Tag: CBA

How to Live off Crypto by Staking

Update December 2022: I no longer recommend staking crypto. See this post for my more recent views on crypto.

I primarily invest in the stock market and aim to live off dividends mostly from ETFs. However, the cryptocurrency market is hard to ignore. When you compare the total crypto market to the S&P500 (see chart below) you will notice that crypto makes holding stocks feel like holding cash. In the last five years, the S&P500 has gone up by 109 percent which is almost double. However, the total crypto market cap has gone up 18,942 percent.

Total crypto market cap (blue) vs VOO ETF, which tracks S&P500 (orange) over the past five years.

Institutions are starting to look into crypto. For example, Tesla invests in bitcoin, and the Commonwealth Bank has announced it will soon allow crypto to be used within its app. All this shows that crypto is going mainstream.

Recently ETF provider Betashares has released its Crypto Innovators ETF (CRYP). For those who are interested in exposure to crypto, I highly recommend this ETF, which doesn’t invest in crypto itself but in crypto companies (e.g. crypto miners, crypto exchanges, and companies that hold a lot of crypto). It is analogous to investing in a gold mining ETF rather than holding physical gold itself. What is reassuring about this ETF is that it roughly tracks the price of bitcoin and ether, the two largest cryptos.

The CRYP ETF (blue) is roughly correlated to bitcoin (orange) and ether (aqua) prices.

The benefit of buying CRYP rather than holding the actual cryptos itself is safety and security. ETFs are regulated by government, which is reassuring. The alternative way to securely hold crypto is via a paper wallet, which I do not recommend to beginners as it is complex. If you do not know what you are doing, one small error can cause all your crypto to be lost.

When buying and holding crypto investments such as bitcoin, ether or CRYP, you mainly profit from capital gains made when prices go up. Usually there is little income to be made from crypto. The CRYP ETF pays dividends, but it is likely to be very low. However, a recent innovation in the crypto market that has changed all that is staking, which allows you to earn income on crypto.

What is staking?

According to Binance, the term “staking” is defined as “holding funds in a cryptocurrency wallet to support the security and operations of a blockchain network. Simply put, staking is the act of locking cryptocurrencies to receive rewards.”

To put it simply, when you stake crypto, you are locking it up and allowing it to be used to earn more. The passive income earned via staking is termed “staking rewards.”

Why stake?

What is the purpose of staking? Why not just buy and hold the crypto or invest in dividend-paying stocks? Quite simply, the returns via staking are huge. My favourite place to stake crypto is the PancakeSwap Syrup Pools, and as of November 2021, the average APR from staking is about 60 to 70 percent. Earning 70% from crypto staking is far higher than what you’d earn from dividends. Furthermore, if you buy and hold crypto or CRYP, you are earning either zero or very little passive income.

The huge risks of staking crypto

Of course, if returns from staking are 70% or more, why not just go all in? The answer is that staking is very risky, so I do not recommend putting in too much, and any amount you put in should be an amount you are prepared to lose. When staking crypto, you are giving up control of your crypto and handing it to a protocol. Protocols are merely code, and code can have flaws that hackers can attack. There have been many hacks recently e.g. billionaire Mark Cuban lost a lot of money following the hack of Iron Finance. Other examples of major hacks of decentralised finance networks include PancakeHunny and Poly Network.

So then if crypto staking is so risky, what is the point of staking? Basically you will need to consider whether the high gains are greater than the risks. Everyone has different risk tolerance. Thankfully there are many ways you can reduce the risk of crypto staking. The first is to stake on more reputable networks e.g. PancakeSwap and ApeSwap are examples. Research whether these networks have been audited by reputable crypto audit organisations (e.g. Certik). Furthermore, it is always a good idea to spread your money across different networks just in case one gets hacked. I currently stake crypto on PancakeSwap, ApeSwap and BiSwap.

How exactly do you stake?

In terms of the nuts and bolts of how to stake, more detail can be found on YouTube. In terms of how I stake crypto on PancakeSwap, I deposit Australian dollars into Binance and then convert it into BNB (Binance Coin). Then I withdraw the BNB into a crypto address generated using the Trust Wallet app. Using the Trust Wallet browser, I go to PancakeSwap and convert the BNB into CAKE. I then go to the syrup pool and stake the CAKE. When the staking pool generates a reasonable amount of staking rewards, I harvest the staking rewards, convert it back to BNB, send it to Binance, and then convert it back to Australian dollars before withdrawing it into my bank account.

Conclusion

As mentioned, staking is very risky, so I am relying on both staking rewards from crypto and dividends from ETFs to fund my living expenses. The staking rewards provide high returns whereas the ETFs provide safety and lower risk. Indeed the staking rewards are taxed in full. There are no franking credits on staking rewards. Regardless, for argument’s sake, even if you pay 50% in tax, staking reward of 70% means you have 35% after tax. Dividend yields are about 5% and assuming franking credits completely offset income tax, 35% is higher than 5%, so it is better to simply pay the tax. Often investors are focused too much on tax or other aspects of an investment (such as how much leverage you can achieve). What matters is total return.

