We’ve all heard a thing or two about negative gearing or positive gearing in the news lately. Especially in relation to property investment and mortgages in Australia, everyone seems to have an opinion on this matter. So here is a short article on negative gearing explained.
So what is negative gearing or positive gearing? Does it deserve so much attention?
When investing in an asset you might be considering if it is worthwhile to apply leverage and get a loan to amplify the investment.
This will require appropriate money management and debt management strategies. You will need to think carefully about your personal circumstances and objectives. The interest expense on the loan can reduce your tax bill, which is a small added bonus.
Generally, when you use debt to invest and if your investment income is less than your investment expense, it is negative gearing (for more details, see ASIC article). When you have negative gearing, you will need cash flow from elsewhere to make up for the cash flow shortage. When you have positive gearing, you have extra cash flow at your disposal.
Of course, if your investment is in a cash flow shortage position and is making a loss, your tax bill will reduce. Similarly, if your investment is in cash flow surplus territory and is making money, your tax bill will increase.
Wealth creation is not about seeking negative gearing or positive gearing.
You can read more about wealth creation via long-term investments here.
Do not start your investment process with negative gearing or positive gearing in mind as they are merely an outcome that needs to be understood and managed.
Start with critical investment decisions and due diligence.
Do your research and ask yourself:
- What is the expected cash flow from the investment year on year? Does it look too good to be true? Is it too aggressive? Too conservative?
- Is there value in this investment? Consider the opportunity cost, such that the value of $1,000 today is not the same value as $1,000 in 10 years’ time.
- How does it impact your overall asset mix? In light of diversification, liquidity and home bias?
- Have you considered other investment options in the investment universe?
- How does this investment impact your overall financial health and wellbeing? Is it in line with your goals and objectives? See Goggling article “Here’s to an Early Retirement: The ultimate option of not having to work”.
- Is it worthwhile to apply leverage and amplify the investment?
- Stress test various scenarios, do you have room to move when the economic environment changes or when something unexpected happens in life. See Goggling article “Forward thinking: Contingency plans and protection for your family”.
All else being equal, generally you want your investments to have positive gearing. Neutral gearing is the second preference and negative gearing should be the last preference.