Gearing should be used to extend an investment portfolio. Photo by CPL Mark Eaton, 1JPAU(P)

Geared for results - planning ahead

There are not many successful get-rich-quick plans but there are sound strategies that might help fast-track your savings.

One such strategy is gearing, where you borrow money to invest and ideally hold the asset until its capital value increases and offsets the running (interest) costs.

Many people have heard the term “negative gearing,” which is when the cost/interest payable on the borrowing exceeds the income from the investment and can result in a personal income tax deduction for the shortfall. This strategy has been quite popular with property investors.

But the asset need not be a house or a unit – it could also be shares.

Gearing has advantages for some service people because it best suits investors with reliable cash flows and surplus income who are prepared to wait and take advantage of long-term growth.

Investors contemplating a gearing strategy need to make sure they have a good understanding of the investment market and the volatility associated with investing.

They should only invest their “play money” – money not needed for day-to-day living.

Gearing does have some disadvantages. Gearing an investment will exaggerate any gains and losses due to the costs associated with borrowing money over and above any investment returns.

It makes most sense where there is a high probability of investment returns being greater than financing costs.
The first step, obviously, is to get a loan. Your financial adviser can help you with advice on who to approach and how to do this.

Once you have the loan you can use it to supplement your savings or buy a larger investment portfolio than you could otherwise afford, increasing the potential for growth.

The advantages when you buy an investment property are that maintenance costs, including the interest on and fees associated with the loan, can be written off against tax.

The higher the tax bracket you are in the more you stand to receive.

Getting into share investments offers the added advantages of dividend imputation credits.

Gearing should be used to extend, but not completely finance, a share portfolio. An investor, particularly in negatively geared property, should have the financial reserves to meet repayment shortfalls and unexpected costs.

Your financial adviser should be able to help you calculate the level of borrowing that best suits your circumstances and help you choose the most appropriate investments.

You might, for instance, like to think about starting an instalment gearing plan for your investments.

Using this sort of plan you can borrow some money initially to extend your portfolio and then borrow an additional agreed amount each month or so to augment your regular investments.

If you do decide to borrow to invest, concentrate on quality growth investments.

Gearing into the sharemarket is not a short-term strategy. The longer you hold on the more the peaks and troughs are evened out.

A close look at the performance of the sharemarket explains why.

The sharemarket performance indicator, the All Ordinaries Index, has returned an average of more than 10 per cent a year for the past 10 years.

But it has not made 10 per cent every year. In fact in 1993 it rose 45 per cent and the following year, 1994, it fell by 9 percent.

• David Raits is a financial adviser with CIS Financial Services.
  

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