Gearing

Gearing occurs where an investor borrows monies to invest. Generally, the monies are secured against either the investment or an alternate asset, such as the principle residence.

Provided the investment is made with the intention to produce income, any interest expense incurred in borrowing funds to invest is tax deductible under section 51(1) of the Income Tax Assessment Act. Therefore, gearing provides tax advantages, especially if the portfolio is negatively geared.

Negative Gearing

Negative gearing occurs when the income received from the investment is less than the interest incurred on the loan. The total amount is deducted from the investor’s taxable income in the financial year incurred, which effectively reduces the other assessable income for the investor in the same period. Negative gearing reduces your day-to-day cashflow, as you are intentionally making an investment knowing that the income you earn will not necessarily cover the ongoing costs involved.

Investors are able to gear investments into direct shares and property as well as managed funds and unit trusts. Rental property investments pay income in the form of regular rent and direct shares pay dividends in line with company profits. Similarly, property trusts, sharemarket funds and other unit trusts generally distribute income paid from the underlying investments either quarterly or half-yearly. However, unlike a rental property, managed investments are generally more attractive for gearing for the following reasons:-

Investors are able to gear investments into direct shares and property as well as managed funds and unit trusts.

• Deposits and ongoing investments can be in smaller quantity and regular;
• Maintenance issues are not the direct responsibility of the investor but the investment manager;
• Pooling of funds allows for smoothing of tenancy problems and other risk factors;
• Investments are professionally managed;
• The investment is more liquid and cheaper to redeem;
• The complete investment does not need to be redeemed, with the ability to downscale the amount invested.

Investors in the higher marginal tax bracket achieve the greater tax advantage due to the reduction in tax payable from the deduction. This generally assists in providing greater long term benefits.

Risks Involved In Gearing

There are risks involved with gearing that make it unsuitable for some types of investors. It is definitely not a get-rich-quick scheme. Although gearing can magnify your capital gains it can also magnify your capital losses. It is possible that your investments will fall in value, however, it should be remembered gearing is not a short term investment and fluctuations in your investment value will occur.

To find out more

To find out more or to determine the suitability of gearing to your financial situation, we recommend that you contact your nearest Avenue financial planner.