While gearing has many advantages, using savings to gear on a regular basis can offer some additional benefits. Regular gearing involves combining savings with borrowed funds to invest into selected managed funds and / or shares on a monthly basis. It can help grow a portfolio faster and is a simple and automatic way to drip-feed money into investments, taking advantage of dollar cost averaging. This means buying more when the market is down and less when the market is up, which can help smooth out the highs and lows of investing.
Case study: how regular gearing works
Sam has $2,000 equity and wants to invest into an Australian share fund. He can afford to invest an additional $500 per month and wants to maximise his return over a 10 year period. Sam considers the following options:
Option 1 - no gearing strategy
Invest the initial $2,000, plus $500 per month into an Australian share fund. After 10 years the total net value of the investment would be $84,867.
Option 2 - regular gearing strategy
Combine the initial $2,000 with a loan of $5,000 to make an initial investment of $7,000. Sam invests $500 per month, as well as using regular gearing to invest an additional $500 per month from the loan, i.e. he borrows $500 to create a total investment of $1,000 per month. After 10 years the total net value of the investment would be $92,202 (net of a loan balance of $65,000).
After 10 years |
Option 1 |
Option 2 |
Sam’s equity contribution |
$62,000 |
$62,000 |
Investment value after interest and tax |
$84,867 |
$157,206 |
Less Loan balance |
$0 |
$65,000 |
Investment value after interest, tax and loan |
$84,867 |
$92,206 |
Assumptions applied: interest rate 8% per annum; distributions reinvested; capital growth 4% per annum; income yield 4% per annum (70% franked); marginal tax rate 47% (including Medicare levy). Capital gains are realised in the final year and qualifies for 50% general discount.
What are the benefits of regular gearing?
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Provides an automatic and disciplined approach to saving and investing every month.
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Benefits from dollar cost averaging — may smooth out the highs and lows of investing.
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Allows the investment of additional money as and when available.
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Potential to purchase more as the investment portfolio increases in size.
What are the risks of regular gearing?
Carries the same general risks as gearing but may benefit less in a rising market.
Debt management strategies
Understanding reverse mortgages
Self-funding instalment warrants
Understanding annuities
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