Considering Gearing. An Educational Guide produced by Suncorp

Transcription

1 Considering Gearing An Educational Guide produced by Suncorp

2 Contents 1. Who is this booklet for? 1 2. Gearing What does it mean? 2 3. Benefits of gearing 4 4. Is negative gearing the only way to go? 6 5. What investments can you gear into? 8 6. Popular types of gearing 6.1 Using home equity Margin lending Instalment gearing Simple tips for managing the risks How can financial planning advice from Suncorp help? 17 Disclaimer Various products and services are provided by different entities of the Suncorp Group. The different entities of the Suncorp Group are not responsible for or liable in respect of products or services provided by other entities of the Suncorp Group. Financial product advice, including any advice contained in this booklet, is provided by representatives of Suncorp Financial Services Pty Ltd ABN , Australian Financial Services Licensee ( SFS ) This advice is based on information available at the time of preparation. SFS is a member of the Suncorp Group and may recommend products provided by related companies. As a result, those companies may receive fees and charges, details of which are set out in the relevant Product Disclosure Statement ( PDS ). SFS receives commisions from the product providers of products it recommends, including other members of the Suncorp Group. Further information about these commisions is contained in SFS s Financial Services Guide ( FSG ). For a copy of any relevant PDS, SFS s or FSG contact us on , electronically at direct@suncorp.com.au or at Suncorp Financial Services Pty Ltd, GPO Box 1453, Brisbane QLD Any advice contained in this booklet has been prepared without taking into account your particular objectives, financial situation or needs. For that reason, before acting on the advice you should consider the appropriateness of the advice having regard to your own objectives, financial situation and needs. Where the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a PDS relating to the product and consider the PDS before making any decision about whether to acquire the product. We recommend that you seek advice from a financial planner. Suncorp Income Protection Insurance is issued by Suncorp Life and Superannuation Limited ABN Lending products are issued by Suncorp-Metway Ltd ABN The taxation information contained in this brochure is based on our interpretation of tax laws as at 1 July You should seek advice from your tax adviser for your individual circumstances.

3 1. Who is this booklet for? Here s a quick quiz. Just tick the boxes that apply to you. Would you like to: reach your financial goals sooner? find enough money to get started investing earlier? have more money to invest? get more mileage out of your existing investments? achieve a better spread of investments without selling what you own? have the capital tied up in your home working for you? If you ticked any of the boxes, then this booklet is for you. This booklet shows you how gearing has the potential to make all those things possible. Gearing may help you achieve financial goals that may not otherwise have been possible. Gearing may allow your money to work harder, helping you to get where you want to go sooner. You don t need to be wealthy, and you don t need a huge income. You don t need to be a speculator or a big risk-taker. But you do need to know how gearing works, about the benefits and also the risks. If you haven t looked at gearing before, we suggest you treat this booklet as an introduction. We ll explain how gearing works, and look at different approaches to gearing that you might consider. Use this booklet as the start of a 2-step plan Step 1 Read the booklet, think about what it means for you and jot down your own questions and ideas. If the idea of gearing interests you, move on to step 2. Step 2 Let your financial planner work out if a plan is appropriate for you. They ll explain the benefits and the risks in more detail, and suggest the type of gearing that suits you best. They ll get you started on your plan and review your progress regularly. If you don t have a financial adviser, why not make an appointment with a Suncorp Financial Planner by calling , and ask for Financial Planner. Or else drop into your nearest Suncorp branch and they ll be able to help you. Investments 1

