Debt Recycling Strategy vs Paying Off Home Loan [Part 2]

So yeah, last time we went over kind of the returns and just kind of setting up kind of the analysis. Yeah, hope to show today is just kind of the outputs that that's given us to, yeah, to see what the different results are over time. As we have gone over in prior videos, that debt recycling in and of itself, obviously, it saves tax if you go down that road. But at the end of the day, it's an investing decision and with any kind of investing comes risk. So we just want to kind of say, well, what did that risk look like over time? So what I've done here is this is kind of a scenario with a couple both on one hundred and sixty thousand dollars investing in a portfolio of international shares at 60 percent and 40 percent into Australian shares. And just seeing what that looks like after tax over time. So we look at here on my screen so we can see that you might remember from the prior video. And I might leave a link to those returns in the comments. So we can remember that obviously 1990 interest rates were quite high, the highest that they were. And in that year as well, investment returns were poor. So we can say, obviously, in that year when interest rates are high after a year, after multiple years, you would have been better off actually paying down your mortgage as opposed to paying that down and redrawing that and investing, obviously, into bad investment returns. So what we can see here is obviously there's a lot of numbers here. So we can kind of concentrate just on this 1990 example. And obviously that goes back to further. So we've got the most number of years under that example. So what we can see here is in that first year, let's say, let's wind back the clock to 1990. After one year, you would have been 23 percent worse off, debt recycling, as opposed to just paying down your mortgage or putting it into the offset account and saving the interest. And then after the second year, you recap some of those losses. So investment returns were better in that second year. And then you can see you've gone backwards again in year three. So you can make the assumption that in 1992, investment returns were poor. In year four, you've gone into the black. So then it's kind of broken even effectively at two percent. Go back and so you can kind of see along the journey at the different time intervals. It's not always kind of smooth sailing, like there's no kind of investment journey that's smooth sailing. So we can see here that it kind of keeps its broken even and it gets quite profitable in 1990 after, say, seven years. And it holds on to those returns and it holds on to them for a while. It gives some of those back. There were poor returns in 2002. So you can see at year 13, after year 13, that you've pretty much broken even again. And then when the GFC hits, you go backwards so that after pretty much in the middle of the GFC, after being up, after being down, after being up and down, you would have been 27 percent better off actually just paying down your mortgage as opposed to debt recycling. And then from year 24, that's actually kind of the longest period from a debt recycling point of view, where it actually you've broken even on that and then it holds. So you can kind of think of from 1990 all the way until 2023 and that's 34 years worth of data. You're 46 percent better off investing in this portfolio as opposed to just paying down the mortgage and saving the interest. So that's obviously the longest. So you can kind of look at that over any point in time. Just before I continue on any longer, did you have any thoughts or questions on that? Two observations. Number one, I think I said in the pre-recording, but I've heard that situation in the past. So if you look at year 10, you'd be looking good. You'd be sitting there going, hey, I'm pretty smart. But then you go to year 22 and you sit there and you're starting to potentially regret the decisions you made. So I look at it and I say, well, I guess the important thing is figuring out the strategy and sticking to the strategy, because it doesn't help you if you get to year 22 and then you decide you want to change your strategy. It's actually going to make it worse. It's actually really interesting to see that obviously that's the worst case scenario, but it's taken really, you could say where it's starting to get a clear benefit is really 30 odd years. But even at 30 years, it's still the same level as the 10 year mark. So, yeah, I guess you've really got to pick your strategy and stick with it. Yeah, because I think going along that, like any kind of investment journey should be a long term endeavour. So you can kind of see that it's so important that you maintain that strategy. Because if, for instance, you went with a strategy to debt, recycle and invest, and you obviously would have been down over those first couple of years so that it's not uncommon that naturally in that kind of situation, we get fearful and might want to sell down and say, well, I'm just going to put it into the mortgage and sleep better at night. If you then go down that avenue, you then don't have the opportunity to get those inevitably high returns. At one point, we never know where they are. Those high returns to then recoup those poor returns that if you're unlucky enough to start investing in 1990, if you change strategy, you've been locked in and then you're going to obviously get the return of the interest rate, whatever you're saving. And that's kind of crystallised that loss in that situation. So you're never actually going to, I guess, recover from that. So that's probably the most crucial kind of, and