral geared investment via income funds.

    The purpose of the negatively geared investment is to reduce tax.. by having income offsetting the loss, defeats the purpose.

    If you invest in a negative IP and then draw down equity to invest into another growth asset, like growth shares.. thats fair enough, but to move into income style investments is only really canceling out the objective of the negative geared investment.

    If you can't afford the shortfall, lower your LVR.

    Income funds typically pay less. ie 8%PA income and possible some capital growth.
     
  5. coopranos

    coopranos Well-Known Member

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    ...but...are you serious??????
    nah...your taking the piss...you must be!
     
  6. AsxBroker

    AsxBroker Well-Known Member

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    Everybody has different objectives.
    If your in a high tax bracket and have a bit of disposable income you can afford to negatively gear and wait for the growth to kick in.
    If your in a 30% or lower tax bracket, there possibly isn't too much of a good reason to negatively gear, if the growth isn't there it's not really worthwhile.

    I think what CRC is trying to say is that he's not purely looking for tax deductions, he's probably looking for growth or high income while gearing.

    Cheers,

    Dan

    PS If your paying tax you've made assessable income which can't be that bad (can it?)...
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Actually no ... the purpose of the investment is to make money. IPs in many cases are cashflow negative, but show a net positive return due to capital growth (if is doesn't, you are going backwards !!).

    I don't hold investments just because they reduce my tax - I hold investments because they make me money.

    In my case, I hold IPs in a trust that has no negative gearing benefits, an income fund like Navra helps offset those costs.
     
  8. coopranos

    coopranos Well-Known Member

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    Of course if you invest in something and there is no growth it isnt worth it, tax deductions or not. Tax deductions dont decide whether an investment is viable or not, they simply increase the effectiveness of an already viable investment. To invest purely for negative gearing benefits is short sighted and quite frankly pretty stupid.


    No, what he said was that negatively geared investments are only good for tax purposes, which is plain wrong. Property (which is traditionally negatively geared) is a sound investment for many reasons, and tax advantage is well towards the bottom of the list. Sure, you might get some more deductions if you are on a higher tax bracket, but it is still incredibly effective on the lower tax brackets as well.

    Its not that bad, but not as good as not paying tax when your net worth has increased the same amount!
     
  9. crc_error

    crc_error The Rule of 72

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    Yep, I'm on the piss.. lets look at the last 5 years.

    All Ords 20%+ PA

    Residential Property 8% return..

    Which one will Mr Bean invest in?

    BUT the only reason Mr Bean would choose a lower performing asset is because he has a tax problem and wishes of offset some of his 40% tax bracket....

    Only benefits of property is a) High level LVR ie 90% AND/OR benefit of negative gearing to reduce taxable income..

    Essentially if your investing into a income fund to lower the annual loss on a IP, your basically lowering your LVR on the IP and losing your tax deductions for the year.
     
  10. crc_error

    crc_error The Rule of 72

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    So in general why would you invest into IP? Its historic long term growth is 8% PA and the outlooking isn't looking to promising at present, while the all ords have returned 14%PA long term. So tell me, how is it a more sound investment over shares? It would only suit someone who is looking for high LVR or negative gearing benefits..


    Would you like to list some of these advantages for me?

    You shouldn't invest into something only considering its tax advantages.. you need to look at the fundamental investment.
     
  11. crc_error

    crc_error The Rule of 72

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    Exactly, and if a investment is showing a loss each year, how can it be a good investment? How many loss making IP's can you hold?

    There is nothing wrong with paying tax, but it is good in the early stages of your investing to limit the tax you pay.. so choosing growth assets over income ones may be of benefit. However I wont discount a investment just because it pays income and I will pay tax..

    As you pointed out, if your someone in a tax bracket below 30%, its usually not really worth getting a IP, as there is better growth/income in shares or LPT's.
     
  12. coopranos

    coopranos Well-Known Member

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    Crc_error: although every fibre within my being wants to abuse the hell out of you for your continuously stupid and ignorant comments, I will leave it at this:
    Learn how to use a spreadsheet and sit there and work out how many years it takes for $100,000 invested in shares to catch up with a property on which you pay $100,000, say a $1M property. For our purposes, please completely ignore tax (obviously the only reason anyone would invest in property), even growing at your 20% vs 8% estimates (which i assume for property completely ignores rent while your 20% for shares includes dividends)
     
  13. AsxBroker

    AsxBroker Well-Known Member

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    Hi Coopranos,

    I have a client who geared into the MBL Small Companies fund (MAQ0258) he's very happy this year with his 76% return.

    Anyway, if you are LVR up to 90% on both investments you are really only chasing the % returns. CRC thinks residential prop did 8% so your $1m prop is worth $1.08m. $1m of MBL Small Cap is now worth $1.76m (in 1 year). Cash out the loan and your left with $80k for residential prop and $760k for MBL Small Caps.

    I think I'd be batting behind the equities myself. Even Challenger MicroCap fund did 30%.

    When your comparing things you need to compare Apples to Apples, not put 100k in one asset and $1m in another...

