Discussion in 'Investing Strategies' started by Simon Hampel, 21st Nov, 2005.
Use this thread to discuss the article: Living on Equity - part 2
Can we start a discussion as to the merits of using a managed fund such as the Navra funds to "help" build your deposit for the next investment property as envisioned in the LOE articles?
As seen in other threads, investors have been querying the short-term performance of the Navra funds and the PDS does state investors should have a longer term outlook of at leat 5 years which seems to go against the grain of using it as a savings plan for the next investment property deposit?
My thoughts are that you can earn the paltry interest provide by bank accounts while saving your deposit or take more of a risk and invest in a M.F. for the short-term where you may well have some wild ups an downs...
(where I've used the Navra fund above - obviously it applies to any M.F.)
It comes down to risk management ... and risk is one of the things the general public understand the least (and worse - they think they DO understand it, but they generally don't).
Some examples (ignoring tax):
Scenario 1: You have a goal of saving $50,000 for a new house within 2 years. You have $25,000 now.
Option 1: Invest the money in a high yielding bank account earning 5.5%pa. Result: after 2 years, you now have $27,825 - and you have FAILED to reach your goal.
Option 2: Invest the money in a high growth managed fund, that returns -10% the first year, and +30% the second. Result: You now have $29,250 - and you have FAILED to reach your goal, but you are closer than option 1. Is this more or less risky than option 1 ??
Option 3: Invest the money in another (slightly more conservative) fund that returns 12% each year. Result: you now have $31,360 - and you have FAILED to reach your goal, but you are closer than both options 1 and 2. Is this more or less risky that either of the other options ?
- - - - - -
Scenario 2: You have a goal of saving $50,000 for a new house within 5 years. You have $25,000 now.
Option 1: Invest the money in a high yielding bank account earning 5.5%pa. Result: after 5 years, you now have $32,673 - and you have FAILED to reach your goal.
Option 2: Invest the money in a high growth managed fund, that returns 5% the first year, -10% the second year, 15% the third year and 25% the fourth year, and 30% the fifth year. Result: You now have $44,148 - and you have FAILED to reach your goal, but you are much, much closer than the other options. Is this more or less risky than option 1 ??
Option 3: Invest the money in another (slightly more conservative) fund that returns 15% each year. Result: you now have $50,283 - and you have SUCCEEDED in reaching your goal. Is this more or less risky that any of the other options ?
- - - - - -
The point I'm trying to make is that RISK is dependent on what it is you are trying to achieve, and the TIMEFRAME in which you are trying to achieve it.
So, is saving for your next IP in a managed fund a better choice than saving in a bank account ? Well, if you can make better returns in a bank account over the period of time you realistically expect to be saving the money - then go for the bank account!
If you are investing money you can't live without - then DON'T invest it in something that isn't capital guaranteed.
If you think a fund/investment has a high chance of going backwards for longer than your target timeframe for that moeny - then DON'T invest it in that fund.
- - - - - - -
As for NavraInvest ... there's two arguments at play here.
1. Outperformance of the index ... for this I believe you should take a long term view - see how the fund has performed over 5+ years before judging it.
2. Is this a save place to invest your money while saving for your next house deposit ? ... let's consider the recent December quarter ... performance of the fund for that quarter was 0.27% - that's how much the fund grew by between Oct 1st and Dec 31st. That's not much. Yet, the fund managed to find 2.53% income to distribute !! How ? Trading profits! What we don't know yet is how the fund will perform in a down market - we haven't really had one recently.
With regards to 'parking' $'s in a Managed Funds, I think Sim has hit the nail on the head. It's primarily about your Risk Profile!
If the Risk Profile is high enough then I would assume the Financial Planner may say 'go for it......but be aware of these possible ramifications'. However I think there are some good reasons why most FP's are conservative in their investment recommendations.
Keep in mind, FP's are human too and in the years their recommended 'higher risk' investments go well, the individual investor will be patting themselves on the back, and in the years when the 'higher risk' investments don't perform.........well lets just say the Financial Planner wouldn't always be looking forward to that annual Client Review as it will often be all the Financial Planner's fault.
Having said that, I wouldn't be at all surprised if some old nuggets like 'Past performance is not an indication of future performance' and 'Investing in shares is only suitable for investors who have an investment time horizon of at least 5 years' are just as often used as excuses for poor performance by some less scrupulous Groups as they are as valid warnings
Sim, the line of this thread would seem to be Living on Equity, rather than parking lazy dollars in the fund. By this I mean the implication is that rather than parking spare funds (cash) in the fund if you are truly Living off Equity then you are borrowing against your assets and all monies in the fund are borrowed funds thereby involving you in paying that loan at between 7-8% on your line of credit or whatever. Now if you take it a step further and leverage you have obviously increased your exposure further and hopefully increased your returns (and potentially your losses). This additional borrowed money has to be repaid at approx 7.5-8.3% to your margin lender. Now to average that out all monies are borrowed and repayment runs approx. at 8%. Now I dont know about you but I have not invested for a net 2% return, and this seems to be the obvious area that is being ignored in these discussions.
Having known Steve for over 5 years and in the early days in Sydney most of the presentations were showing returns of between 25-35%, a fact which I highlighted to Steve recently. Also if you remember at that time Steve gave us newies a beta testing disc to test the system and I still have that loaded on my computer which historically shows a return of this 25-35% level.
I cannot understand why anyone would settle for a meagre 10% return on borrowed funds when the underlying debt servicing is running at 8%. Never mind about capitalising the interest and all the other ways numbers can be played with ultimately you still have to pay the piper, I want to know why the huge discrepancy from a system 5 years ago showing 25-35% returns to a now "quoted" return of only 10%, unless this all gets eaten up in administration.