it's not exclusive to debt recycling, but any kind of investing journey, you need to be a long term investor. When running this analysis, I was quite surprised. Obviously, 1990, that's probably the longest data point that we have. That kind of included a few different crises over that situation. So that's, I would say, one of the worst situations in terms of that broker even point where it stays into the black thereafter. But I was quite surprised how long that is. Like usually, like when you think about investing in most investment portfolios or products, that'll give a minimum investment timeframe of seven years. And that's pretty much like around the mark of worst case scenarios to, I guess, regain your capital. So if you invested $100,000 just before the GFC, you obviously would have been down. But then after six or seven years, including dividends, that $100,000 was $100,000 again. Difference with mortgage investing, because those returns are effectively banked into this analysis. But the difference with paying down your mortgage is, and I touched on this in the prior video, is you're always chasing a positive return. So in that prior example of seven years, that $100,000, that was $100,000 that you were chasing. So it wasn't moving. Whereas in this analysis, why it goes out to the 23 years as opposed to seven or a normal market kind of break-even point is that that $100,000 goes to $114,000 and $120,000. So with this analysis where we're effectively chasing the goalpost of paying down the mortgage, even when you have got a good return, that in that situation, you've got a good return as well by paying down the mortgage, whatever the interest rates were over that period of time. So that's why I think my analysis or kind of takeaway from this analysis is that I think it's a combination of both. That here we can see that over these worst periods, that I think 23 years, that's probably even the most patient people wouldn't want to wait that long. But there are plenty of periods as well where it's a lot less than that. And over here, for instance, that you can see over the longest period, the advantage, you're 46% better off. So effectively, let's say you put in $100,000, your portfolio at the end of it was 46% better off. Then if you just paid down the mortgage, that's still not a bad outcome, but it's over 34 years, it's not crazy. Just if you are lucky enough to avoid that 1990 situation and invest in 1991, it's 82%. So that's kind of the worst scenario in terms of you're just unlucky. This is really interesting because I think some people would just pick a strategy and think, okay, this one will work. One straight, like for example, if you waited for the GFC crash and you got in in 2012, you'd be sitting pretty good. But if it was 1990 or the year 2000 or something like that, it actually takes a long period of time for things to work out. Lots of red there. And I think just because something happens, like the thing that I'm taking out of it is like, you got to stick to that strategy because you might cop some losses up early, but you got to have confidence in your strategy because if you don't, you'll sell out too early. But I also get what you're saying is if you're in 1990 and you're waiting 20 odd years to basically start to get to clear water, 25 years, that's probably too long for most people as well. Yeah, and it wasn't red all the way through. So that's kind of other point as well. So like some people might have had the temptation after 10 years, maybe realise some of the portfolio and pay down more of their non-deductible debt or mortgage. Like they would have been fortunate in that situation because they've kind of timed it and sold down it before these kind of bad years. So that gets rare like anything. And this is why I think this exercise is why I thought it was important that no returns are linear. So like it's not a case of always just always going one way. So there's ups and downs with the strategy. So sometimes you're even in 1990, for instance, that you're down and you're up and then you're down again and you're up again. So it's a bumpy ride and obviously a long time in that situation. Another point that I would add is here, we've got this is obviously just the debt recycling scenario. But if we compare that to, I ran the analysis, obviously, if you don't debt recycling, if you just took those funds out and just invested, you can actually see over here in that situation, there's just a lot more red with that. So these are the exact same investment returns, exact same incomes, etc. Just so just kind of repeat that again. That's so this scenario is if you just had 100 grand cash and just invested that. So you didn't go through the process of paying down your non-deductible debt and redrawing it for the tax advantages. So you still invest in the same amount. You still got the same market risk. You just haven't structured in the correct way. And this is probably why I'm passionate about debt recycling is because it's one of the only kind of free lunches, if you like, in investing in terms of if you've made the decision to actually invest that you've got this market risk in any case. So if you debt recycle, at least get those tax deductions. So you can see here that after you won, you would have been negative 28 percent as opposed to negative 23 percent. So let's call it a 5 percent difference so that you can kind of think I think it was 14.52 percent was the interest rate in 1990. That difference at 5 percent, that's roughly like kind of the tax benefit of 14.52 percent tax deduction in that year. And that tax deduction obviously gets lower when interest rates are lower in the years