Is negative gearing into shares a good idea?

Investing with borrowed money — a strategy known as “negative gearing” — is a high-stakes endeavour that a select few navigate successfully. Negative gearing into shares, specifically, entails borrowing money to invest in shares, with the interest on the loan exceeding the dividends earned from the shares. 

Without proper financial guidance or market experience, this strategy is more trouble than it’s worth. So, today we'll look at the potential benefits and risks of this strategy to help you make an informed decision. 

Understanding your marginal tax rate. 

One pivotal factor in determining the viability of negative gearing is your marginal tax rate. When you find yourself in the higher tax brackets, you stand to gain by leveraging borrowed funds for investments. The reason lies in the potential tax deductions on the interest payments made towards your loan. However, it's crucial to proceed with caution here! This approach only works if your post-tax investment returns surpass the associated loan costs. Otherwise, you might find yourself grappling with negative returns… 

Unlocking the power of franked dividends. 

While franked dividends may not directly enhance your bank account, they still optimise your financial position. Essentially, companies pay a certain amount of taxes, and these tax credits are associated with the shares you purchase from the same company. By investing in franked dividends, you can potentially eliminate tax liabilities, leaving you with more capital for investment. 

The benefits of negative gearing. 

We’ll get to the risks, but we want to start on a high note and cover the potential benefits of negative gearing. 

1. Tax credits. 

Investing in quality shares can grant you tax credits on the dividends you receive, thanks to the dividend imputation system (DIS). This can positively impact your cash flow by reducing the tax burden on your income. 

2. Wealth accumulation. 

Negative gearing allows you to increase your investment capacity beyond what would typically be feasible. This means you could potentially multiply your earnings in a favourable market. 

3. Expense & interest deductions. 

Current taxation laws permit deduction claims for expenses and interest, which can be offset against assessable income from various sources, including business, investments, or salaries. 

Navigating negative gearing risks. 

Like any form of investment, negative gearing into shares carries inherent risks. 

1. Lower income 

There's a high chance that the income generated from your investment will fall short of expectations. Companies may offer lower dividends or none at all, leaving you with limited income. 

2. Capital risks. 

The value of shares purchased with borrowed funds may not meet your expectations. Investors aiming for capital gains may face a scenario where their returns fail to cover the remaining loan balance. It's a good idea to have a financial cushion to help mitigate this risk. 

So… Is negative gearing into shares worth it? 

The annoying answer is: it depends. Negative gearing is best suited for those with a willingness to confront potential risks head-on. If you're new to the concept, seeking advice from a business advisor in Perth or a financial professional is essential. The right guidance will help you weigh the pros and cons, enabling you to make an informed financial decision that aligns with your objectives and risk tolerance. 

Remember, investing with borrowed funds can be extremely beneficial, but it’s not without its challenges. Success depends on careful planning, market awareness, and sound financial advice. Want some? Contact us today.