I firmly believe Steve can at least perform to a minimum of 15% p.a. and hopefully a lot more. You can get 11% capital guaranteed on some of the investments you see in the Financial Review every week. Dont know if you can leverage into them, but if you were risk averse you would park your money in them rather than have the fluctuations of a managed fund.
If the scenario is truly LIVING OFF EQUITY then it is all borrowed money, otherwise how do you access your "equity" without selling that equity! Therefore we should be looking at "net" returns and start quoting a "net 2%" return rather than keep on about a 10% "gross" return. Lets talk about what is actually left at the end of the day to "live on"?!
If you are put all "cash" into the fund then fine you are looking at your 10% plus return, but to keep on track with this thread living off equity means borrowing against that equity and making your repayments accordingly.
Time frame of five years plus - fine if that is your horizon. The downside of this is that most people I know whenever that 5 year timeframe expires and they want their funds it never seems that the market is at the optimum time for them to get out. If only they could have help on for an extra year, or perhaps they would have withdrawn at year 4. That is the market. Any specific timeframe cannot offer any better or worse probabilities of success over any other time period. If Steve's system is reactive, it cannot possibly predict that five, ten, two or fifteen years is better to invest for than any other.
Parking spare funds while you find another investment property, also fine depending on your ultimate goals, but the underlying theme is still living off equity and meeting your payment schedules and what is left over at the end of the day to "live" on.
Most people do understand risk, but most people get fed up with FP's using this argument to "apologise" for poor performance - reads like "all care and no responsibility". Try this line of agrument with your employer and I suggest many employees would be shown the door.
It would certainly be good if Steve could start addressing some of these questions soon.
Personally I like NavraInvest because of cashflow. No other fund distributes regular income like NI. Its like a property trust but diversifed into Aussie shares.
Other funds may return better cap growth but you have to sell units to realise it and the fees are a factor whereas NI has no fees or only out performance fees.
Also you cant judge NavraInvest on a single qtr performance. The first qtr this fin year was pretty good and the second qtr was on target.
Also some of us that leverage into Navra do it via LOC and our cost is more like 6.7% pa so our margin is 3.3% on a 10% gross return.
In the end it does come down to how much faith you have in Steve and the Navtrade system to continue to deliver a safe positive return over 10% gross pa with no nasty surprises just good surprises
Spot on !!.
can someone help me out here? i am reading part 2 and there are somethings I do not get.
if not explain the conepts to me, a point towards the right thread would be greatly appreciated.
In the section: Value Adding with Shares (page 3):
1. why has her debt increased by the amount she is drawing down? i think i am not understanding the fundamental concepts of drawing down spare equity.
2. where are the additional interests costs coming from?
The following questions might be answered from the understanding gained from solutions to 1 and 2 but i will throw them in anyway
3. Where are the net savings of $20167 derived?
Also, are we assuming that all the loans used are interest only?
Many, many thanks
Accessing equity in an asset is generally achieved in one of two ways:
1. sell the asset (or part of the asset in the case of shares)
The issue with this option is that you lose all future growth and income from the asset (or from the part you have sold).
2. set up a new loan (or extend existing loan) secured by that asset
With this option, you are increasing your debt levels and interest payments - hence the figures you see in the examples.
In most cases for investment purposes, it is more convenient to use IO loans - this way you get better control over your cashflow and YOU get to determine when you make principal payments - rather than being dictated to by the bank.
Naturally, the longer you avoid paying back the principal, the more interest you will pay overall - an IO strategy isn't about saving money, it's about improving cashflow (and an assumption that the income and growth you will receive will outweigh the additional cost of interest).
Thanks for your reply Sim. I don't think I have got a firm grasp on it yet, but I think I am getting there.
If we could take the example of drawing down equity from year 1 to year 2.
Jane's property has increased from 500k to 525k. I understand that.
So she tells her bank that the LVR is only 66% and wants an extra 20k to bring it back up to 80%
The bank agrees (because they will get extra interest) and she puts the extra 20k into the managed fund.
One more thing - in the first two methods on this page (i.e. the two before the margin loan discussion) Jane accesses her equity by "redraw" in the first and by "drawing down" in the second. Are these two different methods or two different names for the same method?
Mostly the same thing.
Technically, we usually use the term "redraw" to refer to a LOC type facility (margin loans are a type of LOC), where the outstanding balance is less than the maximum allowable balance (typically because of principal payments, although it may also be as a result of capital growth in the case of a margin loan which automatically extends the limits as values rise) ... hence allowing you to "redraw" some of that money from the loan to use for other purposes (additional investment).
Drawing down is a generic term used to describe accessing equity in some unspecified way.
It seems much cheaper to redraw through the LOC option than having to extend the loan and pay the increased associated interest.
why didn't jane use the LOC option in the second scenario and opt to extend the loan instead?
If we're talking about real estate, then applying for an extension of your LOC facility or applying for a "top up" loan (or new additional loan facility), takes mostly the same kind of effort, and both occur additional interest costs since you are increasing your debt levels.
A line of credit (LOC) is basically just an Interest Only (IO) loan which doesn't have a fixed end date - it operates kind of like an automatically rolling over IO loan which never moves into P&I mode like IO loans do.
Accessing additional equity in your real estate requires the same basic process regardless of whether you use a LOC, IO loan or P&I loan.
It is only margin loans which are automatically adjusted based on the asset value of your investments - they are quite different to real estate loans.
so does that mean there are missing interest costs for the first scenario where Jane used the LOC?
Separate names with a comma.