All Topics / Legal & Accounting / Best investment is to pay down debt

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  • Profile photo of Brenda IrwinBrenda Irwin
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    @brenda-irwin
    Join Date: 2003
    Post Count: 119

    This seems wierd, but I have done and redone the figures, and it seems I am better off at present, to pay down debt.

    I am in the process of selling an IP and I was going to invest the profits by either buying more ip’s or shares. Trouble is, I cannot find the ip’s I want with a decent return, nor the right shares either. I calculated that if I pay out an existing loan with the proceeds, I was financially better off. Can this be right?

    Profit I will have nett is $70,000. I was going to buy some shares with it. Without complicating it all with buying costs, I was going to buy 2333 shares at $30 each. Now I figured the future rise would go to $34 per share, but that only shows me a one-off profit if I sell of $9333.
    The shares could give a dividend of 5.5% or $1.65 per year. But that means it would take 18 yrs before my $30 outlay per share started any profit. There are other cheaper shares around with better dividends but more adverse to wild market changes. Not my cup of tea.

    So I thought, buy more IP’s using the $70k as deposits. The best return I can find is equivalent to interest rates, and I would have to pay all extra expenses from my pocket. OK, I’m patient. I can’t see the prices rising any time soon and while I wait, rents are increasing and making the yield better.

    Next thoughts are to pay off some debt. I have an IP with a 30yr P&I loan of $70k on it. The IP has at least doubled in value recently and is now worth $140k. I am thinking, it will be another 10yrs before the value doubles again to $280k. Using an average growth rate, that is $14k per yr. Pretty good I think compared to the share scenario.

    I have decided to pay out the loan on the IP which saves me loan repayments of $5161 per year.
    The rent on this IP has also risen by $10 this year, so that’s an extra $520 income too.

    Seems wierd, but it looks like I am actually better off by paying down some debt, at present, than investing in more IP’s or shares.[blink]

    If you want to get out of a hole, first stop digging.

    Profile photo of SmethemSmethem
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    @smethem
    Join Date: 2004
    Post Count: 16

    With $70,000…

    If you pay down debt at say 7% interest you make a guaranteed $4,900 per year.

    Based on your given assumptions the shares don’t look attractive enough given that these returns are *not* guaranteed. BUT, what you really need to do (IMHO) is look at the range of possibilities – what is the outcome in the worst-case scenario assumptions and what is the outcome in the best-case scenario assumptions. This gives you an idea of the risk/return profile.

    By paying off the debt you won’t do worse than your current interest rate but you also won’t do any better. By investing in a growth asset like shares or another IP there is certainly a risk of doing worse but there might be a possibility of doing much better. Based on your own goals and situation you need to decide whether the possible returns make the risk worthwhile. (And you need to evaluate the risk in the context of your own personal circumstances, a worst-case negative cash-flow might be an inconvenience to someone on a large salary income but a disaster to someone who is forced to sell assets at the bottom of the market in order to service debt.)

    The IP is similar to shares, you have to look at a range of scenarios for capital growth/rental growth/interest rates etc. to see what you expect the best/worst outcomes to be. Of course as you’ll be using a lot of leverage that is going to multiply the possible gains/losses so the best case scenario is likely to be considerably better than paying off debt over the long term and the worst case scenario is likely to be significantly worse.

    Keep in mind that returns from growth assets like shares or IP are compounding, so they might look like marginal investments in the first year but over the years they do increasingly better than the fixed interest return. You could of course invest your increased cashflow (from paying off the debt) elsewhere but even that’s disadvantageous because you have to pay tax on the cash each year whereas in the compounding growth assets you are deferring tax until you sell.

    Your thoughts on the future performance of your existing IP aren’t really relevant to this decision. You are planning to keep that property regardless of what you use the $70k for so you’ll get the benefits of futher capital gains/rent increase on that property regardless.

    Some assumptions I would challenge:
    – Shares with 13% capital gain in the first year then nothing. If you’re buying shares you should be looking at a 5yr+ horizon and for a balanced portfolio you would probably expect some ongoing growth in the long-term. Your assumption is equivalent to average 2.5% growth p.a. over five years which is pretty conservative.
    – You don’t assume any growth in dividends, but it might be more realistic to expect dividends to grow as the company grows.

    Your decision to pay off debt might still turn out to be the best option for you, especially if you are bullish on both the property and share market, but it looks to me like you could afford to do some more scenario modelling?

    Profile photo of Still in SchoolStill in School
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    @still-in-school
    Join Date: 2003
    Post Count: 1,844
    Originally posted by Smethem:

    Your decision to pay off debt might still turn out to be the best option for you, especially if you are bullish on both the property and share market, but it looks to me like you could afford to do some more scenario modelling?

    Quite Agree

    Cheers,
    sis

    Wanna Talk About Stocks

    Profile photo of GreatPigGreatPig
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    @greatpig
    Join Date: 2004
    Post Count: 284

    Brenda,

    Regarding the shares, I wouldn’t personally put all that money into one share, as it leaves you too exposed if it falls – even with a blue chip. With $70K, I think you could buy at least half a dozen different companies without brokerage making too much of a dent (especially if you bought them yourself through an online broker).

    Also, when you buy shares at that price (sounds a bit like NAB), you’re getting low risk with relatively high yield, but at the expense of slow growth (and generally slow decline, if that’s the way it’s going, which is one reason why it’s low risk). Even so, with those big banks like NAB and CBA, the share price fluctuates up and down quite a lot within a relatively small range, so if this was only for the short term, you’d want to make sure you were on an up-trend otherwise you’d be better off having your money in the bank rather than in its shares (same yield but no capital loss).

    As always, if you want better returns you have to accept higher risk, and compensate for that by spreading your money around a bit and watching your investments closer.

    Not sure what you mean by it taking 18 years to show a profit. If the share price doesn’t fall, then you’re showing a profit from your first dividend, as you can always sell the shares and get your initial capital back. The dividends don’t have to have covered the capital cost for the investment to be showing a profit (although it would be nice to be able to tell the tax man it did [:D]).

    Another alternative is to invest the money into managed funds – either share or property. Easier than doing it all yourself, but again, likely to have lower returns. But I wouldn’t be putting the whole lot into just one of them either. You could look at something like Steve Navra’s share fund, which at last report was returning about 17% over 9 months, but of course past performance is no guarantee of future performance, as they say.

    And of course this is all just general comments based on my own opinions, and should not be construed as any type of advice.

    GP

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