thereafter. But each year, you're kind of just pocketing those tax deductions. And obviously the tax savings on those tax deductions. So that's what kind of makes it a little bit more, that's what adds to the return. So that then when you actually kind of extrapolate that, if we look at 1990, so that 34 year, obviously in the debt recycling scenario, remembering back, you're 46 percent better off. Whereas if you didn't debt recycle, you're literally 1 percent better off. So this is where I wouldn't give it a rule. But I would almost make the, for somebody who's a little bit kind of risk averse, like if you're not debt recycling, you probably should just pay down the mortgage. Because obviously on that, the funds that you're investing, you're going to get taxed on that, get any tax deductions on the debt because you haven't structured it correctly. So there are situations still where investing as opposed to just paying down the mortgage still makes sense. But it's always worse off as opposed to debt recycling because those tax deductions are on the table no matter what with that. So we can say obviously in 1990, for instance, you're 46, first one, so there's a 45 percent better off. If we go to say 2009, just picking a random year, it was 67 over here. If we go to 2009 here, it was 96 percent better off. So over time, you can just say that that's where the benefit each year of those kind of tax savings, which are variable based on the interest rate in that any given year. That's kind of, you're just popping that and accruing that each year. And then so what I'll do is I've kind of got another kind of way to look at that over here. So here what I've done is just kind of summarised each of those periods. So here is up the top is just debt recycling. Down the bottom is not debt recycling. And here's kind of the difference between that. Here we go to the 34, like a time frame, investment time frame of 34 years. We only have one of them, obviously, because that's the longest. So next year, when we bring in 2024 data, we'll have two years of that, and we'll have a 35 year period. But at the moment, we just have the one. So that one example, when you get recycled, you're 46 percent better off, where you're 1 percent better off, effectively broken even if you didn't get recycled. So down here, I've just kind of put the difference between each of those. So that then what we can see from 24 years where you get recycled, from thereafter, there were no negative kind of years where you were actually worse off. Whereas where you didn't get recycled, 36 percent of the time, you were worse off, 30 percent, 11 percent, 13 percent, 17 percent. So after 30 years, you always remain better off, but just better off. Because obviously, from 1990, you were only 1 percent better off. So it wouldn't have taken much for that to have been a negative year. So that here you can kind of see the difference that you're always better off, obviously, debt recycling. But I think this would kind of just looking at this percentage, because now that we've made the decision to say that, well, it always makes sense, debt recycling, you can probably just ignore these numbers here and just concentrate on this table here, just to make it a little bit more, somewhat easier to digest into the numbers. I think the summary I took away from that is if you want to do that investment, so put money into shares, for example, and you've got a home loan, structuring is important because if you structure your debt in the right way, so that you're maximizing your tax effectiveness, that's going to be better 100 percent of the time. Yeah, because those tax deductions are on the table no matter what in that situation. So I would add, probably going a little bit above the scope of this call, I would add the only caveat where you shouldn't debt recycle, if you want to invest, is if you currently have a home that's going to be turned into an investment property. If that's the situation, you just want to kind of pause and maybe just do a few more numbers or send me an email or something like that. Because that's probably the one situation, if somebody has a home, it's not uncommon for an Australian to have a home that might be their first home and then at one point they might have a family, an upgrade, and then if they have the capacity and inclination, they might keep that former home as an investment property. If that's the situation and that's going to happen imminently and then you've got to hold it for a long time, in that situation you probably shouldn't debt recycle because you're going to lose tax deductions in terms of the structure. So I won't go down that avenue too much, just one caveat because definitely one, you have to open the floodgates and go down that avenue because there's that one caveat. Okay, yeah, but even then you could effectively structure, so long as you've got your strategy clear, you can effectively structure for that scenario as well, yeah? It's actually quite hard to defeat, to, I guess, structure that scenario because with debt recycling as part of the process is you pay down non-deductible debt and then you redraw that and then for the investment purpose. So if you currently have a home that's going to be turned into an investment property, you actually want to maximise the debt on that when it becomes an investment property and by debt recycling, you've kind of killed the sum of the debt that otherwise could have been tax deductible. I get what you're saying. In terms of, maybe take the term debt recycling out of it, you can effectively do it by putting those returns into your offset account because you're not reducing the loan