Gearing Up for Wealth.
Let’s start by defining what gearing (or ‘margin lending’) is and what benefits there are to using it as part of your financial planning strategy.
Simply put, gearing is the act of borrowing money from a Margin Lending Institution to invest in any market.
Such gearing can be carried out via a lump sum, or piece-meal over a longer period of time in a process known as ‘installment gearing’ - making it easy to establish and maintain a long-term savings and investment strategy.
Such a Margin Lending program offers a new way to use the equity in your home - or investments - to maximise your overall investment power, and diversify your investment portfolio.
You can use your existing investment portfolio or cash as security to enable you to make regular investments every month with loan advances from your borrowed funds. (You can also supplement your monthly investment with contributions of your own.)
This type of gearing is ideal if you want to:
- Smooth out the 'highs and lows' of market movements
- 'Drip feed' your investment funds over time
- Avoid the pressures of trying to 'time the market'
- Build a geared investment portfolio
Apart from providing the means to build real wealth, margin lending can offer a range of highly effective tax advantages including:
- Tax deductions for loan interest paid
- Interest can be pre-paid up to 12 months in advance to maximise your tax deductions in the current financial year
- Borrowing against your existing portfolio can give you access to cash without incurring the capital gains tax liability which would arise from the sale of your investment
- Australian shares are often franked, so you may receive franking credits which could help reduce your overall amount of tax payable
Margin Calls
However, a small caveat. You need to be aware that every investment carries risks, and although margin lending has the potential to magnify returns it also has the potential to magnify losses.
Increases in borrowing, or a falling market, can affect the security of your loan. Whilst the Margin Lending institution provides a buffer zone to allow you to absorb small market fluctuations above your borrowing limit, if the amount borrowed exceeds the borrowing limit by more than the allocated buffer zone, you will be required to meet a Margin Call - by 2pm on the next working day - to restore your borrowing capacity.
Gearing – a case study
Perhaps the best way to explain is by example. Harry wants to build more wealth before he retires, and so chooses to invest $50,000 of his own capital - as well as borrowing $50,000 through a margin loan - so he can invest the full amount in shares.
Over the five years of the loan, Harry's shares grow from $5.25 to $12.52, and he receives dividends of $1.28 per share.
The table below shows how Harry's margin loan helps him to build more wealth in comparison to his investment potential without a margin loan.
| Without margin loan | With margin loan | |
| Harry's own capital | $50,000 | $50,000 |
| Loan amount | Nil | $50,000 |
| Total investment | $50,000 | $100,000 |
| Dividends | $12,190 | $24,381 |
| Borrowing costs | Nil | $19,125 |
| Market value of shares at the end of the loan (before sale) | $119,238 | $238,476 |
| Capital gains tax if shares are sold | $20,867 | $41,733 |
| Net value of shares after capital gains tax and repayment of any loan | $98,371 | $196,473 |
In this example, Harry’s gross borrowing costs have been covered by his dividends received. At the end of five years Harry may choose to sell his shares, incur capital gains tax and repay the loan - or he could repay the loan utilising other funds and continue to earn dividends on his $238,476 share portfolio.
Please note this example assumes Harry is on the highest MTR and uses an historic average interest rate of 8.58% p.a.; your own costs and outcomes may vary.
To discover how a gearing based financial strategy could work for you, simply contact Metaplanners for an obligation free consultation.