Boost your investment capacity.

Why Gearing?

There are different factors investors should consider in reaching their financial goals. Most people know how much they can contribute initially and over a set term when they set out, and they will know the size of their goal. They will also have a likely idea of their capacity to invest after living expenses and their disposable income. However, there are also other factors to be considered rather than just the amount they can contribute.

These include:

• The timeframe or set date the goal needs to be reached.
• The returns earned on investments over the long-term.
• The risk an investor is prepared to take to generate investment returns.

Over the long-term, investment returns tend to have the largest impact because of the power of compounding. An investment in equity markets may earn more than cash-based or risk-free investments in the long-term. However, it does require more appetite to take on risk.

An investment into equity markets combined with the use of a gearing strategy may help boost potential returns. This is because investment is being made with not just an investor’s own funds but also additional funds through borrowing, or gearing. However, gearing may also magnify losses for this reason.

The use of gearing through a margin loan is also often a tax-effective way to access further funds. Interest is generally tax deductible dependent on each individual’s own circumstances.(*)

The Gearing Process

Step 1: What is the goal in mind?

Financial goals drive investment decisions. Goals should be realistic, achievable and consistent with the risk appetite of the investor.
Examples of goals for using gearing to develop and grow a portfolio include building:

• A deposit for a property purchase.
• An income-producing portfolio outside of superannuation.
• Contributions for children’s education costs.

Step 2: How to go about achieving it?

Having identified a goal, the next step is to set out some reasonable scenarios. This includes how much can be contributed, when the money is required and what potential returns are expected.

An investor should also consider their risk appetite and what potential loss they are prepared to accept. Some key considerations are to determine if a ‘set and forget’ investment is preferable, which may produce slower but more reliable returns, or if the volatility of share markets can be tolerated in search of more growth.

Step 3: Research

Finding investments expected to achieve the required returns is often the hardest step for investors. Factors to consider include:

• Is a diversified portfolio required?
• Liquidity. Can the investments be turned to cash easily should it be needed?
• Ongoing cost of managing and holding the investments.
• Investment returns for each asset class that may form the portfolio.

If the amount generated using regular investment and investment returns still fall short of the goal, the use of gearing may assist.

Step 4: Consider the risks of gearing.

Investing is not without risk, and market or stock volatility can occur at any time. If the portfolio decreases in value to the point where it exceeds the maximum gearing level plus the buffer (if any) on a margin loan, a margin call will occur. The borrower will be required to cover the margin call in a short period of time, usually 24 hours. A buffer is usually included in a margin loan to allow for short-term market fluctuations.

Other risks include:

• Investment return risk. By using gearing this may end up resulting in losing more capital and larger losses than not using gearing.
• Interest rate risk. Increases in the rate will negatively affect overall returns.
• Investment Income risk. Income from the portfolio may fall or not be paid at all.
• Regulatory and legislative risk. Changes in regulation may impact gearing.

Step 5: Implementing Gearing

An investor’s capacity to purchase is typically made up of several factors, such as the loan-to-value ratio (LVR), credit limit, and the credit available on the loan.

The LVR offered on each security is the maximum percentage the lender will lend on for that particular security. An investor will need to make a contribution toward the purchase of each security, which is determined by the LVR. They also may choose to borrow less and put in more of their own funds.

Secondly, the ability to borrow to invest is capped at the investor's credit limit. The Lender will usually determine whether the credit limit requested is not unsuitable.

If there is an existing investment portfolio and there is no existing loan on it already, it can be mortgaged to the lender to provide initial capital and borrowing capacity.

Considering all of these factors, the investor can then build a portfolio using a gearing strategy in line with their risk appetite.

Conclusion

If you are considering how you may be able to fulfill your investment goals sooner, a Leveraged margin loan might be able to help you achieve this.
Using a licensed financial adviser may also be worthwhile in developing a portfolio with a long-term goal in mind.

We can help you get started today, complete our enquiry form or call 1300 307 807 to speak to one of our customer service consultants.