Share investors: Is negative gearing into shares a good idea?
Borrowing to invest—also known as negative gearing—is a risky venture that many embark on but only a few succeed at. It can be marred by risks if you don't get the correct financial advice or you don't have vast experience in monitoring and predicting markets.
Negative gearing into shares is where you borrow money to invest in shares and the interest accumulated from the loan is more than the amount of dividends earned from the shares.
In other words, in the short-term, negative gearing into shares is where you’ve had more cash go out (interest on the loan) than has come back in (dividends from the shares).
If that’s the case then, what’s the benefit from negative gearing into shares? And what are the risks involved?
Read our guide to find out…
What is your marginal tax?
When you are at the point where you are paying the highest amount of tax, also known as marginal tax, you are better set to make gains by borrowing to invest. Here you can often get a tax deduction on any interest payments made towards your loan.
However, you must be very careful here. This method only works if, after tax deductions, your investment returns are more than the costs involved in your loan. Otherwise, you may end up having to deal with negative returns.
Franked dividends
While franked dividends do not put money directly into your pocket, it is still worth mentioning that when you pay less tax, you have more money at your disposal to invest.
Franked dividends attached to shares come about because companies pay their taxes and then a portion of this “tax paid” amount is attached to the shares you buy from the same company. Once you receive payment by investing your money in franked dividends, you are relieved of paying any additional taxes on those dividends. This avoids taxing the shares twice.
Three benefits of negative gearing
There is a lot of talk about the risks of negative gearing but it also comes with some benefits for investors:
1. Tax credits
Investing in quality shares enables you to receive a tax credit on the dividends that you collect. This is made possible by the dividend imputation system (DIS). The franked dividends, as mentioned above, can have a positive effect on your cash flow. This is because the income attracts a small fraction of tax deduction.
2. Builds wealth
You can increase the ability to create more wealth by negative gearing because borrowing allows higher levels of investments than you could normally using your available capital. This means you could multiply your earning potential in a favourable market.
3. Make deduction claims for expenses and interest
Under the current taxation laws, you can make deduction claims for expenses and interest, offset against any assessable income you are making. This includes income such as business, investment or salaries.
Two risks of negative gearing
Of course, any form of investment carries risks, and here are some of those associated with negative gearing into shares:
1. Lower income
There is a high chance that the income you are able to make from the investment will be much lower than what you may have expected. For instance, if you borrowed money to buy shares, the company may pay lower dividends or even not pay any dividends to you at all.
2. Capital risks
What if the value of the shares you bought with the borrowed money turns out to be lower than you expected?
Anyone who borrows money to invest in shares is looking to make capital gains. However, there is no way of telling if the money you make will be enough to cover the remaining balance. It is wise, therefore, to have some money set aside to cover this risk.
Negative gearing into shares: Is it worth it?
Negative gearing is suited to those who are bold and ready to face the potential risks head-on. If you are quite new to negative gearing into shares, it is advisable to first talk to a business advisor. Our Perth-based team can guide you independently to help you see both sides of the coin and ultimately make an informed financial decision about whether it is right for you.
