Q: I’ve saved $300,000 to invest. Feeling that I did not know what options were available to me, I sought advice from a financial planner on where to invest. The planner’s recommendation was that the savings be invested in a combination of managed funds on a wrap platform [a wrap platform is an online administration service that holds the investments for you, provides performance reporting capabilities and prepares the annual tax report]. I also have a $600,000 home loan with an interest rate of 4.5 per cent. I need a second opinion.
A: At the current interest rate, the loan has principal and interest repayments of $3,493 per month. To pay off this home loan over the next 23 years, you will have to make total loan repayments of $964,158. You are on the second highest marginal tax rate, so you will need to earn $1,593,650 over the next 23 years to have enough income after tax to pay back $964,158 to the bank for the $600,000 that is currently owed on their home.
You should have been given advice to pay off the home loan first. The adviser was probably paid on the amount of funds under management and that was their priority, rather than giving strategic financial advice.
This is what I would have recommended:
Use the $300,000 to reduce the home loan debt. The monthly principal and interest loan repayment would fall to $1747. Over the next 23 years, you would now only pay $482,079 back to the bank. This will save a massive $182,079 in non-deductible home loan repayments and you will now only need to earn $796,825 before tax to pay off their home loan.
With the new equity in the home, you may use this as a deposit towards an investment property or to draw new debt and purchase a diversified investment portfolio. If we were to redraw $300,000 to invest in the exact same investment portfolio all the interest repayments on the loan would be tax deductible.
The end position would be similar. You would still have a $300,000 investment portfolio and you would still have around $600,000 of debt.
The significant difference is that half of that debt would now be tax-deductible because you would have halved your non-deductible principal and interest home loan repayments.
If your financial planner does charge a fee based on how much they manage for you and you still have a non-deductible home loan, it’s time to seek new advice elsewhere.
If you are thinking of using debt to fund investments, you need to feel comfortable that such a strategy is appropriate for your circumstances. There may be a risk at some point in time that the volatility of a diversified investment portfolio may be worth less than the loan you owe to the bank. Like all strategies, it is important to properly work out the cash flow implications and understand what risk you are taking on.
Andrew Zbik is a senior financial planner at Omniwealth