From Money Magazine, February 2007
By Peter Freeman
For those with plenty of investment savvy who are prepared to accept lots of risk the sort of risk that will probably give many people sleepless nights it is possible to turn a modest starting outlay of $5000 into $50,000 in just a few weeks.
And, no, it is not a case of putting the lot on a ten-to-1 winner at the local races. Instead there are legitimate investment products and strategies which, if handled well, have the genuine potential to deliver this sort of high-octane, super-fast return.
"It is possible to generate big profits very quickly," says David Skilton, head of sales at IG Markets, a firm that specialises in highly leveraged products such as Contracts for Difference (CFD).
While Skilton is quick to acknowledge that CFDs can leave investors suffering painful losses, he argues that, in the right hands, they can be extremely powerful investments.
But such high-powered products aren't for everyone. Despite this it is still possible to set yourself the goal of turning $5000 into $50,000. The key is to understand your own risk tolerance. If it is very low you will need to use a cautious strategy and so accept that the $50,000 goal will take a long time to achieve.
Most of us fall somewhere between the two risk-taking extremes. Depending on where you sit on this risk spectrum, the $50,000 goal can take as little as three years to achieve or as long as 20 years.
Triumvirate and Macquarie Bank crunched the numbers for the various investment strategies outlined in this report. As both stress, the precise outcomes, and the time frames, depend on a lot of assumptions. Vary one and the result can be very different.
Quite reasonably, both also stress that past performance doesn't provide a reliable guide to likely future returns. As experienced investors appreciate, investment returns can fluctuate wildly, especially over the short term.
Despite these caveats, the investment scenarios outlined in this report provide a guide to possible, real-world investment strategies that might be useful for someone trying to turn $5000 into $50,000.
1. Ultra-high octane
If you have nerves of steel, and strong investment discipline, one of the quickest ways to turn $5000 into $50,000 is to trade Contracts for Difference (CFD).
A CFD is a contract between you and the provider (there are almost 20) that involves you paying a relatively small deposit to take a highly leveraged exposure to any one of a range of different assets, from Australian shares to commodities and currencies.
Usually you pay around five percent to 10 percent of the total value of the assets bought, with the rest financed by an in-built loan.
While the interest on these at the moment is around nine percent, the total interest bill is usually small due to the very short-term nature of CFDs, which are held, on average, for only around three weeks or so. Brokerage costs, at both ends of the trade, are also relatively low.
"The main focus should be on getting the actual trade right, and on making sure you take out a guaranteed stop/loss so as to cap your potential loss," says Skilton of IG Markets.
For example an investor uses $5000 to buy CFDs over about 20,000 shares in a company at $5. The price surges to $7.50 and the investor sells for a pre-tax net amount of $50,000. With a marginal tax rate of 31.5 percent the shares would have to jump to just over $8.60 to deliver $50,000 profit after tax.
Perhaps the investor could carry out another successful CFD trade. All this could be achieved in just a few weeks.
Unfortunately with this strategy, if you get them wrong you could turn your $5000 into nothing just as quickly.
2. Fast and furious
Macquarie Bank, asked to come up with an aggressive investment strategy suitable for a high-risk taker who wanted to try to turn $5000 into $50,000, suggested a combination of heavy borrowing and a defensive put option.
As an example it looked at what would have happened if someone had borrowed to buy BHP shares back in mid-2004.
A margin loan is used in mid-2004 for 2039 BHP shares. At $12.03 the cost is $24,529. $3304 of his $5000 pays for a put option over BHP shares, guaranteeing he can repay the loan. The rest is used to cover the net cost of the loan interest.
The shares are sold in January 2006 at $24.06 for a net after-tax gain of $16,547. A repeat of the process, with another surging share, will deliver the net $50,000 in about three years.
"The assumptions are based on what happened to share prices and so what an investor actually could have done," explains Peter van der Westhuyzen, head of sales with Macquarie Bank's margin lending division.
3. Controlled aggression
Triumvirate Investment Consultants adopted the strategy of using a margin loan to finance an investment in a geared share fund.
In particular, it assumed the investor borrowed $5000 at an average interest rate of 8.5 percent and invested the resultant $10,000 in the Advance Geared Australian Equity Fund.
"The margin loan gearing is relatively modest, which reduces the risk of a margin call," says Esler of Triumvirate, who adds that the Advance fund is also relatively conservative as it focuses on looking for sharemarket value.
"This strategy definitely involves taking risk, but it is controlled risk and usually would give an investor the scope to recover from a setback," he says.
Using the historical annual returns generated by the Advance Fund 17.7 percent growth and 9.7 percent income and applying an average franking credit of 50 percent, Esler calculated that the investor's initial $5000 would be turned into $50,000 in just over seven years.
That amount is net of tax (a marginal tax rate of 31.5 percent was used) and the repayment of the margin loan.
4. Defensive gearing
The emphasis here is again on using gearing in an effort to boost returns, but with the requirement that the total gearing level is restricted to a relatively conservative level of 50 percent.
This is a fairly straightforward investment strategy centred on using a standard margin loan to finance an investment in either a diversified growth fund or a portfolio of quality shares.
Again the same standard parameters, including the assumption that the investor has a marginal tax rate of 31.5 percent and is able to get a tax deduction on interest costs and benefits from the 50 percent capital gains tax discount. They also assumed an average margin loan interest rate of 8.5 percent.
The investor uses gearing in a relatively conservative approach by using the $5000 to borrow, via a margin loan, another $5000. A total of $10,000 is invested in the sharemarket to track the S&P/ASX 300 Accumulation Index.
The recent average annual return of 8.6 percent growth and 4.3 percent income (70 percent franked) means the investor reaches the $50,000 goal, after repaying the loan and paying capital gains tax, after 14 years.
5. Ungeared and patient
This is a very cautious approach that avoids gearing. Instead the $5000 is invested in shares.
Assuming the same return as the S&P/ASX 300 Accumulation Index the $50,000 goal, after paying capital gains tax, is reached after 21 years.
A vastly longer wait, however, is needed by the investor who simply puts the $5000 in a high-interest bank account. Reaching the $50,000 target takes around 60 years. Even worse, this long wait will have meant inflation will have wreaked havoc on the real value of this sum, reducing it to the equivalent of $9000 in today's purchasing power.
For the complete story see Money Magazine's February 2007 issue. Subscribe now.
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