Olivia Maragna

I am looking at borrowing some money against my home and investing in shares. Can you please explain how negative gearing works and the benefits? I earn $140,000 and my wife earns $18,000.

Olivia says:

There are a number of benefits when it comes to borrowing to invest. In the simplest case, the more money you invest by increasing your funds through borrowing, the higher your returns will be dollar wise.

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By using the banks money, you can build wealth if you invest wisely. If the rate of return on the investment is higher than the interest rate on the loan plus any other expenses associated with the investment, you will be making a profit. For example, if you are borrowing money at 6 per cent and your investment is making you 8 per cent, you are making a 2 per cent profit.

How does negative gearing work?

People generally negatively gear investments when they are on high incomes as the losses associated with the investment can be used to reduce your tax.

Here is an example.

Bill borrows to invest in shares. It has cost him $7000 in interest this year and the shares have returned $4000 in income from dividends this year. He is negatively geared as his investment is producing a loss of $3000 per year. He can deduct this $3000 from his taxable income. If Bill pays tax on his salary at 39 per cent, he can reduce his tax bill by $1170 (39 per cent of $3000). His tax saving effectively reduces Bill’s cost of borrowing to $1830 after tax this year.

If Bill earned only $18,000, he would receive no tax benefit on the interest cost as his marginal tax rate is nil. He will receive no reduction in the interest that he pays and will pay the full $7000 interest bill.

Is borrowing for you?

Borrowing to invest is only suitable if you have enough income from other sources such as a secure salary, or you have extra funds you can use to pay off the loan if there is a significant drop in the market. Borrowing should only be done when you have a high income so you can make the most of any tax benefits, and lastly, you must understand and accept the risks and volatility of investments.

The risks

Borrowing to invest magnifies your returns, both positive and negative. If the market falls and you’re not prepared, the results can be devastating. You may lose your entire investment or worse, end up owing money to the lender.

The more you borrow, the greater the risks become. If you are investing in a diversified portfolio of shares or managed funds, borrowing more than 50 per cent is usually considered risky.

If you are considering borrowing to invest, seek professional advice about all the traps and risks and to make sure the investment is suitable for your needs before you jump in.

Why not increase the financial savviness of those around you pay it forward and pass on these tips to your family, friends and kids.

Olivia Maragna is the co-founder of Aspire Retire Financial Services and is a respected and independent financial expert. Olivia’s advice is general in nature and readers should seek their own professional advice before making any financial decisions.

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