Using home equity to invest in shares – genius or stupidity?

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Should you take advantage of low-interest rates to invest in shares rather than pay down your mortgage? My quick gut response after talking to thousands of people about mortgages is ‘NO WAY!’ 

Then I catch myself in a little bit of doubt and say ‘under what circumstances is it a great idea to use your home equity to play in the stock market?’

If you have a mortgage, whenever you use money, you are choosing between paying down your mortgage, investing elsewhere (like in shares or more property), or spending it. This means that topping up your mortgage to buy shares has the same effect as choosing not to pay down your mortgage and buying shares with cash. 

Over the past few years two trends have emerged, interest rates started dropping and kept dropping at the same time as stock markets have had an extraordinary bull run. Both trends have seen huge amounts of publicity so many people are putting them together and saying ‘I have access to cheap money and I have access to a high performing share market – perhaps I should buy some shares!’. 

The low-interest rates look here to stay. In 2015 when we started our mortgage advisory business, rates were much closer to 6% and people could not believe their luck getting mortgage rates with a 4 in front of them. 4.69% was thought of as an insane bargain just a few years ago and you should have seen the faces of our team when 3.99% rates came into play. 

In 2015 the cost to borrow $1 million for property investment was over $50,000 a year, in 2021 it could be under $20,000.

A few short years later we are seeing rates below 2%. Let’s add some more context, this means the cost to borrow $1mn for property investment was over $50,000 a year in 2015. In 2021 it will be under $20,000 a year if rates fall below 2% (because investors largely use interest-only loans, their cash flow calculations are what we consider, they have an advantage over first home buyers who have to pay down principal).

Interest rates look like they may fall below 2% at main banks this year. These low rates won’t last forever, but for now, all pressure is downwards. You cannot count on it but it’s good to know.

This, in my opinion, will push house and share prices way up (quicker than we are used to) because the cost of borrowing is so cheap. If you do sell in this hot market then replace the asset quickly so you do not miss out on a few months of capital gains.

Why does it matter if borrowing costs go down? Why do investors flood the market when this happens? This is because the yields are much higher than they are accustomed to. Negative gearing (making a cash flow loss) was common and understood as a necessary evil back in 2015 for properties in Auckland. Now, most Auckland properties are cash flow positive for investors and it’s a big unknown for how long.

If you are considering shares it’s likey your desire is to diversify investments and maximise your return on equity. If your mortgage rate is 3% and your returns on shares are 9% after-tax, this 6% surplus can be ploughed back into your mortgage or can be compounded by re-investing in shares. Do this long enough, and it will make a big difference to your net worth when you retire. However these are generalised market rates, you as a singular investor have to be confident in achieving these outcomes. If you do not have the math or spreadsheet skills to work out the benefits and differences, you may just want to stop right now. Focus on your mortgage bro, it is a sound financial move! It’s not going to hurt you to have a little FOMO and focus on one thing at a time. Check out Sir Bob Jones’s recent post about FOMO investing in shares.

Investing in shares is risky, and more so if you are investing for short term capital gains… when someone ‘wins’ it often means someone else ‘loses’. Could you consistently beat Dan Carter in a kicking contest? No, maybe 1 time in a 100 if he slips over. The people you compete against in the share market are All Black equivalent investors, they invest fulltime and often manage money in the billions. What edge do you have? Do you have a great reason to pick individual stocks, do you know something the market does not know? If not, then investing in an index fund probably makes sense if you want to mix up your investments and follow the stock market. 

Side note – my favourite index fund, where you can draw funds in and out as you please, is Simplicity’s investment fund (not for profit and extremely low fee). 

Andrew Malcolm

Assuming you know how to conduct due diligence and read company statements and financials, and you understand picking stocks based on valuation metrics and how to apply discounted cash flow to your assumptions of business’s true value, then picking stocks to invest in with your home equity should be easy for you. 

Good luck! Go Tesla! Or is that TSLAQ? (if you know, you know)

Whereas the price of shares have risen and risen often far outstripping the company’s dividend potential – meaning most investors are buying shares for capital gains with no personal cash flow. This parallels with property investments when they were more negatively geared.

Let’s assume investing in shares with your home equity is the comfortable surplus cash that you would have to decide what to do with it (not your everyday money but your savings). If you are going to spend your equity (mortgage top-up) on cars, clothes, food/drinks and holidays – then yes you will be financially better off over the long term if you reallocated that money to invest in shares (no guarantees though). 

You could also compare investing in shares versus buying an investment property – we aren’t going to focus on that but assume you are specifically talking about whether to invest in shares or property by paying down your mortgage. When you pay down your mortgage there is a guaranteed return on your investment because you are building up equity with a reducing LVR. If you have seen capital gains work in your favour in the past, why try to learn something new with investing in shares or crypto when you can double down and keep investing in property?  

Sharesies, Hatch Invest, and other cheap and easy investment platforms are making capital allocation decisions so quick and fun… you can buy almost instantly and sell again too. Just don’t forget the tax and the time investment is real and should be factored into your calculations of returns. Ask yourself where is your edge? Do you have the experience and knowledge to do extraordinary things with shares or a business or an investment property – it is likely that where you are most skilled is where you will find the biggest returns. 

If you really want to up your investment game, and simply find shares confusing or boring, then look to invest in real estate more. Double down on property where the capital gains and leverage work in your favour. The lack of tax on the gains if you hold, and the tangibility and relative lack of complexity of property make it super exciting for all investors because most people understand houses and rent giving them a great foundation to build their edge and personal strategy. 

Before you get tempted to invest in public offerings (IPO) take a step back and assess the situation. When a company goes to the public for money, it is because institutional investors have either been bypassed (because they would understand the business and choose not to invest at the valuation that company is seeking) or they have been shoulder tapped directly to invest and said no (too expensive or the business is not seen as safe/good). 

So if the professional money managers are having to fight in the trenches for shares at the same time as the public, then you have to question why the company is listing. Reading Brian Gaynor’s take (paywall) on the My Food Bag listing tells it all. The shareholders of the company are saying the company is poised for big growth but they are selling their equity! The very thing that they are saying will make you rich is what they are getting rid of… you have to ask why.

Should you invest in shares with your home equity just because interest rates are low? Hell no! Looking at rates in isolation is a foolish thing to do because those low rates for you to borrow are already greatly impacting the share market too. Probably in ways you do not understand.  

As always you should be developing your edge and your strategy. If you are uncomfortable with that – pay off your mortgages faster, it’s a safe return and builds the opportunity to recycle equity and invest in property further down the track. 

This is not intended as investment advice. Do your own research and get advice based on your position, risk tolerance and goals.

Alternatives to the share market and buying more property – 

  • Buy into a business
  • Buy a business yourself
  • Invest in your existing portfolio like a minor dwelling or new roof
  • Use revolving credit or offset products to minimise your repayment obligations
  • Pay down debts
  • Education for you and your family – ie training for a new career or career progression to increase income

Don’t let the media hype force you into playing the game just because you don’t want to miss out. If you top up your mortgage $100,000 to invest in shares then the share market collapses with values dipping 40% then you are going to stress a lot about that, aren’t you?

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