Case Study(Borrowing to Invest (Gearing))

Borrowing to Invest (Gearing)

Sarah wants to save for a deposit on her first home. She already has savings of $40,000 and decides to take out a margin loan of a further $40,000. With double the money to invest, she has the potential to earn a greater return than if she just invested her own money. However, Sarah understands that borrowing to invest (a strategy known as gearing) also means she has the potential to lose a lot more – and if her chosen investments don’t perform well, she will have to repay the loan regardless.

Sarah chooses to invest her money in a managed fund. As you can see in the table below, based on an annual return of 9%, at the end of seven years her investment would be worth around $71,500. If she’d not borrowed any funds, she’d have around $64,500 using the same investments.

Strategy 1: Savings Only ($) Strategy 2: Savings and Loan ($)
Sarah’s Savings 40,000 40,000
Loan Amount 0 40,000
Total Invested Start Year 1 40,000 80,000
Investment balance end Year 7* 64,547 111,610
Less balance of loan to be repaid 0 40,000
Net investment balance ** 64,547 71,610
Notes

* Figures shown after tax and loan interest costs have been paid. Assumes the same growth investment for each strategy with an average return of 9% pa (4% income plus 5% growth, with a 50% franked component of income return). Return assumes dividends are reinvested, a marginal tax rate of 38.5% (including Medicare), and an average margin loan interest rate of 8% pa. Excludes brokerage and any other fees. Inflation has not been considered. Over long periods, inflation can reduce the purchasing power of your money.

** This example is for illustrative purposes only. It does not represent the past or expected performance of any particular fund, portfolio or investment. Any changes to taxation, loan interest rates, investment returns, or the other assumptions will affect the outcome.

Sarah’s strategy is easy and tax-effective. Even after allowing for the interest payments and the final repayment of the loan, she is $7,000 ahead. Because she is borrowing for investment purposes, she may also be able to claim the interest paid on her loan as a tax deduction, further increasing the value of her strategy.

It is important to remember that borrowing to invest does involve significant risks. Although it has the potential to magnify gains, it will also magnify any losses suffered if the value of your investment falls. Roe’s Financial Services Pty Ltd can help you decide whether a geared investment strategy is appropriate for you.

Disclaimer

These case studies are for illustrative purposes only. They are not to be taken as personal advice and are intended to provide general information only. They do not take into account your individual needs, objectives or personal circumstances. The information is based on Financial Wisdom Limited’s understanding of the relevant Australian laws at 17 November 2011. You should assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. Past performance is no indication of future performance. Financial Wisdom Limited ABN 70 006 646 108, AFSL 231138.

This web page has been prepared by Financial Wisdom Limited ABN 70 006 646 108, AFSL 231138, (Financial Wisdom) a wholly-owned, non-guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124. Financial Wisdom advisers are authorised representatives of Financial Wisdom.

Information in this web page is based on regulatory requirements and laws, which may be subject to change. While care has been taken in the preparation of this document, no liability is accepted by Financial Wisdom, its related entities, agents and employees for any loss arising from reliance on this document.

This web page may contain general advice. It does not take account of your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.

Sound advice is the key to success

As you can see from these case studies, a carefully thought-out strategy could make all the difference to achieving your goals.

Roe’s Financial Services Pty Ltd offers knowledge, expertise and experience. We’ll take the time to understand your individual circumstances and your goals, and then recommend appropriate investment strategies to help you achieve them.

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