In the midst of a credit crisis you may be excused for questioning why I have chosen to raise this topic, but please, humor me for a moment. The truth is, without the benefit of hindsight it is difficult to know when is a good, or bad time to invest.

If history has taught us anything it is that the more time we spend invested in the market the better off we will be. With this in mind, investment markets (shares and property) have fallen significantly over the last 18 months and the widely held view is that we are much closer to the bottom than we are from the top, remembering of course that no one has ever rung a bell to let us know when we have reached the bottom.

From an emotional stand point we appear to be more comfortable investing in a rising market than in a falling one, but does this attitude maximize returns? The world’s most successful investor, Warren Buffet, once said “sell when other’s are greedy and buy when others are fearful”. Surely it is fear that is dominating current market declines.

Added to this, interest rates have been slashed making the cost of borrowing much more attractive and falling capital prices have resulted in higher dividends paid by quality shares and rent earned by property investments. In some cases gross investment income returns are more than double that of the cash rate, currently 3.25%.

When is gearing appropriate? Several factors will affect the answer to this, however, as a minimum you need to be in a position where access to borrowing is available. Using the equity in the home in many cases is the best place to begin as it generally offers the cheapest interest rates, currently around 5.5%pa.

For example, Ben and Kate own their home valued at $600,000. They have worked hard to reduce their mortgage to $200,000. They now have equity of $400,000. They have the ability to re-draw some of these funds via a line of credit through their bank for investment purposes. Should they decide to borrow $100,000, their borrowings would rise to 50% of the value of their home.

In simple terms, the above table demonstrates that without considering long term growth potential, based on current dividend rates verses current interest rates, the above gearing strategy would pay for itself.

FOOD FOR THOUGHT
- Markets are volatile. Investors should understand that markets may fall further before improving.
- Investors should seek independent advice to ensure such a strategy is appropriate for them.
- A gearing strategy generally works best when the investor contributes
some savings to the portfolio annually to reduce the gearing ratio.
- Current dividend and interest rates may vary.