Overview of financial gearing
GEARING is when borrowed money is used to buy growth investments such as property or shares. Gearing can increase investment returns but can also magnify investment losses.
Generally, gearing is most suited to clients who are still working and earning an income. Therefore, a gearing strategy is most commonly used by people in wealth accumulation to increase wealth over the longer term.
A gearing strategy can be set at three levels – negative, neutral or positive.
In assessing your suitability to a gearing strategy, you should consider, among other things:
The appropriate risk profile required for gearing.
The cash flow needed to service the loans or make additional payments if and when required.
If gearing is appropriate, the next step is to review the gearing facilities available and determine which option is most appropriate.
Consideration should be given to the choice of collateral, the type of repayments required, the frequency of additional investments and the investment choices allowed.
There are also different interest rate options available on different loans.
The choice of fixed and/or variable interest rates is important.
The choice may depend on the type of gearing facility and the product provider.
There needs to be a direct link between the interest and the investment, because for interest costs to be tax deductible the purpose of the underlying investment must be to produce assessable income.
You should also consider and compare other forms of wealth accumulation such as investing into superannuation.
One advantage of gearing outside of superannuation is its flexibility and access to money when needed.