Gearing is the process where money is borrowed for investment. It can be positive, neutral or negative. With negative gearing the costs associated with the investment are greater than the income received, creating a loss (on paper at least) and reducing the investor’s income tax liability. Ideally the asset value would grow over time, enabling the costs to be recovered and deliver a profit.
The most common investments that are negatively geared are real estate, shares and managed investment trusts.
By gearing into an investment a profit is magnified because the gain is made not only on the investors’ capital but also on the borrowed funds. Equally losses are magnified as the debt, interest and charges must be repaid.
It is important that investors have adequate income to meet their loan commitments in the event there is a shortfall in income from the geared investment. To maximise the benefits of gearing, investors should be in the higher marginal tax rates and have surplus disposable income.
These investment strategies are complex and professional advice should be sought before investing. Even the most researched and best intentioned advice may still result in a loss. As with all strategies for investing negative gearing may not be suitable for the particular circumstances of all investors, especially for some
retirees with modest savings who require investment security.