FACT SHEET Gearing – borrowing to invest Gearing, or borrowing to invest, is a strategy used to increase your wealth by leveraging your savings or equity. What is gearing? Types of gearing Being able to invest more can mean greater investment returns You can be positively or negatively geared: and exposure to a greater range of investments than would > Positive gearing is when you borrow to invest in an income otherwise be the case. Your financial adviser can point you in producing asset and the returns from that asset exceed the cost the right direction with the information, finance and brokerage of borrowing. An example would be if you borrowed to invest in services you will need, whether you are looking to gear property, shares and the dividend distributors exceeded the expenses of shares or managed funds. the loan. Why borrow to invest? > Negative gearing, put simply, is when you borrow to invest in an income-producing asset and the cost of borrowing exceeds the Borrowing to invest makes sense when you believe the income returns from that asset. For example, negative gearing investment returns you achieve will exceed the cost of the on a property occurs when the annual interest payable on the borrowing. Gearing is a strategy best suited to investors who loan used to acquire the property, plus allowable deductions, can cope with higher risks and have income from other sources exceeds the annual rental income the property generates. to service the loan. What are the pros and cons of gearing? What gearing strategies are available? > Home equity loan Gearing is not suitable for everyone. Here are some key points to consider when deciding if gearing is the right option for you: You may be able to draw down on the equity in your home as > Potential to increase gains and magnify losses – your returns security for a loan to leverage into other investments. This may may be increased by investing a larger sum of money through be appropriate for people who have a large amount of equity in borrowing and while you will experience increased gains in a their home with minimal diversification. rising market, you may also experience magnified losses when > Personal loan markets fall. You can borrow funds to invest, although this strategy may > Tax benefits – you may be able to deduct interest expenses attract a higher interest rate. This type of loan is usually and ongoing borrowing fees for tax purposes depending on established on an unsecured basis and the loan amounts are your individual circumstances. If you invest in funds that therefore limited. include Australian shares, the income generated by the investment may also have tax credits which may be used to > Margin loan reduce your tax liability. A common gearing strategy is using a margin loan. The term > Accessibility to funds – some investments, such as ‘margin loan’ refers to the way in which lenders protect direct property, have large upfront costs and may not themselves from market volatility and its impact on the security allow you to release part of your investment immediately. you have provided. Lenders permit you to have a maximum The investment option you choose will in part depend on your lending ratio. For example, a managed fund might have a need to access the funds. lending ratio of 60%. This means, if you had capital of $40,000, you could borrow another $60,000. Of the total $100,000, 60% > Diversification – you may be able to reduce your risk by would consist of borrowings. spreading your investment across more asset classes. Lenders then allow a margin of safety, say another 5%, which means the value of the portfolio could fall without any action Who does gearing suit? being taken, as long as the borrowings do not exceed 65%. Gearing will generally suit long-term more aggressive style The reverse side of this is when the value of the portfolio drops investors with surplus cash allowing them to meet their below 65%, you will be faced with a margin call (see over for ongoing liabilities, including interest payable on the loan. It is explanation) which requires you to rebalance your portfolio by also important to consider insurance options, such as income selling part of the investment or adding funds to bring the ratio protection or death and disablement insurance, to enable you to back to an acceptable level. meet your obligations in case of job loss, illness or death. This type of strategy may also suit you if you have equity in your home you wish to unlock and diversify into other asset classes. What is a margin call? How does it work? A margin call requires you to restore the gap between the security Meet Brian and Sue value of your investment and the balance of your loan. This can Brian and Sue have $100,000 to invest and after meeting be done by topping up your account with cash or additional their financial planner have decided to invest in a number of investment securities, or by selling some of your managed managed funds. They can use their savings of $100,000 only, or investment units or shares. There is usually a strict time limit of they can use a gearing strategy to borrow another $100,000 and 24 hours in which this must be done. invest a total of $200,000. If you fail to meet a margin call, the lender has the right to sell If Brian and Sue decide to only invest their $100,000 without enough of your investments to restore your margin. They are gearing, after 20 years, their net cash position after tax is not usually obligated to consult you before taking action, and $396,685. If they decide to invest their $100,000 and borrow an you will have no control over which stock will be sold to cover the additional $100,000 (with 50% gearing), the net cash position margin call. after tax is $481,485, taking into account the repayment of Therefore, if you are considering a margin loan, you need to interest and the $100,000 principal sum borrowed. By utilising ensure you have the necessary reserves available to meet margin this strategy they have an additional $84,800. calls. It is also critical you review the margin lending agreement Assumptions: prior to investing. This document will outline the terms and >Capital gains of 5% p.a. conditions of the loan, how interest will be calculated and what >Income of 3% p.a. >Imputation credits of 50%. your obligations are. >Interest rate of 7.5% p.a. (interest only). Your financial planner may recommend strategies to help limit the >Net-of-tax investment income is being reinvested. possibility of a margin call. >Investment growth subject to capital gains tax (CGT) on redemption of investment. >CGT discount of 50% applied. Are there any tax benefits? >Example customer is on the 31.5% tax bracket (including Medicare levy). >Results shown are net of all taxes. Borrowing to invest through a margin loan can offer various tax >Part performance in service of future performance. advantages. The interest on margin loans can often be claimed as The savings amount is an illustration only and is not a prediction or estimate of the a tax deduction. Also, if you decide to invest the money you have actual savings you can achieve. borrowed in Australian shares (either directly or via a managed Would you like more information? investment), any income in the form of dividends you receive may provide franking credits which can be used to offset income tax. Contact your ANZ Financial Planner who can provide you with information so you can make the decision that is right for you. What about interest rate rises? Interest rate rises may also impact margin lending borrowers. The interest you pay on a margin loan can often be claimed as a tax deduction. So while a rate rise will trigger an increase in the interest on your margin loan, the after-tax impact could be less, depending on your marginal income tax rate. L3267L/0807 This information is for information purposes only and current as at November 2007. It may be subject to change. Neither Australia and New Zealand Banking Group Limited (ANZ) nor ING Custodians Pty Limited has taken into account ING Australia Limited your personal needs and financial circumstances in producing this information so you should consider whether it is ABN 60 000 000 779 appropriate for you. You should also read the Product Disclosure Statement or terms and conditions for the relevant 347 Kent Street financial product and consult with a financial adviser before making any investment decision. ANZ’s colour blue is a Sydney NSW 2000 trademark of ANZ.