4 2. Gearing What does it mean? Gearing means borrowing money to invest. Gearing magnifies gains and losses. Gearing means borrowing money, not to spend on a holiday or a car, but to invest. It s a little like taking out a loan to buy your home, but better. Better because: unlike your home, you expect to receive income from your investments which can help meet the interest payments or be reinvested for more growth, and depending on individual circumstances, interest on a loan used to buy an income-producing investment can generally be claimed as a tax deduction. That s not the case with a conventional mortgage, where the purpose of the loan is simply to buy the home. The basic principle of gearing is simple. Looked at over the medium to long term, if the net return from the investments you make is higher than the net cost of borrowing and investing, then you re ahead. And because you re investing a larger amount (using borrowed money as well as your own), the amount of any gain on your equity is magnified. By the same token, if the investment doesn t perform as well as you expect, gearing could also magnify your losses. Of course there s more to it than that, but the following example illustrates the basic principle. Case Study Jill has $20,000 available to invest. She can go it alone and just invest that $20,000, or she can borrow another $30,000 and invest a total of $50,000. We ll look at the gross return she makes in both scenarios if the investment goes up by 8% over 12 months. Gearing can magnify your gains Nil borrowing (ungeared) Jill s money $20,000 $20,000 Plus borrowed money $0 $30,000 Total amount invested $20,000 $50,000 Result of 8% gain* + $1,600 + $4,000 Gross gain as % of Jill s initial $20, % + 20% Borrowing $30,000 (geared) * These calculations are for illustrative purposes only and do not take into account income tax, interest costs, capital gains tax or investment fees and charges. Assumptions: Jill s investment earns 3% income (which she re-invests) and 5% capital growth. Of course, there is no substitute for professional advice. The information contained in this booklet is of a general nature only. Everyone has different needs, so we highly recommend that you see your Financial Planner for personal advice. 2 Gearing is not for everyone, and there are risks involved. As long as you understand those risks you can take steps to manage them. We ve listed 12 simple tips for managing risks on page 16 of this booklet. Your Suncorp Financial Planner can also help you to assess the suitability of gearing for your situation.

5 It s important to note that gearing magnifies losses as well as gains. So if Jill s investment had gone backwards, the amount of the loss would have been greater with gearing than if she had just invested her own money. The obvious message is that there are risks, and you should only gear into an investment that you can reasonably expect to go up in value over time. Isn t gearing just for wealthy people? Jill s example gives you an idea of why gearing has become so popular. It has long been utilised by businesses and high income earners, but these days there are plenty of ways for smaller investors or beginners to enjoy the benefits of gearing, too. In the next section we ll take a more detailed look at the benefits of gearing. Tax implications References to tax throughout this booklet are based on our interpretation of tax laws as at 1 July All forms of gearing have tax consequences, and we strongly recommend you take advice from your tax adviser before making any decision to undertake an investment gearing plan.

6 3. Benefits of gearing There s a lot that s good about gearing, and a lot of reasons why you might consider it. Some or all of the following might apply to you. Gearing opens up more opportunities. Gearing may help build your investments sooner Sometimes it can take a long time to save up a meaningful amount of money to invest. That can be frustrating, especially if there are good opportunities you d like to take advantage of. By borrowing money and adding it to your own, your investments may start to build faster. You really don t have to have a lot saved up to start gearing. Suncorp, for example, has a gearing plan where, if you re able to put aside just $250 a month (and pay the interest as it accrues), you can get started with as little as $1,000 of your own money (in cash or approved security value). Gearing can make it easier to diversify You ve probably heard how important it is to diversify your investments so as to reduce risk. Basically it s the old adage of not putting all your investment eggs in the one basket. For long-term capital growth, which is what you re looking to achieve if you re gearing, it makes sense to invest in a spread of growth-oriented investments, such as Australian shares, property and international shares. That way, you are not exclusively reliant upon the fortunes of any one market to provide returns over the longer term. It can be hard to get that level of diversification if you ve only got a small amount of money to work with. By increasing the amount you have to invest, gearing can provide some extra financial muscle, so you can spread your investments more widely. Case Study Instalment gearing plan Geoff is saving $400 a month, trying to build up enough money to start his own investment portfolio. He s saved up $4,000, but thinks he needs a lot more to get a good spread across 2 or 3 managed share and property funds. But with low interest rates, and paying tax on what interest he does earn, he feels he s making very slow progress towards that target. With an instalment gearing plan, Geoff could start that investment portfolio right away. As long as the managed funds he wants are on their approved securities list, a lender may add a regular loan amount to his own savings, and use the combined amount to invest in the funds. That way Geoff has a larger portfolio, with a better spread than he could get using just his own savings, and it s working for him now. For example, Geoff could choose to contribute $250 per month of his own funds and borrow, say $250 or $500 per month, to invest $500 or $750 per month into a couple of approved managed funds. This would leave Geoff with $150 per month over to meet interest payments and perhaps do some top-up investment from time to time. 4

