Newbie calculations

Hi,

Can someone tell me if I'm on the right track here ?

I want to start with a 30K portfolio.

5 Blue chip shares with average grossed up yield of 6.89%

Interest on borrowings of 8.87%

Difference approx 2%

2% of 30K is a $600 loss = $11.50 per week.

Actual loss = $6.92 after tax benefits

i.e. it costs $6.92 per week to run a 30K investment in the stock market

n.b for simplicity I have not included borrowing costs as an expense.

Have I missed anything ? Also, some idea of the potential pitfalls, apart from the value of the portfolio not increasing in value and the yields varying from the estimates, would be very much appreciated.


Thanks in advance

Calculations look about right but without knowing marginal tax rate can't be certain.

Potentially pitfall is managing cashflow. Many investors overlook this fact. Dividends are usually paid twice yearly but interest is generally a monthly cost. You need to be able to pay for interest repayments from cashflow otherwise if you pay down bulk amounts off of loan and it is an interest only loan you don't get full interest expense and deduction.

marginal rate 40%

Aware that dividends are not monthly and have allowed for this.


Thank you very much for your help.

On marginal rate of 40% your numbers are spot on. Not many people bother to calculate the cost of gearing into their projected investment return. Therefore your real cost of borrowing ($600*0.4 = 240) (600-240) =$360/$30,000 = 1.2%. If you make an net annual capital gain of 10% over 10 years your real return will be 8.8% per annum. Of course if dividend growth outpaces interest rates your real return could be higher. Good luck.

Hi again,

Am I also on the right track here ?

(Dividends+Imputed tax credits) = taxable income.
Taxable income - interest = loss (in my case).
Tax on loss + imputed tax credit = refund.
Refund plus original dividend = overall return (after tax).

Thanks again

Let me get this right. You are borrowing to invest in shares?

I am considering it, yes.

Nudge said:

Hi again,

Am I also on the right track here ?

(Dividends+Imputed tax credits) = taxable income.
Taxable income - interest = loss (in my case).
Tax on loss + imputed tax credit = refund.
Refund plus original dividend = overall return (after tax).

Thanks again

Click to expand...

The first line is correct. Therefore if you are on a marginal rate of 40% as suggested imputaiton will pay you back 30% but you will pay 10% of the dividend as tax. This is why retirees with no taxable income end up with tax refunds becasue their marginal rate can be 0% if taking a tax-free pension.

The second and third line are almost right. Taxable income is reduced by interest expense as a deduction and then the tax is calculated. You won't have loss that you can offset as such unless you are referring to a Capital Loss. Following on from this you will be entitled to a tax credit as an offset but the interest expense is a deduction. The difference between an offset and a deduction is that a deduction reduces taxable income whereas an offset is applied to your tax liability at the end.
The last line again is not quite correct as you will unlikely have a refund as such unless you are on a marginal rate lower than a company rate which is 30%. As you are on 40% there will be no refund. I will try to demonstrate with an example below.

Salary = $100,000
Interet exepense = $3,000 (10% on $30,000)
Dividend = $1,500 (5% on $30,000)
Imputation Credit =30/70 * 1500 = $642

Therefore Taxable income = $100,000 + $1500 + 642 =$102,142
Less Deductions $3,000
= $99,142
Tax Liability calculated on this amount $26,757 (excludes medicare levy).

Imputation credits offset against tax liability therefore tax liability = $26,115.

In your current situaiton tax on $100,000 = $27,100.
Strategy tax saving = $27,100-$26,115= 985

Therefore strategy benefit = $100,000 + 1,500 + tax savings on liability $985 less interest expense $3,000 = $99485. (100,000 - 99485 = 515). Therefore real return is -$515 / $30,000 = -1.7% return. Lets put it this way you would be 515 better off if you didn't do any gearing hence the term negative gearing. Note I have assumed an interest cost at 10% which could throw these numbers out for your situation but you get the idea. The real gains from borrowing are made when a capital gain is made or the dividends growth outpaces the cost of borrowing.
You should also note that you can't add imputation costs into the strategy benefit as they reduce your tax liability and unless you are on 0 or 15% you won't get a refund of credits.

Thanks for your detailed response TR!

So, to summarise, on your figures it would COST $9.90 (515/52) per week to run a 30k investment in the stock market. Obviously, I would have to make a capital gain that outweighs my costs in order to make an overall return. Also, hopefully, the dividends will also increase over time to a point where I am not out of pocket at all.

Your figures are very close to mine so unless I've missed anything I am on the right track.

Thanks for your help.

Nudge said:

Thanks for your detailed response TR!

So, to summarise, on your figures it would COST $9.90 (515/52) per week to run a 30k investment in the stock market. Obviously, I would have to make a capital gain that outweighs my costs in order to make an overall return. Also, hopefully, the dividends will also increase over time to a point where I am not out of pocket at all.

Your figures are very close to mine so unless I've missed anything I am on the right track.

Thanks for your help.

Click to expand...

You are on the right track. A positively geared share portfolio is your goal as with owning a rental property.

Good Luck.

Disclaimer: none of this has been financial advice but merely a discussion of general concepts and has not been applied to anyone's personal situation.