Best investment is to pay down debt

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?

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 []).

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