Shifting gears!

We have all geared before, but may not have realised it. Borrowing to purchase your family home is a form of gearing.

When you are gearing for investment purposes you are borrowing money to invest more. Your long term goal is to sell your investment for more that the principle you borrowed and the out of pocket costs of investing.

Gearing can amplify gains and magnify your losses. The more you borrow the more you can gain or lose.

Servicing of a geared investment is a matter of cash flow.

• Positive gearing is where the income from an investment exceeds the expenses. You will have money flowing into your pocket.
• Negative gearing is where the expenses of the investment exceed the income. You will have to pay the difference out of your pocket. The investment gain in value must make up that cost and opportunity lost just to break even.

Some people are attracted to gearing for the tax benefits associated with the interest costs and negative cash flow. A loss is still a loss. It is essential that the investment selection is consistent with your strategy and focus remains on growing wealth and not just tax advantage.

Gearing can be undertaken as a contribution strategy known as instalment gearing. A margin loan is drawn against existing cash or investments to create greater exposure to growth assets. You can choose the level of borrowing known as the loan-to-value ratio (LVR). Your contribution to the investment is joined with a loan draw down to maintain the loan to value ratio and improve your exposure to the investment.

Some people use a home loan facility and draw existing equity for the purpose of getting exposure to investment opportunities. We can advise you of the most appropriate loan structure for your circumstances.

Selection of the investments and the correct financing is crucial to the success of the strategy.

The higher your marginal tax rate, the greater the benefits of any tax deductions you may receive. But don't fall for the trap of investing in shares or any other asset simply because they promise good tax deductions through negative gearing.