7 Another benefit of gearing is that it can open up opportunities to make investments that would otherwise be beyond your reach. Some particular investment opportunities require higher initial investment entry levels and are only available to people who can put in a minimum of, say, $20,000 or $50,000. With the extra financial muscle you have with gearing, what might otherwise take more time to achieve can come within reach sooner. Gearing gets your lazy capital working for you Like many people, you may have lazy capital tied up in an asset typically in your own home where it s not earning income. By using that asset as security for an investment loan, it stops being lazy and starts working for you. Gearing can offer tax benefits* Last, but not least, gearing can be very tax effective. Assuming you borrow to invest in income-earning assets, the interest payments can be claimed as deductions and help reduce your taxable income. If the interest and associated on-going investment costs are more than the income you receive from your investments, the difference can help to reduce your overall income tax liability (including income from salary or bank interest). This is known as negative gearing, and we ll look at what that means in the next section. * Depending on your individual circumstances, you may be able to offset any loss from geared investments against your taxable income, such as wages and investment income. The tax information contained in this document is intended for general information purposes only and does not constitute tax advice. Suncorp strongly recommends you seek tax advice from a qualified professional. Case Study Line of credit loan Noel and Denise have paid half the amount owing on their home. Now in their late 40 s, they re starting to think ahead towards retirement. They re already saving money in superannuation, but they don t expect to be able to touch that until they retire at 60. Meanwhile they re keen to accelerate their wealth building some other way. With a line of credit loan they can. It makes use of the equity they ve got in the house as security as a line of credit they can draw on to make investments. They choose to invest in several managed funds which give them a good spread across Australian and international sharemarkets. They re hoping for some good capital growth over the next 10 years or so and, because they are investing in income producing investments, they ll be able to claim tax deductions for the interest they pay on their borrowings. Investments 5

8 4. Is negative gearing the only way to go? A lot of people use what s known as negative gearing, not just as an investment strategy but also as a legitimate way to reduce their overall income tax liability. While negative gearing can certainly achieve that, it should not be the dominant reason to gear. Nor is negative gearing the only way. It s all a question of cashflow, as we ll explain below. Negative gearing explained An investment is negatively geared when the income you receive from it is less than the on-going costs you pay (on the borrowings and investment). In other words, your cashflow is negative. Case Study Negative gearing Malcolm borrows $40,000 at a fixed interest rate of 7% pa. He uses it to make an investment that returns an income of 4%pa. His cashflow over the year looks like this: Income received ($40,000 x 4%) $1,600 Less interest paid ($40,000 x 7%) - $2,800 Net cashflow - $1,200 Why would Malcolm borrow to invest like this if it means he is having to make up the shortfall? Because he s expecting the capital value of the investment to go up over time, together with increasing income flows, to compensate him. There s also the question of his income tax to take into account. Malcolm earns a salary of $80,000 a year. That s the only income he has other than that received from his geared investment. If we look at his before and after tax calculations we can see the effect of negative gearing. Before Salary $80,000 Less tax (incl. 1.5% Medicare levy) - $21,050 Net income after tax $58,950 Change in net income after tax $58,248 $58,950 - $702 So although he was down $1,200 in cashflow terms on his investment, Malcolm s net income after tax is $702 lower. That s because the interest deduction has offset some of the tax on his salary, as well as on the investment income itself. After Salary $80,000 Less net income loss on investment - $1,200 Taxable income $78,800 Less tax (incl. 1.5% Medicare levy) - $20,552 Net income after tax $58,248 He still needs the investment to go up in value, or the income he receives to increase, before he ll be ahead overall. But for him, negative gearing has brought the break-even point potentially lower. 6

9 There s neutral and positive gearing, too Not everyone wants or can afford to have a negative cashflow from their investment. That s fine, because gearing doesn t have to be negative. It s quite possible to achieve a positive cashflow (positive gearing) or just to break even (neutral gearing) by managing one or more of the elements involved. Cashflows will change over time Even though an investment might start off negatively geared, it won t necessarily carry on that way. Over the longer term, most growth investments (shares and property) would be expected to pay an increasing income increasing dividends in the case of shares and increasing rent in the case of property. If that happens, your cashflow can go from being negative to neutral to positive. Investment Income Value ($) Negative Gearing Positive Gearing Cost of borrowing Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment Timeframe Investments 7

