Borrowing to invest
Borrowing to invest is also known as 'gearing' and it can be a
risky business. Gearing can increase your returns when markets are
rising but losses can be devastating when the markets fall.
Here we explain the pros and cons of borrowing to invest to help
you decide if it is right for you.
Benefits of borrowing to
Borrowing to invest is high risk and you should seek
professional financial advice to
make sure this strategy is right for you.
The main benefits of borrowing to invest are:
- it allows you to have more money to invest, both your money and
the borrowed money
- if you are on a high marginal tax
rate there may be tax benefits as you are usually
allowed a tax deduction for interest payments on the loan.
However, borrowing to invest only makes sense if the investment
return (after tax) is greater than all the costs of the loan, such
as interest and fees. If not, you are taking on a lot of risk for
an overall low or negative return.
Risks of borrowing to
Borrowing to invest is not for the faint hearted. The more you
borrow, the greater the risk becomes as you have to repay the loan
regardless of the performance of the investment.
Here are some of the major risks of borrowing to invest. You
need to understand and have a plan to deal with each risk. If you
are not entirely comfortable with these risks, borrowing to invest
may not be right for you.
- Investment income risk - The income you
receive from the investment may be lower than expected. For
example, a company may not pay a dividend or a tenant may default.
Do you have funds set aside to cover this?
- Interest rate risk - Interest rates on the
loan could rise. If they rose by 2% or 4%, could you still meet
- Income risk - What if your income ceases due
to sickness, injury or redundancy? Do you have a plan to manage
- Capital risk - The value of your investment
may fall and the proceeds from the sale may not cover the remaining
loan balance. Do you have other funds set aside for this?
You can use our personal loan calculator to see the impact of a
rise in interest rates on your loan repayments.
Personal loan calculator
Some lenders allow you
to borrow money using your home as security. It is very risky to
borrow against your home and put this money into an investment. If
the investment turns bad and you can't keep up with your loan
repayments you could lose your home.
borrowing to invest right for you?
Make sure you shop around for a loan that meets your needs. Take
a look at the interest rate, fees and other features such as a
redraw facility or the ability to repay the loan early.
Borrowing to invest is a high risk investment strategy for
experienced investors only. If you are looking to use this strategy
ask yourself these questions:
- Do you have secure income from other sources such as your
salary to top up the loan if you get a margin call?
- Do you have a high marginal tax rate so you can make the most
of any tax benefits?
- Are you in it for the long haul? Gearing is generally a
medium to long term strategy (at least 5 to 10 years).
- Is there flexibility in your strategy to allow for changes in
your personal circumstances such as having children or a reduction
- Will you lose sleep at night if your investment performs
It is important to get independent financial advice when you are
investing. If an adviser is connected to a company they recommend
you invest in, this investment may not be best for you. You can
look at your adviser's financial services guide to see any
relationships or associations they have with other companies.
Margin loans and investment property loans
Many people borrow to invest in shares through a margin loan or
in property through an investment property loan. Each carries their
own benefits and risks. Find out more about margin loans and investing in
Negative or positive
If you are thinking about borrowing to invest you need to
understand if the investment will be negatively or positively
Negative gearing is when your income from an investment (such as
dividends or rental income) is less than your interest and/or other
expenses. If you negatively gear your investment is initially
making a loss which you hope you will make up with a capital gain
when you sell your investment.
A loss can be used to reduce your taxable income which will
reduce the amount of tax you pay. Remember, you are only reducing
your tax because the income from your investment isn't covering
your expenses. You will still need to cover the negative cash flow
from other sources.
Positive gearing is where your income from an investment is
higher than your interest and/or other expenses. This means you
will have extra money in your budget but you will have to pay tax
on the additional net income.
Case study: Bruce's geared investment
has a geared investment that has cost $10,000 in interest this
year and has returned $7,000 in income from dividends this
year. He is negatively geared as his investment is producing a loss
of $3,000 per year. He can deduct this $3,000 from his taxable
income. If Bruce pays tax on his salary at 39%, he can reduce his
tax bill by $1,170 (39% of $3,000).
This may be reducing his tax but it is still costing Bruce
money. For the investment to work for Bruce this loss, and any
losses in future years, will need to be offset by a capital gain
(after tax) when Bruce sells it, in order to achieve an overall
If the investment decreases in value, Bruce will have lost some
of his capital as well as having paid expenses along the way,
giving him a negative return on his investment.
If you are borrowing to invest it's important to make sure your
investments are diversified. Diversification will reduce your
investment risk and leave you less exposed to a single economic
event, so if one business or sector you've invested in fails or
performs poorly, you won't lose all your money.
The less diversified your investments the higher the risk. It is
risky to borrow to invest in one company, one property or one
Find out more about diversification.
Borrowing to invest is not for everybody.
Consider if you have the timeframe and discipline, and make sure
you understand all the risks before you make a decision.
Last updated: 13 Dec 2016