Buy a House vs Invest in ETFs

This is a common dilemma. You are saying up money and want to know if it is better to buy a house and live in it or invest in ETFs and rent (also known as rentvesting).  Personally I would invest in ETFs. The reason why is because the key difference between the two options is you pay far higher taxes when you buy a house.

For example, if you buy a house then you’re need to pay stamp duty. On a $1 million house that is roughly $57k in stamp duty, which will reduce your net worth. Assuming you save up a $200k deposit, then right after you buy your house your net worth will be $143k whereas if you simply keep your money in ETFs you’d still be at 200k.

However, an argument can be made that if you buy a house, because you have borrowed money to buy $1m worth of asset then you have leveraged exposure, which moves you up the risk-reward curve (also known as the efficient frontier). If you save $200k and invest it in ETFs, if there is a 10% increase, you have made $20k. However, if you have purchased a $1m house and it goes up 10% then you have made $200k. However, what is misleading about this comparison is that it compares apples with oranges, that is, it is comparing leveraged real estate vs unleveraged ETFs. To compare apples with apples, you need to compare leveraged real estate vs leveraged ETFs. Leverage does not increase returns without any consequences. Leverage increases risk, which may result in higher returns.

You can move up the risk-reward curve with ETFs simply by reallocating a portion of your ETFs into internally leveraged ETFs e.g. GEAR or GGUS. Another option is to invest in higher risk niche ETFs (e.g. ROBO or TECH) to move up the risk-reward curve. The benefit of buying higher risk ETFs is that there are no mandatory monthly mortgage payments or, if you take out a margin loan, margin calls. The effect of leverage is handled by the fund itself and there is no obligation for you to pay anything.

Gearing into equities is expensive before tax but cheap after tax

Another way to move up the risk-reward curve is to take out a margin loan and buy ETFs with it. The downside to taking out a margin loan is higher interest rate compared to home loans. According to Canstar, the cheapest margin loan rate is 5.20% from Westpac whereas the cheapest home loan it is 3.49% from Reduce Home Loans. However, if you buy a home to live in, the mortgage debt is not tax deductible, but the margin loan debt is tax deductible, i.e. you can negatively gear into ETFs by taking out a margin loan, which effectively lowers your interest rate by your margin tax rate. Assuming you earn between $87k and $180k and face a 37% margin tax rate then rather than pay 5.20% interest rate you are effectively paying 3.27% which is in fact lower than the home loan. If you have chosen to leverage using internally geared ETFs, because the fund manager has high bargaining power, he or she is able to get low interest rates anyway. According to the GEAR and GGUS brochure from Betashares, “the fund uses its capacity as a wholesale investor to borrow at significantly lower interest rates than those available directly to individual investors.”

Another advantage of investing shares or ETFs is that Australian shares often pay dividends with attached franking credits (e.g FDIV pays 100% franked dividends), which lowers you tax burden even further.

Capital gains tax has little impact

Even though living in a home does not make you eligible for negative gearing, you are eligible for capital gains tax exemption. However, capital gains tax is easy to avoid if you buy a hold shares or ETFs. Because capital gains tax is triggered with you sell and because capital gains tax is charged at your marginal tax rate, simply buy and hold and wait until you are retired. When you are retired, you will earn no salary, so your income will drop and your salary will likely face lower income tax, perhaps even being within the tax free threshold. You then sell off shares or ETFs bit by bit when you’re retired, ensuring that you pay little or no CGT.

Low rental yields vs high dividend yields

Now that we have established that ETFs have lower borrwing costs than real estate due to the impact of negative gearing, stamp duty avoidance, and franking credits, a huge argument for investing in ETFs rather than real estate is the huge difference between rental yields and dividend yields. As of right now, a three-bedroom unit in Brunswick East costs $1.3m and has rental yield of 1.42% i.e. around $18.5k in rent per year. However, as of right now, Commonwealth Bank shares are paying gross dividend yield of 8.6%. This means that if you have $1.3m, then rather than buying the Brunswick East unit and living in it, you can simply take out a margin loan, invest $1.3m all in CBA, and then receive $110k in dividend income per year. After income tax and franking credits, this will be around $90k. After paying rent of $18.5k you have roughly $70k per year extra simply by using ETFs.

Not only do you get $70k per year extra thanks to the extreme spread between rental and dividend yields, but the benefits for ETFs are magnified even further because of lower post-tax borrowing costs.

Using one Brunswick East unit vs one high dividend paying stock (CBA) is an extreme example. Not all stocks are the same and not all residential real estate is the same. However, the general trend is indeed that rental yields in Australia are low and dividend yields on Australian stock are high. If you bring up a list of all properties on the BrickX fractional property platform and sort by rental yield, the highest yield property, a one-bedroom unit in Enmore NSW only delivers a rental yield of 2.76% with the average rental yield about 1.5%. However, a broad ASX200 ETF such as STW provides gross dividend yield of 5%.