10 5. What investments can you gear into? Managed funds are delightfully low maintenance investments and many are well suited to gearing. In theory you can gear into any income-producing investment, as long as you can find someone prepared to lend you the money. However, some investments are much better suited to gearing than others. The most important feature in a geared investment is the potential for capital growth and an increasing income return over time. In fact, those two features generally go together. Where an investment is expected to pay an increasing income in the future, investors will want to own it and an increase in demand should see its value rise. Characteristics of a good investment for gearing There are other desirable features to look for as well. The ideal investment to gear into is one that: has the potential for capital growth over time; has the potential for an increasing income return over time; has low buying and selling costs; has low running costs; requires a low minimum investment; has built-in diversification or the ability to diversify over time; and is liquid ie. it can be sold (wholly or partially) at short notice. Having set down the judging standards, let s assess the most likely candidates. 8

11 Assessing Investments for Gearing* Capital Expected Transaction Running Low initial Built-in Liquidity growth level of costs costs capital diversipotential income required fication Direct Low to Low to Low to Only with Australian high medium medium a large shares Portfolio Managed Australian Low to Low to Low to Can diversify share funds high medium medium within and across sectors Direct listed Medium Low to Low to Only with property to high medium medium a large trusts Portfolio Managed Medium Low to Low to property to high medium medium securities funds Direct Low to Medium Medium Property medium to high to high Managed International Low to Low to Low to Can diversify share funds high medium medium within and across sectors * Criteria above are broadly indicative of general investment classes shown. Characteristics of individual investments may vary significantly. You should satisfy yourself of the suitability or otherwise of a specific investment before making a decision to invest. Of all the main candidates, direct property is probably the one most people tend to associate with gearing. However, as you can see, it does have some shortcomings which potential investors should carefully consider limited ability to diversify, high entry threshold, and potentially medium to high transaction and running costs. Perhaps the most important shortcoming of direct property, such as a rental unit, is that it lacks liquidity. If your situation changes you may need to access your money at short notice especially if you re no longer able to keep up payments on the money you ve borrowed. Unfortunately, you can t generally sell a rental property in a matter of days. And you certainly can t just sell off one of the bedrooms. It s all or nothing. It all depends on what s important to you Choosing the right investment to gear into will depend very much on what s important to you. If you only feel comfortable with total hands on involvement, then direct shares or property may be the best answer. On the other hand, if you re looking for convenience, low to medium running costs, diversification and accessibility, it s hard to go beyond managed funds. Whether they re focused on Australian shares, international shares or property, managed funds are delightfully low maintenance investments and well suited to gearing. Investments 9

12 6. Popular types of gearing 6.1 Using the equity in your home Equity is the difference between the market value of your home and the amount owing on the home loan. That equity may be the full value of your home if you ve finished paying it off, or some lesser amount. It may seem strange to pay off a home loan and then borrow again against the same property, but the two types of loan are very different. A conventional mortgage provides money to buy your home. But you don t receive any tax deduction for the interest you pay, and your home doesn t earn you any income. Gearing allows you to use the equity you ve got in your home to make a productive investment one that is intended to provide you with income. Not only that, the interest component of your repayments is generally tax-deductible. How does it compare? For a start, the interest rate on a home equity loan is generally lower than that of a personal loan or margin loan. There are few restrictions on what you invest in. The security for the home equity loan is your home itself, not what you subsequently choose to invest in. But remember the investments will have to be income producing for you to be able to claim the interest as a tax deduction. There are no margin calls with home loans, either, so if the value of your investments falls you won t be asked to sell them or provide more capital. Finally, a line of credit home loan can be very convenient and highly flexible. With some loans you can split your loan into two accounts using one as your home loan and the other for investment purposes. Home equity loans in a nutshell Security for the loan is your home Line of credit available for personal and investment purposes* Few restrictions on what you can invest in Interest rate generally lower than other personal or margin loans No margin calls All investments held in your own name Case Study Line of credit loan Nick and Jo are buying a new home valued at $400,000. They have a 50% deposit from the proceeds of their last home. They re earning good incomes, and as well as paying off the house as quickly as possible they re keen to invest in the sharemarket. Rather than opt for a conventional mortgage they take out a line of credit for the maximum ($320,000), splitting it into two facilities, one for their new home loan ($200,000) and the other for investment purposes ($120,000). Both their salaries are credited directly each month to the home loan account, paying off the non-deductible debt. At the same time, they have access to $120,000 which they can use for investment. They only pay interest on the money they draw down, and when it s used for investment purposes they should be able to claim a tax deduction. 10 * Where you intend to claim a tax deduction for the interest payable on the investment portion of your loans, it is imperative you keep borrowings for personal and investment purposes separate. We recommend you consult your tax advisor regarding the establishment of your borrowing facility.

