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What are you gonna do to manage risk?

Discussion in 'Money Management' started by dkmc, 21st Aug, 2007.

  1. dkmc

    dkmc Well-Known Member

    24th Aug, 2005
    With recent volatility in the market
    Ive been thinking of this issue all year
    I want leverage but not at the expense of excessive risk

    Given the historical highs of the sharemarket Im wary of not leveraging too much in the sharemarket
    For leverage - property is still king

    I fortuitously sold 30% of my portfolio at the peak of the market as I had sell orders on everything. I was moving all funds to a discretionary trust.
    Unfortunately I set my limits too high, otherwise Id be 100% cash prior to the drop

    My current dilemma is when to sell the other 70%
    tho it wont really matter as Ill rebuy in the trust
    Im trying to time sale of navra fund and am waiting for some outperformance above that of just ASX/cash

    My current plan is to rebuy into a index portfolio with dfa, vanguard
    plus possibly bank shares to tilt the yield
    CBA is 4.9%, which is pretty good when u look at it on a pretax basis
    It will be a buy and hold forever portfolio
    Margin loan will be 15-35% LVR and neutral to just positively geared
    I wont ever worry as much as I do now about drops but rather look to inject more funds.
    Im gonna setup a LOC for emergency funds

    Meanwhile I'll look to property for higher leverage. Property with large land content. Its just that rental yields dont make sense fundamentally atm - in Adelaide that is.

    Sometimes its better to do nothing, hold large reserves and wait to take advantage of big drops

    If I'm wrong at least my index fund portfolio should do 10-14% long term, LVR of 30%
    Property LVR currently at 53%

    Also Ive stopped relying on navra fund for 10% income return
    I dont think its good to rely on one fund and the trading strategies of one man as the basis of your portfolio balance (by that I mean income to fund negatively geared capital growth investments). Plus the MER is now there even when it underperforms

    In terms of structures - ive gone Discretionary trust for shares
    and will setup a separate trust for property

    Another strategy ill employ is setting LOC on all properties in my own name
    Paying /capitalising interest +/- expenses as a tax deduction and shifting the rental income of approximately 50k into the shares trust.
    Its kinda like LOE - except you spend the equity on investments
    the rental income - effectively becomes tax free income

    This will drip feed 50k every year into my structured index share portfolio
    with leverage increasing - to keep it cashflow neutral

    On the property front the structure is still up for debate
    DT is ok for asset protection purposes - but no negative gearing
    Without negative gearing benefits I cannot find any decent investment opportunities in the current climate
    HDT - still awaiting word on from the ATO I guess

    I could set the shares trust to be cashflow positive - to feed the property trust
    Tho the numbers do not stack up at all
    Property is too negatively geared - like -ve 10-30k per property

    The other risk management strategy I have is to keep a wad of cash
    to your comfort level

    If there were a 30% drop in the market over 1month
    Id be in a good position to draw down on a LOC
    increase margin lending to 50%

    In the meantime I cant see the point of going aggressive all out atm
    Ill still buy shares and the right property

    I wish I could go back to pre 2000 with 10% rental yields
    knowing what I know now
  2. JIT

    JIT Well-Known Member

    2nd Dec, 2006
    Great post dkmc, funny how it got no replies??!! :confused:

    With the above setting up all these LOC's, aren't you reducing your future borrowing power, as banks assess LOC's as fully drawn - even if they aren't?

    Also, by using up the LOC on property expenses, aren't you using up money that could have otherwise been used for deposits + purchase costs on other IP's?

    Also, if the property is in your own name, the rental income still goes to you and you have to pay tax on it at your personal tax rate, don't you?

    How is the 50k tax free?

    I didn't think you could divert rental income into trusts like this??

    Thanks for the clarifications...
  3. dkmc

    dkmc Well-Known Member

    24th Aug, 2005
    Hi JIT
    Its been a while

    Properties in personal name - negatively geared so minimal tax

    Shares in discretionary trust

    LOC in place - in personal name against IPs

    LOC pays for property expenses eg interest + management fees, land tax, etc - ie it is capitalising interest
    you could pick what the LOC pays for
    say it adds up to 50k / yr over 4 properties
    That 50 k is paying for expenses which are income producing hence it is tax deductable

    Rental income = 50k

    So effectively the LOC 50k is deductable, against the rental income 50k

    Before the LOC you were paying property expenses and interest and only getting expenses/interest as a deduction

    The rental income is effectively offset - Its cash in hand. Its 50k cash that you wouldnt otherwise have. You can do anything with it - even buy a car - dont though
    You gift the money to the trust for asset protection, and buy an asset like shares

