The Dangers of ‘Tax-Led’ Investing

Do you want to pay less tax?

I think I can guess your answer to this.

As a former financial planner, some of the greatest value I could add to my clients’ portfolios was by reducing their tax liabilities. Both current taxes and future ones.

But there’s a difference between a good tax strategy, and investing because of a tax benefit.

Even the tangible, black and white benefits of tax reductions in an investment decision can become a very dangerous thing.

As investors in agribusiness managed investment schemes discovered to their cost back in 2009.

This is a cautionary tale if ever there was one.

8,000 investors lost money. Investors received just $3 million back out of $2 billion invested.

I personally know people who lost six-digit figures, nearly seven — not my clients, I must stress. I never recommended these products, as they were clearly a tax dodge dressed up in an investment vehicle.

But I think that the current danger lies a bit closer to home. Namely, the effect of negative gearing on residential properties.

The facts around this are interesting…

A nation of landlords

Australians are mad on property.

Everyone knows this.

But they’re getting even madder.

We’ve bet the farm on it.

According to the ATO, the number of landlords owning five or more properties is growing. Driven primarily by the benefits of negative gearing. As well as the capital gains growth.

In fact, also according to the ATO, the negative gearing benefits are worth five times more for Doctors and Lawyers than Nurses and Teachers.

The logic of investing in highly geared property if you are on a stable income is very clear. Especially if you are on a high stable income.

The taxpayers subsidise your losses. And as property has yet to let us down, capital growth continues to grow at a lot faster pace.

I’m not judging this one way or the other. Just saying what it is.

But the property market has an oversized effect on the whole economy. And the nation’s wealth.

The average Australian has around $1.1 million in assets. And 60% of this is property assets.

Construction activity is 8% of economic growth at present. Just behind mining and finance. It employs over one million people directly. And 330,000 businesses.

But this sector could slow soon. 

The Commonwealth Bank is forecasting that dwelling commencements will slow to 200,000 in the current financial year, down from 217,000 last year, before declining to 185,000 in the 2018/19 financial year.

If property is a house of cards, then the effects of any decline will be big.

This is probably why no party should tinker with negative gearing. Right now, only the Labour party are making noises to this effect.

This is dangerous, in my opinion.

Not that there aren’t justifiable reasons for making a case. But the medicine might be worse than the illness in this instance.

Let the investment guide you

Whether negative gearing remains or not, the decision to invest in property should be led by the fundamentals. As in, will it make a good 10-year or 20-year investment?

This is tricky to work out of course. It relies primarily on wage growth (which is low) and interest rates (which can’t get any lower, really).

If you think the property will still be a good investment after a few ‘stress tests’ then you should work out the benefits of the tax deduction through negative gearing. As I said at the start, letting the tax advantage guide any investment is putting the cart before the horse.

Decide what you are going to invest in first. Then work out the best way of (legally!) minimising your tax.

I’m not saying there will be a property fall soon.

But a slowing down of property prices is clearly in the interests of a large swathe of younger Australians.

Australians whose tax dollars will support an ageing population.

What we need now is a clever solution. And an engineered soft landing. Steep falls and steep rises would both effect the economy badly.

And property investors will have to take note.

Good investing,

Ryan Dinse,
Editor, Money Morning

PS: Matt Hibbard is one analyst who finds good both good investments and good tax benefits. I’m talking about the gift of franking credits. Right now, he’s found a very unique way to start generating some extra cashflow. If you need extra income, click here to read more.

Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.

Ryan's premium publications include:

Money Morning Australia