To Gear or not to Gear
13 May 2013
By Tim Breen
'You need to borrow money to make money'. This is a common phrase when it comes to investing or wealth accumulation. Unfortunately it is bandied around all too often and flippantly used within the financial services industry.
While gearing to invest is a powerful way to increase your wealth, if things go pear shaped, it will also magnify your losses. If the right advice is not given, gearing to invest can be devastating and even have an irrevocable impact to a person's financial and mental health.
There is no such thing as a free lunch and when it comes to borrowing funds to invest, there are a range of issues to consider.
1. Is it the right or appropriate strategy for you?
The answer to this will depend on your own situation. Some things to consider include:
- your current levels of debt
- your cash flow
- the amount you borrow
- your job security
- will the investment income cover the loan; and
- your objectives, for example if are you thinking of buying a house (if you are, run away from anyone who recommends that you should to gear to invest by using your funds earmarked for a house or deposit)
2. How will you feel?
The greatest strategy in the world is a failure if it influences your 'sleep at night factor'. How will you feel if you started and 12 months later you had an unrealised (i.e. on paper only) loss of 45%? This may have happened if you began in August 2007.
3. Do you really understand what the strategy is?
Generally, for gearing to invest you want a low LVR (loan to value ratio) whereby you bring a lot of your own money (not just equity) to the table and it isn't all debt. Be conservative with this, borrow only 10% to start off with and see how comfortable you feel.
4. Is it in your best interest or is someone giving inappropriate advice?
Storm Financial. You may have heard about them!
5. Seek financial advice
Getting the right financial advice will help to ensure whether gearing is an appropriate strategy for you, how it should be structured, and help you understand the risks involved.
Remember: If it sounds too good to be true, it is!
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