Creating Wealth through the Magic of Leveraging & Gearing
by Nick Carydias, Senior Mortgage & Finance Adviser
At some stage in our lives most of us will have heard someone say, "You have to spend money to make money." And most of us have replied, "Yes, that's right," and then done absolutely nothing about it.
If we actually took a minute to think about that statement, not only is it about money, but it’s right on the money too.
And it also goes part of the way towards explaining why there are so many millionaires around nowadays, as well as people who hold substantial investment assets.
The one thing most of them have in common (excluding those who have won the lottery, inherited their wealth or happen to be called Ronald Biggs) is that at some point in their lives they’ve taken a calculated risk by putting themselves into debt. They’ve borrowed money to make money. And it has obviously paid off.
Leveraging and gearing are the terms used to describe the financial mechanisms for borrowing (the creating of debt) in order to invest a greater sum of money than would have been possible without borrowing. This then allows for the purchasing of a bigger asset.
In everyday life, a fulcrum is the support at which a lever turns, and leverage is the using of something small in order to operate something big. And that’s exactly how it works financially: you use a small amount of money or capital to purchase a bigger asset, and then enjoy the returns on the purchased asset rather than on the amount you invested.
The cost of that investment and the cost of your borrowings are tax deductible against the income earned from the investment.
What’s more, if you use another asset, say the house you live in, as security to raise the initial investment capital, then the cost of those borrowings can also be deducted against income.
For many investors, leveraging and gearing, whether equities or property, are very sound, safe strategies just so long, as always, you do your homework conservatively and correctly.
And they’re used by so many investors and wealth creators because of the numerous benefits they bring. Consider these:
- The direct costs, including interest in excess of income, are tax deductible, so the real after tax cost of owning the investment is significantly reduced.
- This is even truer if the investment is a new property. This is because of the impact of the non-cash tax deductibility of both the depreciation of fixtures and fittings, and the Building Allowance permitted under Section 43 of the Taxation Act
- Depending on the level of debt appropriate to your particular circumstances, you could end up holding investment assets with just 10 to 20 per cent equity, or even less. At the same time you’re enjoying the benefit of both capital and income, plus income growth of 100 per cent of the value. This can make quality investments over time hugely successful.
- By holding those investment assets, either property or equities, over the long term (property for at least ten years in our opinion), you’re likely to see the value more than double from the original purchase price. That means you’re building up substantial equity.
- If appropriate, you can then use the equity you build up in those assets to leverage against and purchase other investments.
- Holding costs can be minimal, especially today, when interest rates are so low, which means your lifestyle is unlikely to be affected. Having said that, always be careful in your planning to allow for possible rate increases.
- The strategy creates a tangible investment asset base which you can either choose to keep and use as a source of income, or sell and live off the capital when you retire.
In the meantime, the debate as to whether it’s better to accumulate assets in the form of shares or property continues. In my opinion, both are appropriate.
Quality property is more secure than equities, therefore it may come down to considerations of debt ratios, the amount of debt appropriate for particular investors, the individual's circumstances, what they’re hoping to achieve, and at what level they’re comfortable with.
When making any investment or major financial decision, it needs to be carefully considered and reviewed as part of your overall financial strategy. It must not only be sound, but it must be appropriate to your particular circumstances. Once that’s decided, then you’ll be free to reap the rewards from leverage and gearing in the years to come.
Keep in mind that your first leveraged investment is always the hardest, but do it right the first time and the next one will seem almost too easy. So … just get started!
Remember, the present markets and low interest rates present a special opportunity that could be right for you to invest. If you would like to get your Financial Strategy in place, or would like to find out more, click here.
For more information, or to arrange an appointment with a John Hopkins Finance or Mortgage Adviser, please contact our Client Liaison Officer on 1300 726 082 or click here.