Australians are no strangers to borrowing for investment. In fact, most first home buyers will probably look to borrow 80 per cent of the value of their first home.
One of the benefits of doing this is you get access to the property’s full value, even though you’ve only paid for a portion of it yourself. In other words, your money’s power is multiplied.
The same principle can be applied to investing in shares, which can be done by taking out an investment loan.
How does it work?
With an investment loan you can multiply the amount of money you have available to invest in shares. Most investment loan providers lend against the majority of the ASX 200 companies, as well as other securities.
For example, you may have $25,000 to invest. If you take out an investment loan for an additional $25,000, you can buy $50,000 worth of shares – giving you a loan-to-value ratio (LVR) of 50 per cent.
The maximum amount you can borrow usually depends on the types of securities you decide to buy, with LVRs between 30 per cent and 80 per cent generally available.
Here’s an example of how much you can borrow, based on a $25,000 deposit and a range of LVRs.
ANZ Global Wealth 2014
What difference can it make?
Increasing the size of your investment can help you achieve a few important benefits:
- you can buy more shares, or a wider variety of shares, than you could otherwise afford
- it enables you to diversify your investments
- it increases your exposure to any gains in value on the investments you buy
- it increases the value of any dividends and franking credits you receive.
As the graph below shows, this can help your investments grow faster over time.
ANZ Global Wealth 2014
What are the risks?
It is important to remember that borrowing to increase your investments doesn’t just magnify your potential gains, it also magnifies your potential losses.
While this is the same with property, shares tend to be more volatile over short time periods, which can make any losses more noticeable. Your loan provider may require you to pay down some of your loan (eg with cash or by selling some of the shares you own) if the value of your investments fall below a certain level. This is known as a margin call.
What are the tax advantages?
Another potential benefit of borrowing to invest is that the interest on your investment loan is generally tax-deductible, similar to a loan used to buy an investment property.
This can make borrowing to invest particularly attractive for people in the higher marginal tax brackets.
For example, if you earn more than $80,000 pa, more than one third of your interest expense generally comes back to you as a tax deduction. If you earn more than $180,000 pa, the tax deduction is generally close to half of the interest expense.
The flipside of this is that all capital gains and dividends from your investments (including the portion bought with borrowed money) are assessable for tax purposes.
Where do I start?
ANZ’s website has more about investment loans and how to get started with one.