A gearing strategy enables you to use borrowed money to invest in more assets. As with borrowing for the purchase of any asset, you make a contribution with your own funds first.
A margin loan is a form of gearing which allows you to invest more than you could if you were just using your own savings. Initially you make a lump sum investment into shares or managed funds with your own savings and then borrowed funds are added. Your own savings, shares or managed funds are used as security and the amount you are able to borrow will depend on the value of your own assets, their Loan to Value Ratio and a credit limit determined by the lending authority.
You may choose to add to your investment by making regular monthly contributions of savings and more borrowed funds. This strategy has all the benefits of a disciplined savings plan as each month a borrowed amount is invested along with your own contribution which gradually increases your portfolio.
- Potentially your investment returns are higher because you have increased the amount you are investing.
- You are diversifying your portfolio more because you are spreading your investments across a greater variety of shares and managed funds.
- Borrowing to increase your investments may yield tax benefits because the interest paid on the margin loan is usually tax deductible.
- Prepaying the interest in advance allows you to bring forward the interest deduction into the current year.
- The added exposure can also increase your losses when the market falls.
- The sudden fall in the value of your investments may trigger a margin call.
- Interest rates may increase which means your investment costs increase.
- Taxation legislation may change adversely.
A margin loan investment is potentially suitable for investors with a long term investment horizon, investing to achieve their long term goals of wealth creation.