THE current record low interest rates may be a disaster for cautious retirees seeking reliable interest income to live on but they provide an outstanding opportunity for younger people or in fact anyone prepared to consider borrowing.
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One of the serious problems in the world today, one reason why interest rates are so low, is that there aren’t enough borrowers about.
Central banks have worked hard to boost the amount of liquidity in the global financial system and increase the money supply.
With lots of cash floating around, too many savers, and not enough borrowers to use all the cash, interest rates are at extreme lows.
However that won’t always be the case. In the capitalist system markets always return to normal eventually.
The balance between savers and borrowers may be at extremely low rates now, but that will normalise.
Interest rates have already started to rise in the US, with a first increase last December and another a real possibility in June. In time rates will rise here too.
The US set the pace in responding to the 2008-09 global financial crisis with ultra-low interest rates and quantitative easing to boost liquidity.
The UK, Europe and Japan followed. In the US those policies have generated a strong economic recovery. Britain is also doing quite well.
There will be a sound recovery in Europe and elsewhere in time too. Stronger demand will result in prices begining to rise again and inflation will return.
That will mean interest rates edging up. Capital growth will return with good quality assets in limited supply appreciating.
Therefore this is an ideal time to borrow to buy quality assets - shares, managed funds, properties, farms and good businesses. Borrowing costs are extremely low and can be locked in and values should increase over the long term.
Selected residential and commercial properties have potential. Growth oriented managed funds and shares provide an easy way to get started. They can be bought in any quantity to suit needs, and increased or decreased at any time to suit changing circumstances. The long term growth potential is high.
Loans for investments can be from banks or margin lenders. Bank loans are cheaper if secured by a property. Margin loans are easy and flexible but cost a little more.
Bank loans are at around 5 per cent whereas margin loans are around 6.5 per cent currently.
The interest is tax deductible in either case reducing the cost sharply for medium to higher bracket taxpayers. Any net shortfall is deductible against other income such as salary.
With margin loans no security is required other than the funds and shares bought but borrowers need to invest some cash. Typically for each dollar put in they borrow two dollars. This means a gearing ratio of three to one.
If values rise by 10 per cent the return on equity will be 30 per cent, less the borrowing costs.
Any losses are also multiplied. Borrowing for any investment means increased risk but a long time-frame will usually ensure sound returns.
It is also possible to prepay interest on the investment loan for the next 12 months and claim a tax deduction for the expense in this financial year. This is an attractive strategy for high income earners.
Instalment gearing is ideal for younger people who have good incomes but little cash savings.
An investment portfolio can be started with as little as $1000 initially and a regular contribution of at least $200 per month. Borrowings are added monthly in line with the regular contributions.
Managed funds focusing on Australian shares, commercial property, international shares and infrastructure all have attractive growth potential.
Choosing several funds investing across all areas gives diversity to better manage volatility.