limit on that owner-occupied loan but you're still getting the benefits of the reduced interest on it. Would that be right? Yeah, it's always a tricky situation and... I guess you're paying it down quicker. Yeah, I think in that situation, if someone's imminently going to turn something into an investment property, probably normally I'd just say, just keep it in the offset account and then once you're in that forever home, when it's turned into an investment property, then debt recycle. There can be some instances where they could just actually invest that cash, as I said before, and what I say, like invest that cash and then maybe at one point in time, restructure the portfolio and debt recycle at that point in time. As I said before, that over a short period of time, that's not a guaranteed strategy with that. So yeah, probably wouldn't want to go down into the weeds too much on that rather just add the caveat that there's one kind of situation where you don't want to debt recycle and you just want to be a bit more careful of paying down that non-deductible debt if it's going to be turned into a deductible debt in the future with that. So just jumping back onto this, that here we can see when we're debt recycling that all the different timeframes. So obviously looking over a one-year timeframe, we have 34 of those and then 35% of the time, you actually would have been worse off debt recycling, just looking at a one-year period and then 30% over two years. And then so we look at, I guess, more reasonable timeframes or like what people kind of think of as an investment journey. So over a 10-year period, the worst you would have been off would have been negative 38% compared to just paying down the mortgage. So that probably would have been like a 1990 scenario or something like that. The best you would have been off over 10 years would have been 156%. So that's how big the range can potentially be. And that's why you can have so much luck that over a 10-year period, you could have had half your, you could have been 56% worse off or 156% better off over that period of time. Over 10 years, this is where like, generally the market trends up. And like when we looked at the averages last time, the returns were on average greater than the interest rate of that period. So on average, you're better off debt recycling. So 32% over 10 years, your kind of portfolio is going to be 32% better off and the median, so just the middle number there, you're 28% better off by debt recycling over a 10-year period. And then, so there's 25 of those 10-year periods and five of them were actually negative. So there was a negative 38%, we know that. And there have been a few different kind of numbers down to zero, that. So you can make the summary to say it, there's 20% of the time over a 10-year period, you would have been worse off by debt recycling. I guess a few takeaways from this is number one, debt recycling makes sense. If you've made the decision to invest. And number two, that, well, you need to be a long-term investor, can be quite long to actually make that a profitable strategy as opposed to just paying down the mortgage or offsetting the mortgage. And probably the third one is that it doesn't have to be all or nothing, as mentioned in prior videos. It can be a case of saying that, well, they'll have $100,000, maybe I'll go $50,000 debt recycle, leave $50,000 in the offset account or pay down the mortgage or any number in between. Could probably add to that as well and say that, well, you don't have to do it all in this year. So if we jump back to a table over here, if we look at 1990, for instance, that if you had $100,000 in 1990, you didn't have to put all of that into the market at that point in time or debt recycled at all at that point in time. You could have said that, well, I want to have $100,000 of investment exposure, but maybe I'll do 50% this year or 50% next year or 25% this right now, 25% in six months time, 25% in 12 months time and so forth with that. So I think with this, there is the sequencing risk. So I find a lot online on online forums that dollar cost averaging or drip feeding into the market, which is when you kind of say that, well, I've got this amount of money. I'm not going to invest it all today. I'm going to invest it over a period of time. I think that probably gets a negative rap because there's studies out there, which I don't contest the studies, but naturally the market trends up. So studies say that, well, 70%, well, I think it's 60 to 70% of the time, you're better off just investing that into the market as opposed to dollar cost averaging over six or 12 months. And so that I think people read that and say that, well, it's rational just to invest it. You know, the risk of investing and that's the best decision. I think there's number one, there's the emotional benefit of dollar cost average or drip feeding into the market because you need to kind of ensure that you're a long-term investor. So if you put it all into the market and then six months later, there were horrible returns and then you might not have been experienced in investing. And obviously it can be the feelings to have regret and unwind that decision. Like that's almost the worst case scenario. So dollar cost averaging is almost kind of accepting, I guess, not get the worst return. I'm not going to get the best return. I'm going to get like somewhere in the middle. I'm going to narrow the range of potential outcomes so that that's one benefit of dollar cost averaging. Another one is I think it can help with decisions because naturally if you know how important the decision is, if you see these numbers and how