Commonwealth Protected Portfolio Loan

[kris]

Background: I am only 22 and have nothing but a $10,000 car I paid off while going to uni. I have started working full time and want to start building up some assets. I have about $300 a week spare after paying for petrol, food and other bills.

Product: Commonwealth Protected Portfolio Loan : http://www.comsec.com.au/publicaccess/default.asp?Page=ML

Advantages in my opinion:
-Forced savings (a good thing at my age)
-Interest only repayments mandatory (so I can borrow quite a bit)
-Put option given for the shares purchased at the purchase price so if the market crashed tomorrow I wouldnt have to wear the capital loss
-I receive the dividends and capital gains
-Good debt (interest is tax deductible)

Disadvantages in my opinion:
-High interest rate, possibly higher then the returns from the blue chips I'd invest in (when taking dividends and capital growth into account)

Question: What do you think about my analysis? Based on my situation would it be in your opinion a good idea to go and borrow say $15k to $40k on a 5year interest only repayment loan (with the intent to put whatever spare cash in to reduce the balance owing)?

I was thinking about perhaps investing in blue chips like NAB, WOW, CBA and possibly BHP. Perhaps to the tune of $5k to 10k in each and maybe another industry sector for diversity.

Calculations: $40,000 borrowed @ 15% pa = $6,000 per annum or a gross cost of $115 per week. Of course I would receive a large tax refund each year to go off the balance owed.

Any opinions would be greatly appreciated.

 

[kris]

Wow I just saw the following in their PDS.

The minimum loan amount is $50,000.00 and the minimum amount for an individual share is $10,000.00. So I would have to take out 50k and have 5 shares of 10k.

Looks closer to $150 per week of interest.

Also, you are unable to repay principal off the loan. I'm not sure if this is a good or bad thing for my situation. I would have thought paying principal (when I have spare cash) would be best for my situation, though I don't know why rather then the interest repayments would reduce over time.

I guess you are really banking on at the end of the loan (say 5 years of a $50,000 loan at 15% being $37,500 interest) that your shares have experienced significant capital growth (and decent dividends) which I'm not so sure will be the case - the current bull run can't go on forever can it?

 

[alexlee]

Paying off principle isn't always the best option. In your case, you're young and your salary should go up, so you should be looking to maximise your gross assets and have time and compounding work in your favour. A bit (manageable) of -ve cashflow shouldn't concern you too much at this point.

Most property investors use interest only loans and do not pay off the loans until far into the future.

Obviously this being a property forum I'll throw this in: have you thought about property? In most cases you can borrow more, there are no mandatory margin calls.

Also, that's a VERY high interest rate. You're basically paying extra (above a normal margin loan rate) for the sake of the put option that only lasts a couple of years. Given your age, you literally have decades to ride out the ups and downs. Do you really want to pay so much for a product that you can hedge yourself simply by holding for the long term?

No, the current bull run can't go on forever, but over 30 years (which you have), would it matter if there is a short term dip? It might make more sense for you to just invest a certain amount every year instead of putting a big chunk out into the market now.
Alex

 

[Deepmarine]

Wow I just saw the following in their PDS.

The minimum loan amount is $50,000.00 and the minimum amount for an individual share is $10,000.00. So I would have to take out 50k and have 5 shares of 10k.

Looks closer to $150 per week of interest.

Also, you are unable to repay principal off the loan. I'm not sure if this is a good or bad thing for my situation. I would have thought paying principal (when I have spare cash) would be best for my situation, though I don't know why rather then the interest repayments would reduce over time.

I guess you are really banking on at the end of the loan (say 5 years of a $50,000 loan at 15% being $37,500 interest) that your shares have experienced significant capital growth (and decent dividends) which I'm not so sure will be the case - the current bull run can't go on forever can it?

Hi Kris,

Protected Portfolio Loans are useful for the following:

1. You are income rich but asset poor and would like to gain exposure to a large portfolio of equities.

2. You have a lot of taxable income in a given year and would like to "defer" that into a capital gain further down the track with little downside risk. You do this by prepaying interest for 1 year on one of these loans.

