Gearing simply means borrowing money to invest. Gearing may be used to accelerate the process of wealth creation by allowing an investor to make a larger investment than would otherwise be possible. The borrowed money can be invested in a number of ways, including direct shares, property and managed investments.
Gearing can be an effective strategy if the after tax capital gain and income return of the geared investment exceeds the after tax costs of funding the investment.
Gearing is only appropriate for growth based investments such as shares and property and should be viewed as a long-term strategy, that is, seven to ten year timeframe. You need to be able to retain the investment (and maintain the loan repayments) during potential short-term market declines, in order to obtain the benefits of long-term growth.
Negative gearing occurs when the interest payable on borrowed funds and any expenses incurred to derive that income exceeds the net income received from the investment. The investor must have surplus income over and above their day to day living expenses to meet the shortfall.
Gearing is most appropriate for people: