Sarah wants to save for a deposit on her first home. She already has savings of $40,000 and decides to take out a margin loan of a further $40,000. With double the money to invest, she has the potential to earn a greater return than if she just invested her own money (Strategy 2). However, Sarah understands that borrowing to invest (a strategy known as gearing) also means she has the potential to lose a lot more – and if her chosen investments don’t perform well, she will have to repay the loan regardless.
In Strategy 1, Sarah chooses to invest her money in a managed fund. As you can see in the table below, based on an annual return of 9%, at the end of seven years her investment would be worth around $71,500. If she’d not borrowed any funds, she’d have around $64,500 using the same investments.
|Strategy 1: Savings only ($)||Strategy 2: Savings and loan ($)|
|Total Invested start Year 1||40,000||80,000|
|Investment balance end Year 7*||64,547||111,610|
|Less balance of loan to be repaid||0||40,000|
|Net investment balance**||64,547||71,610|
* Figures shown after tax and loan interest costs have been paid. Assumes the same growth investment for each strategy with an average return of 9% pa (4% income plus 5% growth, with a 50% franked component of income return). Return assumes dividends are reinvested, a marginal tax rate of 38.5% (including Medicare), and an average margin loan interest rate of 8% pa. Excludes brokerage and any other fees. Inflation has not been considered. Over long periods, inflation can reduce the purchasing power of your money.
** This example is for illustrative purposes only. It does not represent the past or expected performance of any particular fund, portfolio or investment. Any changes to taxation, loan interest rates, investment returns, or the other assumptions will affect the outcome.
Sarah’s strategy is easy and tax-effective. Even after allowing for the interest payments and the final repayment of the loan, she is $7,000 ahead. Because she is borrowing for investment purposes, she may also be able to claim the interest paid on her loan as a tax deduction, further increasing the value of her strategy.
It is important to remember that borrowing to invest does involve significant risks. Although it has the potential to magnify gains, it will also magnify any losses suffered if the value of your investment falls. UNIQUE WEALTH PTY LTD can help you decide whether a geared investment strategy is appropriate for you.
These case studies are for illustrative purposes only. They are not to be taken as personal advice and are intended to provide general information only. They do not take into account your individual needs, objectives or personal circumstances.
Information in this web page is based on regulatory requirements and laws, which may be subject to change. While care has been taken in the preparation of this document, no liability is accepted by Lombardini Allan Pty Ltd, its related entities, agents and employees for any loss arising from reliance on this document.
The advice contained on this site is general in nature and has been prepared without considering your objectives, financial situation or needs. You should, before acting on any advice, consider its appropriateness to your circumstances (including your objectives, financial situation and needs). You should also consider the relevant PDS before making any decision about any product.
Gavin Bramley is an authorised representative of Lombardini Allan Financial Group Pty Ltd. | ABN 36 642 793 717| AFSL No. 525803