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14 6.2 Margin Lending Margin lending is a popular option for people who want to borrow money to buy investments (eg. shares or managed funds), and have cash or existing investments of their own to contribute. How much can you borrow? Lenders, including Suncorp, will generally advance between about 40% to 70% of the total value of approved shares or managed funds. The percentage is called the Loan to Valuation Ratio, or LVR, and it varies from one security to another. There s usually a minimum and maximum loan amount. With Suncorp, for example, the minimum loan is $20,000 which means you can get started with as little as $8,700 of your own cash or sufficient existing approved investments depending upon the loan amount you wish to obtain (based on an LVR of 70% applying to the security). The maximum loan is $5 million. What happens if the investments fall in value? That depends on how much they fall and how much of the loan is outstanding. If the value falls to a point where the loan is more than the maximum LVR, then a margin call will generally be made. You then have to take action to restore the situation, usually within 24 hours. There are normally three options for dealing with a margin call, so you ll need to do one or more of the following: provide some additional security; or pay off some of the loan; or sell some of the investments. Case Study Getting started Lorraine has $20,000 to invest. She has a long term investment view suitable for growth investments such as Australian shares. She would like to invest more if she can and has regular savings to meet interest costs. She takes out a margin loan of $40,000 which, added to her own $20,000, gives her a total investment pool of $60,000. With that sort of amount she can build a good portfolio of shares, with more spread across different companies and industry sectors than she could have with $20,000. You can also use margin lending if you already own shares or managed funds and want to add more. Case Study Getting started Michael owns approved blue chip shares worth $50,000 mostly in banks and retailers. He wants to expand his portfolio, adding more blue chips in different industries. He d also like to diversify into smaller company shares, international shares and property trusts. Not knowing a lot about these sectors, he prefers to invest in them through managed funds. He finds that he can borrow $75,000, giving him a total portfolio of $125,000. He now has more money working for him, and with the broader spread he s less reliant on the performance of just a handful of Australian companies. So while gearing adds some risk, he s comfortable that the extra diversification and the potential for greater profits make it worthwhile. 12

15 Case Study Margin call Ron has a margin loan of $70,000, secured against a portfolio that was originally worth $100,000. The LVR of 70% was the maximum allowed. The value of his portfolio has fallen to $80,000, so the loan now represents 70,000 80,000 = 87.5% of the value. He needs to restore that LVR to 70% or less. His 3 options are: 1. Provide additional securities to the value of $20,000 (assuming they re approved and have a 70% LVR); or 2. Pay $14,000 off the loan to reduce it to $56,000 (ie 70% of the current portfolio value of $80,000); or 3. Sell enough of the portfolio to restore the LVR. In this case it would mean selling at least $46,667 worth of investments, leaving a portfolio of $33,333 and a loan of $23,333. Avoiding a margin call As you can see, borrowing to the maximum makes the possibility of a margin call (and the need to take action) more likely. While no one can predict future prices of your security, there are various ways to make it less likely that you ll be placed in that situation. The best protection against a margin call, apart from choosing quality investments and diversifying well, is to be prudent in how much you borrow. By being conservative and borrowing less than the maximum, you give yourself a lot of extra breathing space if the market turns down. In fact, for Ron, borrowing less initially might have enabled him to take advantage of the falling market by increasing his loan at that time and buying more at a lower price. Who s it likely to suit? Margin lending may suit you if you already have, say, $8,700 in cash or equivalent approved security value, want to expand your portfolio and have adequate income to meet the interest costs. The application process is generally quite straightforward, because the security for the loan is provided by whatever shares or managed funds you invest in. That means other assets, such as your home, are not required as part of the security for the loan. For the same reason, your income is not the deciding factor when you apply for a margin loan. Even so, it s important that you do have a reliable source Being more conservative reduces the risk of a margin call. The best protection strategy is to be prudent in how much you borrow. of personal income to meet interest payments (which will fluctuate over time), and it s a good idea to have that income insured. Your Suncorp Financial Planner can discuss with you the benefits of Income Protection Insurance. It s also important to have access to other money at short notice to cover emergencies and to deal with potential margin calls. Finally, margin lending is really for people who want to be closely involved with their investments and loan. It s not a set and forget strategy, so if that doesn t suit you, then a different type of gearing should be considered. Margin lending in a nutshell Potentially diversify and grow your portfolio Potentially increase your dividend income and franking credits Borrow against the value of approved shares or managed funds you own Use the investments you re making as security for the loan If you intend to borrow to the maximum, consider your preferred options to meet a margin call Investments 13

