WEBVTT - Quick Bite: Leverage AKA the mortgage magnifier

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<v Speaker 1>You're listening to a share these podcast.

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<v Speaker 2>When you're thinking about investing. A lot of people say

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<v Speaker 2>property investing is a way to go, but it's based

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<v Speaker 2>on leverage and on taking quite a big risk. If

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<v Speaker 2>the value drops, you've effectively lost your entire investment, Whereas

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<v Speaker 2>whether shareholding, obviously the gains might be lower, but the

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<v Speaker 2>losses tend to be a little bit lower. So I

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<v Speaker 2>guess there's probably a bit of a chance here for

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<v Speaker 2>people to get both sides of the story if they

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<v Speaker 2>look into it in some death. But on that idea

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<v Speaker 2>of leverage, talk to me a little bit about that

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<v Speaker 2>in property investment at the moment and whether it's a

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<v Speaker 2>good time to be leveraged.

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<v Speaker 1>Yeah. I think the thing in New Zealand is was

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<v Speaker 1>always considered property to be quite safe, and I think

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<v Speaker 1>that's really mischaracterized property because property is actually a pretty

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<v Speaker 1>high risk, higher return. But when we typically think about

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<v Speaker 1>property over the last kind of twenty five a year,

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<v Speaker 1>so since nineteen ninety six, the average property increase in

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<v Speaker 1>New Zealand has been about six point three percent, and

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<v Speaker 1>for shares it's been eight point six percent. So shares

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<v Speaker 1>have been higher return, and that's where a lot of

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<v Speaker 1>people start by saying cool shares, higher return, But then

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<v Speaker 1>we've also got to think about risk. Now, when we

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<v Speaker 1>think about risk and investment circles, often we're talking about

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<v Speaker 1>like the ups and the downs, and so we see

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<v Speaker 1>that with shares that you do have some pretty high ups,

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<v Speaker 1>you also have some pretty high downs. So if we

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<v Speaker 1>think about the best year and the s and P

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<v Speaker 1>five hundred, since Google Finance started reporting the S and

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<v Speaker 1>P five hundred and nineteen ninety six, the best year

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<v Speaker 1>has been about fifty four percent up. Great year if

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<v Speaker 1>you timed that. The worst year has been down forty

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<v Speaker 1>five percent. So shares higher return, but bigger ups and downs.

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<v Speaker 1>The worst year and property has been quite recent it

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<v Speaker 1>was about fifteen percent down and best has been thirty

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<v Speaker 1>percent up. So typically this is the way we think

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<v Speaker 1>about property versus shares in New Zealand that cool shares

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<v Speaker 1>higher return, but also about higher risk. But what that

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<v Speaker 1>conversation misses is the leverage part. So let's run through

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<v Speaker 1>those numbers, because we always think that when you add

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<v Speaker 1>debt to an investment, whether it's property or a business,

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<v Speaker 1>whatever your asset happens to be, that is going to

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<v Speaker 1>make the returns larger, but it's going to make the

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<v Speaker 1>down side much larger as well. I call it the

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<v Speaker 1>mortgage magnifier, just because I love my alliterations. Mate, who doesn't.

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<v Speaker 1>So let's say you're buying a five hundred thousand dollar property.

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<v Speaker 1>You put one hundred thousand dollars worth of cash in

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<v Speaker 1>and we've got four hundred K worth of debt. Now,

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<v Speaker 1>if that property goes up by five percent, that property

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<v Speaker 1>is no longer worth five hundred thousand. It's worth five

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<v Speaker 1>hundred and twenty five thousand. Now most people be like, oh, okay, yeah,

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<v Speaker 1>that sounds about right. But what that means is that

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<v Speaker 1>your equity within that property has gone from one hundred

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<v Speaker 1>grand to one hundred and twenty five grand. So yep,

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<v Speaker 1>the market went up by five percent, your house went

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<v Speaker 1>up by five percent, but your equity within that property

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<v Speaker 1>went up by twenty five percent. Now that sounds pretty good,

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<v Speaker 1>but we've got to talk about the downside as well.

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<v Speaker 1>What happens if it goes the other way. That house

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<v Speaker 1>goes from five hundred k drops by five percent to

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<v Speaker 1>full seventy five. You've now lost twenty five thousand dollars

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<v Speaker 1>and you're down twenty five percent, and we are.

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<v Speaker 2>Seeing that at the moment in some markets, aren't we

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<v Speaker 2>We are seeing values in some respects kind of dropping

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<v Speaker 2>backwards in places, or valuations not kind of coming in

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<v Speaker 2>where they were originally put out. So that's a real risk.

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<v Speaker 1>Yeah, the market's starting to smooth out quite a lot,

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<v Speaker 1>but it's actually even worse than than what you've made

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<v Speaker 1>it out to be. You know, in Lower Hut at

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<v Speaker 1>the largest peak to trough drop, property prices were down

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<v Speaker 1>like thirty percent. And so the reason that those property

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<v Speaker 1>drops hurt isn't just the fact that you know you've

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<v Speaker 1>lost thirty percent on your investment. It's that if you

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<v Speaker 1>put in a twenty percent deposit and your property value

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<v Speaker 1>dropped by thirty percent, you're now in negative equity. Your

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<v Speaker 1>return on the money you put in is negative one

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<v Speaker 1>hundred and fifty percent, because you're getting five times if

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<v Speaker 1>you put in a twenty percent deposit, you put in

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<v Speaker 1>a fifth of the money, you're getting five times the

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<v Speaker 1>market return. And so typically we think of New Zealand

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<v Speaker 1>property a little bit lower risk, a little bit lower return,

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<v Speaker 1>but an actual fact, if you're using debt, it's much

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<v Speaker 1>higher risk and much higher return than shares, and that's

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<v Speaker 1>the thing that I think people miss And I'm not

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<v Speaker 1>really trying to emphasize the higher returns here. I'm trying

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<v Speaker 1>to emphasize the higher risk when we take on debt,

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<v Speaker 1>because that's the thing a lot of people forget about.

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<v Speaker 1>Investing involves a risk you might lose the money you

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<v Speaker 1>start with. We recommend talking to a licensed financial advisor.

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<v Speaker 1>We also recommend reading product disclosure documents before deciding to invest.