Share market volatility over the last few years has resulted in many investors retreating from equities and fleeing to cash. With three year term deposits currently paying 5.80% p.a. it's not surprising that investors are finding this asset class attractive.
But at some point the share market may rebound and investors sitting in cash will miss out on this potential upside.
There is a way, however, whereby investors can get the 'best of both worlds', and that is to implement a strategy combining leverage and a term deposit.
The following hypothetical case study is one such example.
Case study
Neil is the trustee of his SMSF, currently in pension phase, and has $100,000 sitting in cash. He is contemplating investing the entire amount in a three year term deposit paying 5.80% p.a. Neil would be happy to look at gaining exposure to the equity market as long as the potential for loss was limited to the upfront amount invested and the balance of the $100,000 was preserved over a three year period.
Neil carefully considers his risk profile and time horizon and decides to allocate $85,000 to a three year term deposit at a rate of 5.80% p.a. He chooses to invest the balance of $15,000 into a leveraged investment such as CBA's Vantage+, giving him exposure to $100,000 of the S&P/ASX 200 Index.
Neil's maximum downside is the initial investment of $15,000, however, there would be no loss if the market returned a minimum of 4.80% p.a.
The result
| Term Deposit | |
|---|---|
| Neil's tax rate | 0.00% |
| Initial balance in term deposit | $85,000 |
| Interest earned on term deposit | $15,664 |
| Value at maturity | $100,664 |
| Tax payable | $0 |
| Value of term deposit at maturity | $100,664 |
| Leveraged investment | |
|---|---|
| Cost of investment | $15,000 |
| Investment exposure | $100,000 |
| Maturity value | $122,504 |
| Gain / loss | $22,504 |
| Taxable gain / loss | $7,504 |
| Tax payable | $0 |
| Net after tax gain on investment | $7,504 |
| Net cashflow at maturity | $22,504 |
| Combined value at maturity | $123,168 |
|---|
In comparison, an investment in a term deposit only would look like:
| Tax rate | 0.00% |
| Initial balance | $100,000 |
| Interest earned on term deposit | $18,429 |
| Tax payable | $0 |
| Net cashflow at maturity | $118,429 |
|---|
Strategy benefits
- Neil is nearly $5,000 better off having combined a term deposit with a leveraged investment compared to investing the full 100% into a term deposit.
- In the event the market had a zero or negative return over the period, Neil would have lost the entire $15,000 invested. However, his primary goal of having $100,000 in three years time has been met by the term deposit investment.
- Leveraged exposure to the sharemarket has allowed Neil to benefit from a potential rally in the equity market whilst at the same time limiting the downside associated with investing in equities and thereby having a level of comfort during periods of high volatility.
