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Using Debt to Build Wealth - Big Sky Financial Solutions

Using Debt to Build Wealth



Borrowing to partly or fully finance an asset is called Gearing.

Gearing can be a very effective strategy for those who understand the risks. Gearing can be negative, positive or neutral depending on the return from the investment and the cost of borrowing funds.

Borrowing to invest – ‘gearing’ – boosts your investment buying power, allowing you to acquire assets you may not otherwise be able to afford and providing a tax break along the way.

Let’s start with a checklist to see if gearing is a sound strategy for you:

• Do you have a secure and regular source of income?
• Are you comfortable with having debt?
• Can you afford a reduction in your current cash flow?
• Is your prime motivation asset-building (rather than minimising tax)?

If you answered ‘yes’ to these questions, gearing may be well worth a closer look.

At Big Sky Financial Solutions we have put together some criteria that you should review before considering a gearing strategy. These are:

• Your principal objective for considering gearing should be Wealth Creation not tax reduction
• You should have cash flow in excess of your living expenses
• Future income certainty
• You should be ready to accept a higher level of risk
• Be a long term investor
• Preferably on the highest marginal tax rate

It is important to remember that Gearing can accelerate gains as well as losses therefore it is important that you discuss all details including investment options with your Financial Planner. Additional issues to consider are:

• Loan structure
• Income protection insurance
• Type of investing
• Taxation advice
• Exit Strategy

Here are some examples of how combining a gearing strategy with an investment option like the SMA (Separately managed Accounts) product can work well in practice.

Example 1:

Robert is in his late 20s. He has a good job, no other debts and is keen to start a regular investment habit. He decides to use an SMA structure and chooses the Growth Portfolio as the foundation of his investments.

He decides to take advantage of the instalment gearing arrangement available through the SMA. He invests $200 of his own money each month and boosts it by a further $200 a month through borrowings.

He is now able to invest $400 a month, which doubles his investment earning potential. The increasing value of his portfolio funds the borrowings. And with compounding doing its bit to rev up his investments, he is well on the way to creating a substantial nest egg.

With this type of arrangement there is no time limit on the term of the borrowings. As long as the specified loan to investment ratio is not exceeded, Robert can maintain the borrowings indefinitely. Plus, the interest on the borrowings is tax deductible, which means the taxman is also helping Robert build his assets.

There is a variety of ways you can gear into investments, whether by arranging your own finance, for example, through Big Sky Credit Union by taking out a personal loan, or through your home lender.

You may find that a margin lending arrangement or an installment gearing structure are just the ticket for you and will help you grow your investments at a faster rate than you would otherwise be able to achieve.

It’s well worthwhile discussing your individual requirements and preferences with your adviser, who can help you select the most beneficial structure for your personal situation.

Big Sky Financial Solutions can help create a gearing strategy tailored for your individual requirements. Talk to a Big Sky Financial Solutions adviser on 1300 700 189 or email us.