    Yes you are increasing debt but not increasing assets in personal name, the asset is going to the trust instead - effectively u are shifting equity - into the trust (though dont say this to the tax man)
    Your primary purpose is asset protection not tax evasion/minimisation

    Only works if you have taxable income
    You have to be careful how much you eat into your LOC, track asset growth to make it sustainable, adjust how much you spend from LOC for expenses

    Effectively you are transferring equity from personal name to protected trust
    without selling

    Ive checked it with several accountants and my lawyer and for my situation it is ok

    Its complicated to explain and needs a spreadsheet
    Its a variation on the LOE
    And too complex for most
    But for me it allows me to increase my asset protection of the properties in personal name

    It you keep repeating this proces
    eventually u will have in personal name - a LVR of 80% with you owning only 20% equity,
    Before you may have had an LVR of 50% - that available equity is now shifted into the trust

    Its an idea that Rixter used on the somersoft forum

  4. JIT

    JIT Well-Known Member

    2nd Dec, 2006
    But most (if not all) of these expenses were fully tax deductible anyway, so the main difference is just the interest owed (and being capitalised) on the LOC amount, which is now also a tax deduction - isn't it?

    So about a $4k extra tax deduction for all the effort?

    But that 50k rental income would still have to go into your individual tax return as income, wouldn't it?

    And therefore you pay tax on it at your personal tax rate?

    The only difference being a small extra tax deduction of about 4k on the capitalised interest amount?

    So, you are only really effectively transferring an after-tax amount of what would be considerably less than 50k into the trust, aren't you?

    Or does the 'gift to trust' mean your taxable income is reduced by 50k??
  5. dkmc

    dkmc Well-Known Member

    24th Aug, 2005
    before you were paying for the expenses 50k - from your paypacket
    now you are paying for the 50k expenses from a LOC

    you are still getting 50k rental income
    yes it goes on ur tax return as income
    but you also have 50k tax deductable LOC

    Again this is not for tax minimisation this is for asset protection
    You are taking a 50k loan - but you get 50k income that can be gifted - transferred to ur trust.

    WHat u are doing is borrowing 50k and gifting it to the trust
    normally you cant do this - as you lose tax deductability in the personal name
    This way - by paying for 50k property expenses, means that u can gift 50k every year.

    Forget the tax benefits thats not what its for

    The original purpose - is how do i increase asset protection given that I have property in my own name with a lot of spare equity - and I dont want to sell to incur CGT
    - short to medium term answer was - borrow more in own name to pay expenses - and every year gift 50k to the trust until my LVR is closer to 80%

    personal asset - 500k - 50k ------> gifted to trust
    personal 450k Trust 50k
    You keep gifting every year - the amount of ur rental income

    Again this was specific to my situation
    It took me a long time to model it on a spreadsheet
    But it is doable and actually not too complicated once you understand that all you do is pay expenses out of LOC
    and gift a certain amount of cash every year
    Though it needs good record keeping
  6. JIT

    JIT Well-Known Member

    2nd Dec, 2006
    Ah right, so also in a way, before you were paying 50k expenses from after tax dollars, but now you're just paying it out of the LOC (which is money that's not taxed, but comes at a cost, ie. interest, but is tax deductible).

    Ah I see now, the 50k equity becomes a loan, and the loan becomes 50k in the trust.

    Ah ha, I hear you now.

    Yes, yes, thanks for your further clarifications, I see what you're saying.

    You do of course need to top up the LOC's and hope those properties keep going up in value too.

    I guess you could possibly gift back the 50k in the trust too if there was any problems here (assuming the 50k is still there of course)?
  7. The Stig

    The Stig Well-Known Member

    3rd Dec, 2007
    Central Coast NSW
    Don't mean to be a smart arse but Centro share holders may not agree :D

    What I Do to hedge against risk? Diversify across the sectors and industries and into commodities. AND I buy puts when I think they will go down.

    I also plan to collar my investments when they are large enough to warrant it and when I have mastered the strategy.

    The Stig
    Last edited by a moderator: 1st Jan, 2008
  8. samaka

    samaka Well-Known Member

    30th Sep, 2007
    Yeah but Centro isn't property in the sense that DKMC is talking about. It's sharemarket.
  9. The Stig

    The Stig Well-Known Member

    3rd Dec, 2007
    Central Coast NSW
    I agree DKMC probably didn't have Centro in mind when he wrote his comment.

    I was being funny :D

    But Centro is property. It's price on the share market is an exact reflection of what the real price would be if it was a private company.

    Any business that can't repay or refinance is in serious trouble and worth a lot less than when it could repay and refinance :)