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One of the most powerful decisions you can make with your superannuation is whether to run your own self-managed super fund (SMSF) and whether to invest in property through it. Most people know it's possible to use super to buy property. Far fewer know how to do it well. The following seven tips are designed to help you make the right decisions. 1. You Can Borrow Money to Purchase Property in Superannuation. Don't have enough in your SMSF to buy an investment property outright? Since 2008, superannuation held in a self-managed super fund can be used to borrow money for property purchase. This is done through a 'limited recourse loan' using a Bare Trust as the Custodian entity. You can't borrow the total value of the property—typically it's up to 80% for residential properties and 60% for commercial properties, with the required deposit held in the SMSF as security. The SMSF then makes the loan repayments, with rental income received by the fund and property expenses paid by the fund. Importantly, if there is a default on the loan, your other assets in the SMSF are generally protected from standard debt recovery and bankruptcy proceedings. The lender only has recourse to the property itself. Upon completion of the loan repayment, ownership of the property transfers legally to the SMSF. 2. Follow These 8 Steps to Set Up Your SMSF Setting up an SMSF properly can be a complex process. It’s best to set up an SMSF with the assistance of a qualified superannuation advisor, like us! We can assist with both the initial setup and the ongoing management of your fund. There are eight core steps to SMSF set up: Select the appropriate structure and name Sign the trust deed that covers how your SMSF is set up and run (it can have up to four members) Establish a trust for the SMSF by investing assets into the fund Register your SMSF with the ATO Set up a separate bank account for your fund Submit your tax file number (and those of any other trustees) Obtain an electronic service address to receive employer contributions into your fund (if applicable) Roll over funds from your existing superannuation account into your SMSF 3. Keep a Liquidity Buffer If you're buying property through superannuation, make sure you plan to keep a liquidity buffer of cash and/or shares in your fund. Lenders will check for this before lending to you—it should be at least 10% of the value you intend to borrow. But beyond satisfying the bank, it's simply good risk management. Property is an illiquid asset. Having accessible funds in the SMSF means you're not caught short if repairs are needed, the property sits vacant, or an unexpected expense arises. Because superannuation is central to most Australians' retirement security, the government has carefully regulated what can and can't be done with it. They don't want people gambling their retirement away on poor investments or incorrectly using their superannuation fund. 4. Use the Rental Income to Repay Your Loan You cannot live in the property you purchase through your SMSF until after retirement. Most people purchase an investment property and use the rental income generated to repay the loan—which makes excellent financial sense. The key is selecting a property that rents easily and delivers a strong rental return. Your purchasing criteria may look a little different to buying a home you'd live in yourself. For example, proximity to public transport, local amenities, and average rental rates in the area matter more than personal preference. 5. Get It Right and Enjoy Significant Tax Efficiencies One of the most compelling reasons to invest in property through superannuation is the tax efficiency on offer. These benefits can significantly improve the long-term return of a property investment compared to holding it in your own name. Key tax benefits include: No capital gains tax or tax no yearly investment earnings if under super caps. Salary sacrifice advantages if you're sacrificing salary payments into super, loan repayments are effectively tax deductible. Capped tax on investment income—the maximum rate of tax on income after expenses is 15%. Any capital gains on investments held for 12 months or more, is taxed at 10%. Standard investors outside super can pay up to 47%. 6. Follow the Same Due Diligence Rules as Any Property Purchase Buying through superannuation doesn't mean relaxing your standards. If anything, the rules governing SMSFs mean you need to be more rigorous, not less. Property is likely one of the most significant financial decisions of your life. Research, not emotion, should drive your choices. The same rules apply whether you're buying in or out of super: Visit and compare multiple properties Know the values of similar properties in the same area Get all property checks performed by the right professionals Shop around for the right loan structure and lender Don't abandon good investor habits just because the structure is different. 7. Always Get Quality Professional Advice Nothing comes without risk—but the right advice significantly mitigates it. The key is understanding what you're getting yourself into: making informed decisions based on accurate data; keeping a diversified superannuation portfolio that doesn't place all your eggs in one basket; and not underestimating how complex buying property in superannuation can be. Sound Simple? It’s all in the details. If the above tips have made it sound straightforward, know that the detail is where the complexity lives. Getting professional advice from the start helps ensure you make the best possible decisions for your future. When selected according to rigorous property-purchasing criteria, property can be an excellent way to grow your superannuation and increase your chances of building a retirement fund that supports the lifestyle you want. Ready to Explore Property in Your SMSF? Whether you'd like to discuss whether an SMSF is right for you or need help setting one up, reach out to Ascent Accountants . If you want assistance managing the property within your fund, contact the Ascent Property Co team .
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