No matter what stage of life you are in, it is always wise to plan…
Ever considered using gearing to fast-track and maximise your wealth?
It can be an extremely successful investment strategy when used wisely and when the investor understands the best processes as well as the potential risks.
COVID-19 has affected the Australian economy significantly. One of the effects is that interest rates are at an all-time low so if you are thinking of going forward with a gearing strategy, now may be an ideal time for you to get started.
First, let’s find out a little more about gearing and how it works.
What is gearing?
Put plain and simple, gearing is borrowing money for investment purposes.
The goal of gearing is to increase your investment return by using borrowed funds as well as your own money.
Borrowing money enables you to invest more which may allow you to create more wealth. However, if your chosen investments do not perform as well as expected, this can also increase your losses.
The three types of gearing and how they work
Gearing can be negative, positive or neutral. This refers to the cost of the investment (i.e. interest costs and other investment expenses) in relation to the investment income generated (i.e. dividends and rent).
1. Negative gearing: your investment expenses (including the interest for your loan) is more than the income you will receive from your investment. As the investor, you will need to have extra income sources to make up the shortage.
2. Positive gearing: the investment expenses are less than the income from your investment. This is referred to as a self-funded strategy.
3. Neutral gearing: the costs of the loan are approximately the same as the income generated.
For a gearing strategy to be effective, the overall return from your investment should be more than the cost of the loan and other investment-related expense. This can usually be achieved by investing in growth assets such as property and shares.
Many investors negatively gear as they can generally claim a tax deduction on the investment losses. However, this is still costing you money, so it is important to consider how much cash you have coming in from other sources.
The benefits of gearing may include:
- Increasing the size of your investment and increasing your return.
- Interest and other related borrowing costs are usually tax deductible if the loan is used to acquire an income generating asset. The tax benefits of gearing are attractive; however, the purpose of your gearing strategy should be to maximise your finances.
- Enables you to increase the size of your investment portfolio: this can help to diversify your investments or buy larger assets
As with any opportunity, the greater the potential reward, the greater the risk. Although the benefits of gearing are attractive, it is vital that you consider the following risks before implementing a gearing strategy:
- A rise in interest rates is always a potential. You should ensure you have sufficient cash flow to ensure you can absorb these interest rate increases.
- Legislation may change in the future in relation to interest or tax deductibility. You should consider this possibility before investing.
- An unforeseen event such as the loss of your job, an illness or injury that may affect your cash flow. This may make it difficult for you to pay back your loan.
- Your investment may fall in value. This may cause your originally self-funded strategy to become an investment that is not making you money anymore.
Is gearing the right option for you?
Gearing is a long-term strategy. You should make sure you are aware of the risks associated with gearing before deciding if it is for you.
However, the effects of COVID-19 mean that interest rates are at an all-time low, which means the cost of borrowing is also low. The current economic environment may present the perfect opportunity for you to look into your investment options and consider gearing as an option.
If you are looking to fast-track your financial position, gearing may be the right option for you. At NFPG, our Financial Advice Specialists can work with you to assess your circumstances and discover whether gearing is a suitable option for you.
If you are ready to commit to a brighter financial future, take the first step with a complimentary initial meeting with one of our experienced Financial Advice Specialists. We have offices located in Newcastle – The Junction (NFPG), the Central Coast – Erina, (CCFPG) and Sydney CBD (SWA).
The views expressed in this publication are solely those of the author; they are not reflective or indicative of RI Advice Group’s position and are not to be attributed to RI Advice Group. They cannot be reproduced in any form without the express written consent of the author. This information (including taxation) is general in nature and does not consider your individual circumstances or needs. Do not act until you seek professional advice. Newcastle Financial Planning Group, Central Coast Financial Planning Group and Sydney Wealth Advisers are subsidiaries of Coastal Advice Group which is a Corporate Authorised Representative of RI Advice Group Pty Ltd, ABN 23 001 774 125 AFSL 238429.