If you are in the highest tax bracket, the after tax cost of one of these protected portfolio loans after the interest payments, potential tax deducation and dividends are taken into consideration is generally about 4-5% of the Loan amount. So on a 100K loan, it'd cost you (after tax and dividents) about 5K p.a. You're banking on the fact that the portfolio will go up in value by more than this 5% per annum, and that any gain will be a capital gain so you'll only pay capital gains tax on half of the gain since the term is usually 5 years.

Yes as you say it is interest only. You aren't worried about the principal being paid off. At the end of the loan term that you have selected you can choose to undertake one of the following:
1. Take out another loan for another term.
2. Sell all of the securities and pay out the loan, keeping any profits.
3. Sell enough of the securities to pay out the loan and keep the remaining ones.

If you only have 300 per week spare cash, I personally wouldn't recommend this type of investment - I'm assuming that you might not be in the highest tax bracket if you have only just started working - as the benefits diminish as you move down in tax brackets and the capital growth each year has to be "higher" to cover your costs of funding the loan.

Also - another problem with these types of investment is that you are "locked in" for the term and that if you want to get out part way through then it'll cost you a lot of money - this is because to provide the protection feature the bank has to hedge its risk exposure to the underlying securities.

So - my opinion - this product is great if you have large taxable income and want to defer the taxation and move it into a capital gain down the track....but for a starting out investor I'd maybe consider something else.

I think that Mac bank do a product that is a conservatively geared margin loan style investment where you contribute X amount per week and they match it with a loan. This is then invested in one of the funds they run (you get to pick) - might be worth considering.

 

[Deepmarine]

Paying off principle isn't always the best option. In your case, you're young and your salary should go up, so you should be looking to maximise your gross assets and have time and compounding work in your favour. A bit (manageable) of -ve cashflow shouldn't concern you too much at this point.

Most property investors use interest only loans and do not pay off the loans until far into the future.

Obviously this being a property forum I'll throw this in: have you thought about property? In most cases you can borrow more, there are no mandatory margin calls.

Also, that's a VERY high interest rate. You're basically paying extra (above a normal margin loan rate) for the sake of the put option that only lasts a couple of years. Given your age, you literally have decades to ride out the ups and downs. Do you really want to pay so much for a product that you can hedge yourself simply by holding for the long term?

No, the current bull run can't go on forever, but over 30 years (which you have), would it matter if there is a short term dip? It might make more sense for you to just invest a certain amount every year instead of putting a big chunk out into the market now.
Alex

I agree with Alex - go the property first.

Then I'd maybe considering diversifying across asset classes further down the track.

Also - there will be new capital guaranteed products for retail investors coming onto the market over the next few years that will have a lower annual interest rate as they will use different mechanisms for providing the capital protection.

Cheers
Deepmarine

 

[kris]

You make some fantastic points there Alex.

I guess I'll have to do some sums and work out the break even return on investment I require and if the shares in my theoretical portfolio would deliver that return.

I don't really want to jump into property just yet, taking out $50,000 is one thing but $200,000+ is quite another story.

Having said that perhaps I could go in for 50k on a rental property with my parents, so at least I'm not taking on all the risk.

Back to the drawing board for now.

 

[kris]

Deepmarine, I had a look at those margin lending accounts but from memory you need $5k as an initial deposit. Perhaps I'm better off to just deposit money into a netsaver account until I have that initial deposit and then go in.

 

[alexlee]

Deepmarine, I had a look at those margin lending accounts but from memory you need $5k as an initial deposit. Perhaps I'm better off to just deposit money into a netsaver account until I have that initial deposit and then go in.

Uh, if you don't even have $5k for an initial deposit, I'd hold it for now. For both shares AND property. Even if someone was willing to lend you 105% LVR, say, you run the risk of getting killed the first time the toilet breaks.

Incidentally, I also have shares. I hold mine for dividends, though.

If you're living at home and not paying board, get your savings rate up to about 70%-80% of your net income. If you're renting, save about 40% of your net income. Maintain that % as your salary increases and your savings will grow pretty quickly.

Investing with your parents is your own choice, though one I wouldn't recommend. Too hard to separate private from business.
Alex