To gear, or not to gear…

There’s no doubt that investors, particularly in the share market, in Australia have had a good run over the last three years. And, in many instances, investors who have borrowed funds to increase the amount that they had to invest would have been able to multiply the returns on their investments.

Borrowing money may increase the size of your investment, and your potential returns. Of course, a geared portfolio can also increase your potential losses should the investment fall in value.

The hypothetical example below shows how gearing can help investors build wealth more quickly.

Meet Robert…

In September 2004 our hypothetical investor, Robert, decided to invest a lump sum in Australian resources giant, BHP. Robert had two choices – to invest in BHP shares using only a lump sum he’s saved of $20,000, or to gear his investment by taking out a BT margin loan of $30,000, giving him $50,000 in total to invest.

  Without gearing With 60% gearing

Robert’s own capital

$20,000

$20,000

BT Margin Loan

–

$30,000

Total investment

$20,000

$50,000

BHP share price 30/9/2004

$14.36

$14.36
Shares purchased 1,392 3,481

BHP share price 30/9/2007

$44.55

$44.55

Portfolio value 30/9/07

$62,014

$155,079

Interest Cost

–

$8,010

Unrealised capital gain

$42,014

$105,079
Total gain on initial $20,000 investment (before tax) $42,014 $67,069
Annual effective rate of return on investment 45.8% 63.3%
Case study assumptions: Variable interest estimate for example purposes is 8.90%p.a, which was the average BT variable rate for the example period, paid monthly in arrears.  *Loan balance remains at $30,000 over 3 years. *Dividends, brokerage, franking credits, tax benefits are not included in the calculation or any other costs or income derived from the investment.*This example does not constitute financial advice, or in any way recommend the security used for hypothetical investment.

As the table shows, 3 years after Robert invested in BHP, the return on his geared investment was significantly greater through the use of gearing. Robert may also be able to claim a tax deduction against the interest incurred on his margin loan.

Can BT help you build your wealth?

We recommend you contact your financial adviser to discuss whether gearing can help you reach your investment goals more quickly. For more information about BT Margin Lending, call our Margin Lending Team on 1800 816 222 (Monday to Friday, 8.00 am to 6.30pm – Sydney time) or email BT Margin Lending.

Important Information

The information contained in this article, dated November 2007, is given in good faith and has been derived from sources believed to be accurate as at this date. It contains general information only and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. No company in the BT Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way including by reason of negligence for errors or omissions. This disclaimer is subject to any contrary provisions in the Trade Practices Act. This information doesn’t account for your investment objectives, particular needs or financial situation. These should be considered before investing and we recommend you consult a financial adviser. All forecasts and estimates are based on one set of assumptions which may change. A small change in any one of the assumptions may lead to a large change in the results. This information may not be used or reproduced without the prior consent of BT Financial Group.