Grow my Wealth
Use borrowed money to build wealth
There are many strategies we can use to grow your wealth, borrowing to invest is one of them
What are the benefits?
By using this strategy, you could:
- Multiply your investment profits, and
- Take advantage of a range of tax concessions
How does the strategy work?
This strategy, commonly known as gearing, involves borrowing money to make an investment.
Gearing can enable you to build your wealth faster than if you relied exclusively on your own capital. The downside is that it can enhance your losses if your investments fall in value.
For gearing to be successful in the long term, the investments you acquire with borrowed money must generate a total return (income and capital growth) that exceeds the after-tax costs of financing the investment (including interest on the loan).
It is therefore generally recommended the borrowed money is invested in quality shares or property investments (either directly or via a unit trust).
This is because shares and property have the potential to grow in value over the longer term. They also typically produce assessable income (which means you should be able to claim the interest on the investment loan as a tax deduction).
There are a number of ways you can establish a gearing strategy:
- You can borrow against the equity in your home.This approach offers the benefit of a low interest rate and there are no restrictions on which investments you can buy.
- You can take out a margin loanThis type of loan typically enables you to borrow up to 75% of the value of approved share and unit trust investments. For example, if you have $25,000 and you want to purchase an approved investment with the help of a margin loan, you may be able o borrow up to $75,000 and make a total investment of $100,000. It’s also possible to use a margin loan to gear on a regular basis. This is known as instalment gearing.
- You could invest in an internally geared share fund.These are funds that borrow to leverage an investment in Australian or global shares.
Jenny has $50,000 invested in an Australian share fund and would like to use gearing. After speaking to her financial adviser, she considers the following three options:
- Maintaining her investment at its current level of $50,000,
- Doubling her investment by borrowing $50,000 (ie a 50% gearing ratio), or
- Increasing her investment even more by borrowing $100,000 (ie a 67% gearing ratio).
In options 2 and 3, Jenny will use an interest-only home equity loan with an interest rate of 7% pa. The following graph illustrates the potential outcome of the three options after 10 years.
To find out if a strategy like this will help you, please book a meeting.