16 6.3 Instalment gearing Gearing by instalments is increasingly popular, and it s easy to understand why. It brings together some powerful investment strategies and makes them accessible to many people. You may only need $1000 (in cash, shares or approved managed fund equity) to get started. Instalment gearing uses: the potential magnifying effect that gearing has on returns; the power of compounding that comes from starting early and investing longer; and the effectiveness of dollar cost averaging, which avoids the pitfalls of trying to time the market. How does it work? Instalment gearing combines a regular savings plan with regular margin loan drawdowns. The mechanics are very simple. You contribute a fixed amount each month together with an amount drawn from your instalment gearing loan. The combined amounts are then used to buy units in whatever managed funds you choose from the lenders approved list. You don t need much to get started that s one of the great advantages. You may need as little as $1,000 initially (in cash or shares or managed fund equity) and regular minimum contributions of around $250 a month (matched by minimum loan drawdowns), depending on what managed funds you invest in. You don t have to remember to make your contribution each month because it is debited directly from your nominated savings and margin loan accounts. And even though you re making an investment every month, you don t need to apply to invest every month. Leverage your regular savings Example: Steven has $10,000 in cash ($5,000 to invest now) and can afford to invest a minimum of $500 per month. He is keen to accelerate his plans to create future wealth. He has a reliable income and is comfortable with the idea of long-term investing and the fact that growth assets can be quite volatile. Option 1 Using your own power Steven could simply start a regular savings plan, using the initial $5,000 and adding to it by $500 per month. Option 2 Putting the pedal to the metal Steven decides to set up a margin lending (instalment gearing) facility. He invests an initial $15,000 ($5,000 of his cash and $10,000 borrowed from the margin loan which gives him a LVR of 66.67%). Each month, he contributes $750 ($250 of his own money and $500 from the margin loan). What about the rest of Steven s savings? Each month he puts $250 into a separate cash account to meet interest repayments. However, by starting with a small amount of borrowings and building up gradually, not all of the extra $250 will be needed to meet interest payments. That surplus cash reserve (which may include the unused $5,000) could potentially be used in future for additional investment or towards meeting a margin call. In addition to building his investment faster, Steven will also claim the interest he pays as a tax deduction. If his investments have a significant exposure to Australian shares, Steven may also receive some additional tax benefits through the investment income. Option 3 Building in flexibility Steven decides to set up a margin lending (instalment gearing) facility. This time, however, to reduce the risk of a margin call, Steven decides to keep his LVR to around 50%. That is, he will borrow no more than he contributes. He invests an initial $10,000 ($5,000 of his own money and $5,000 from the margin loan). Each month he contributes $500 ($250 of his own money and $250 from the margin loan). This still leaves Steven with an additional $250 to set aside to meet monthly interest costs, future top-up investment, or towards meeting a margin call. Steven will receive similar tax benefits as for Option 2. Investment results will vary for individuals depending upon investment selection, investment fees and charges, timeframe, interest rates, capital growth, investment income and marginal tax rates, which are all subject to change. By increasing your loan each month, you are also increasing your level of repayments (which will be affected by changes in interest rates). You should carefully monitor your regular gearing plan to ensure that you can continue to meet interest repayments. 14