important, like what year, when you actually invest is, that can actually lead to probably analysis paralysis and people thinking, well, I've got a hundred thousand dollars. I've got it. It's all structured. It's all ready to go. Do I invest it now? Or it's been bad returns lately. It's been good returns, whatever people's different theories are. And then they might not actually ever do that because they're kind of, they're scared because it is so critical. Like it just has a bigger risk. It just goes on the numbers more if you don't dollar cost average either way. Whereas if you dollar cost average, it's almost the case of just accepting, well, the market is what the market is and let's just kind of average in and sure you invested and then the market goes crazy. You would have preferred that you had 100% exposure to that. But just on the other hand, if the market crashed, you would be happy that, well, I only put in 25% of my portfolio. Now I've got 75% left and I'm actually buying in a slower return. And then hopefully the higher returns come thereafter. So I think that that's a case to say that, well, you don't have to invest at all. You can kind of straddle 1990 and 1991 just to average the returns so that you're not getting the absolute worst outcome. And similarly, that's obviously the positive side of it. If you did that, you're not going to get the 121% in this situation because you would have been straddling these years in that example down there. So you got to take the good with the bad and vice versa. But that's another kind of takeaway that you don't necessarily have to be exposed to any given year. You can kind of, number one, take a balanced approach and then average into that. Yeah, really interesting stuff. I find through just the videos I do online, people are always on one side of the boat. You know, they might be a gold bug, Bitcoin, crypto. They might be in the shares or super or property. The thing I've learned over all the years, kind of watching on the sidelines as a mortgage broker, is it's rarely as easy as what people think. And we do have a recency bias here. And that's my greatest fear with my clients is that people think it's easy. And I know you've got to own your mistakes. But when it's someone's lifestyle or their family's kind of finances on the line, personally, it does worry me a little bit. I like this sort of information because it just shows that things aren't as easy. And therefore, you have to adjust what risk you're taking with your financial decisions. Yeah, and hopefully, obviously, there's a lot of numbers here and people could see the red and think that, well, I thought it was all rosy and investment returns are positive after seven years and things like that. So hopefully it is, I guess, data is empowering and helps people make decisions either way with that, as opposed to thinking it's all too complicated or something like that. Because obviously, lots of people don't recycle every day. Probably few people know the numbers or have done the analysis and people have done very well. Obviously, people that have net recycled since 2012, which is probably two years since it's become popular, like people probably weren't talking about their recycling in 1996 and things like that, is that a lot of people probably have done well from net recycling with that. So I think it's more just a case of saying that, well, there can still be situations, there is investment return risk, and it's not a bad strategy to actually pay down the mortgage. But at the same time, that statistically on average, that since 1990, you have been rewarded for taking on that risk and net recycling to optimise it so that it probably comes into the equation if you are willing to take on a little bit more risk to get ahead. Excellent, mate. Any other observations or anything you think the audience needs to know that we haven't gone over other in this video or maybe something you wanna reinforce from one of the other videos we've done? I'll leave the link to this in the comments so people can have a look at it for themselves. This is based on $160,000 of joint income. In terms of what happens if, for instance, your tax bracket's higher than that, it tilts it a little bit more into paying down the mortgage, not drastically. And on the other side of that, if your income's lower and your tax lower on investment earnings, it's slightly better to actually invest because you're not getting taxed as heavily. Vice versa to that, when you compare debt recycling to not debt recycling, so that previous analysis, the higher your income, the bigger the difference between that because obviously the tax benefit is higher as your tax rate is higher on those deductions. So that's a couple of things, but it doesn't actually change the numbers too much based on your actual tax rate. So this is based on a 39% marginal tax rate, but if it's 32% or higher or lower, it doesn't change a red to blue, for instance. Excellent. Yeah, I reckon we give that a wrap. If you want to, there's a fair bit of data here, so if you wanna ask questions, just chuck them in the comments and Kyle will get onto them. And we'll leave Kyle's links in the description as well, if you wanna chat to him. Showing yourself in the comments, if you wanna have an individual one-on-one chat, you'll be able to find his details in the comments. And just one extra thing, I have put together a white paper, so just document in all of this, so in a little bit more of a digestible format, or you can take a little bit slower if you'd like to do that. So I'll leave the link to that in the comments as well. Beautiful. Thank you. Awesome. Thanks so much, Will.