    Cheers,

    Dan

    The above is factual information and not an inducement to invest in any investments. Speak to your FPA registered Financial Planner, Accountant or Tax Adviser before making an investment decision.
     
  14. Smartypants

    Smartypants Well-Known Member

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    Don't know about anyone else, but I invest in an income fund for..........yes, you guessed it....INCOME.

    Have said before that I'm happy if the fund returns 10% p/a and my original outlay stays intact.

    Whilst I currently have a margin loan, I am slowly attempting to reduce that by making extra payments.

    Eventually I want to live off distributions from the income fund (and a few other investments including I/P's).

    Personally, by the time that I want to be living off that income i.e, live off ONLY passive income, I don't want the worry of a loan that is capitalising. But thats just me.
     
  15. shasta

    shasta Member

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    Hi

    I am a mere mortal, but no one has mentioned risk. Property may have risen by 20%pa over the last 5 years, but it could fall by 20% over the next few months, who knows?

    Blue chip property rarely falls in nominal terms and when it does it is low single figure falls. If i am going to gear into something, i'll gear into lower, but consistent growth, thanks very much.

    You can hold onto your claims about the share market, but if we are to make a list of all the publicly listed companies that have gone bust (ie shares = $0.00) you'd be surprised at its length. Shareholders in these shares are left with nothing.

    I ask you, where can land go? It might not go up as fast, but it wont disapppear.

    shasta
     
  16. coopranos

    coopranos Well-Known Member

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    Ahhh..see now you are not comparing apples with apples.
    You cant pull out one fund that has performed well over a short period and use that as your flag. Thats like saying "Perth doubled a few times in a four year period, therefore the return you can get from property is 50% a year". I hardly think that is being sensible at all.
    Also, of course you have to compare different leverage on different vehicles, not to do so is stupid. You cant say "lets compare $1M in shares and $1M in property" if you cant actually get the $1M in shares. Leverage is one of the major advantages of property over shares.
    What you are spouting is the typical financial planner spiel - shares average twice as much growth as property therefore shares are better. That is a completely ridiculous argument.
     
  17. crc_error

    crc_error The Rule of 72

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    Yes you can, you can get a capital protected loan which loans 100% for shares. comsec has one.. and so does macquarie and perpetual..

    If your going to compare.. you need to remmeber all the extra costs associated with setting up a property investment.. ie stamp duty ($20,000) valuation fees, socilitor fees, rental agent fees, mortguage insurance, loan setup fees, advertising, rates, body corp, repairs, months without tenents all add up to loss for the investor... you dont pay any of these costs with shares... so transaction and holding costs are almost nil with shares/funds where as property is very expensive.

    So even though you can't gear shares quite as high as property, the appeal of property is lost through hugh costs, and the lower average return.. only 8% rather than sharemarket average of 14%... So punch in the figures counting ALL the extra costs with property, subtract those from the return, and count a 60% margin loan on higher performing shares, and you will see that keeping the SAME commitment to both, shares/funds will leave you ahead in 10 years time.
     
  18. bundy1964

    bundy1964 Well-Known Member

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    Having a quick stab at what I have done since 16/1/07 using your 100k float in place of what I started with.

    100K levereged to 400K interest capitalised with 2/3 dividends being reinvested. Current value 1200k, 300k capital and 900k loan with some outstanding dividends to come in. No out of pocket cash was used and available franking credits I have left out, some will be lost to the 45 day rule.

    Will leave the finer points of accountancy to the experts but I belive that it would be negativly geared. Live revaluations and being able to selectivly trade sections of the market does help me get past what I have been able to do with property. Be a bit harder if I was working for someone to do it.
     
  19. coopranos

    coopranos Well-Known Member

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    Bundy: that is a fantastic effort, although probably not really in line with the original discussion. As soon as your bring trading into the picture, it gets way too hard to compare fairly - we may as well bring in property development into the picture, where people regularly get multiples of their initial cash outlay.
    Looks like the original point of the post has been lost however, was intented to have an intelligent discussion about alternatives to a navra type fund, not the old property vs shares debate...oh well, i thought it was a decent idea at the time
     
  20. bundy1964

    bundy1964 Well-Known Member

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    Last 1/4 I didn't trade just mostly sat and waited and bought into companies that looked like they had a bright future.

    7 winners picked and 2 losers and 1 undecided over the last 3 months. I found I have been doing just as well by buying and holding as I have from trading, now I just use the rising value to leverage into more and now it takes a lot smaller market move to give me a viable buying position. 1/2 to 1% rise will now get me a reasonable buying position.

    I did look the other day at an income fund and found it's 55% of assets listed I already hold so I saw little point in having that fund as they were doing the same as I am. Asian funds I can't match what they can hold and have the benifits of leverage by direct investing so it's managed funds for that part of the market.

    I do see a use of the Navra fund for me to use as spending money 20% of the portfolio would be as high as I would feel comfortable with. I also use hybrid bonds for income as they pay every 3 months and I have 3 differant ones giving me a monthly income, they arn't a great use of capital though.