17 What happens if the investments fall in value? If the value of your instalment geared investments falls significantly, you may be faced with a margin call in the same way as with lump sum margin lending. To avoid the likelihood of that happening, the same advice applies. That is, to choose quality investments, diversify well, and be prudent in how much you borrow. What s the significance of dollar cost averaging? Dollar cost averaging means investing the same amount of money regularly into a market linked investment regardless of movement in prices. It takes the guesswork out of timing the market and ensures you invest a little regularly. Kim decides to set up an instalment gearing investment program, using $300 per month of her own money and $300 per month borrowed from her margin loan. Her financial adviser explains that she is also taking advantage of dollar cost averaging. He explains it using the following example, assuming Kim s $600 a month geared investment buys managed fund units at different prices over a 6 month period. Example dollar cost averaging at work Month Regular Unit Price Units Investment Purchased (rounded) January $600 $ February $600 $0.60 1,000 March $600 $ April $600 $ May $600 $ June $600 $ Total $3,600 (average $0.85) 4,355 So for a total investment of $3,600 over that period, Kim would have bought 4,355 units in her chosen managed fund. That s an average cost to her of 82.7 cents per unit, 2.3 cents less than the average monthly unit price. Just by keeping up the disciplined little and often approach, and not trying to time her investment, she d end up with an investment which, when the unit price became $1 a unit, is worth $4,355. While the example uses exaggerated price movements to make the point, it clearly illustrates the principle involved. Dollar cost averaging has the potential to smooth average unit price volatility and add value, especially over a long period when markets trend upwards, but fluctuate along the way. That s exactly what you d expect from managed investments like share and property funds. Because it s impossible to predict short-term market movements, investing a set amount regularly means there s no agonising about when to buy. This can let you focus on one of the keys to successful investing it s not timing the market but time in the market that makes the biggest difference. Who s it likely to suit? Instalment gearing may appeal if you like the idea of margin lending and have accumulated a small amount of savings or investments, to which you can add regularly. As you ve seen, the requirements to get started are quite low so even beginners with the required minimum savings and the ability to meet interest payments can use instalment gearing. Instalment gearing in a nutshell Build an investment portfolio month by month Having a long-term timeframe gives more time for your returns to compound Dollar cost averaging takes the guesswork out of when to invest Every regular contribution you make is matched by a loan drawdown You receive all income distributions (which you may elect to reinvest if available) Decide on your preferred option for dealing with margin calls (particularly if intending to use maximum gearing) Investments 15

18 7. Simple tips for managing risks We explained earlier that all gearing involves risk because, by investing with borrowed money, you magnify your gains when things go well but you also magnify your losses if things go badly. Like most sorts of risk, though, there are ways to manage and control it. Here are some guidelines you might find useful. 12 Dos and Don ts for Managing Risk Do recognise that gearing is a long-term strategy. Give it time (5 to 7 years at least) and don t be impatient to see short-term results. Don t rely on the income from your geared investments for your day to day living expenses. Do make sure you have enough money available at short notice to tide you over in an emergency to avoid having to sell investments. Don t put all your investment eggs in one basket. Use gearing to get a spread across different types of growth assets either directly or through managed funds. Do make sure you have adequate insurance or other contingency plans to cover your loan interest repayments if you re sick or injured and unable to work. Don t think you have to borrow up to the maximum available. Leaving a little in reserve is good for your peace of mind and gives you the option to borrow a little more and top up your investments when markets fall. Do invest always in good quality assets. The risks of speculating in highly aggressive or poor quality assets can only be increased by borrowing to invest in them. Don t gear purely for the potential tax advantages. The investment should be one you d be happy to own without gearing. Do take some professional advice. A financial adviser can explain the risks involved in different strategies and suggest a strategy that suits your needs and tolerance of risk. Don t borrow beyond your means. Gearing can be used as part of an overall strategy to achieve long-term financial security, but not at the expense of short-term financial hardship. Do speak to your adviser about the effect of changing interest rates. They ll be able to advise whether you should lock in some or part of your loan at a fixed rate, if that s available. You should also consider your ability to cope should interest rates rise. Don t gear if it s going to cause you to lose sleep. Your health and peace of mind are more important. 16

19 8. How can financial planning advice from Suncorp help? Financial planning advice from Suncorp can help you realistically assess your current financial position and identify the best options for achieving your goals. Why choose financial planning advice from Suncorp? Our Financial Planners and Authorised Representatives: are experienced and qualified professionals committed to furthering their professional training and education; are licensed to give advice and follow the Financial Planning Association's (FPA) rules of conduct and ethical and professional standards; can offer you a range of superannuation, investment, and insurance products to suit your needs, including investment options managed by Suncorp and other leading Australian and international fund managers; are linked to every Suncorp branch, so you'll find one near you; and keep up-to-date with the latest financial, social security, and tax rules and regulations, so they can give you advice tailored to your personal circumstances and goals. A personalised financial plan will help you: identify your financial goals; make more informed decisions about your money; invest your money tax effectively; secure your personal and financial assets; protect your money against inflation and maintain your standard of living in retirement; and ensure you obtain the maximum tax and social security benefits to which you may be entitled. At Suncorp good advice is never far away, so call us on and made an appointment with a Suncorp Financial Planner today. Investments 17

20 If you would like to make an appointment with a Suncorp Financial Planner, call and say Financial Planner at the prompt. Your Financial Planner or Authorised Representative /11/06 A