11 October 2024
Managed accounts? Simple.
For advisers and their clients, are managed accounts simply a better way to invest? Read more to find out why managed accounts have become so popular with investors and advisers. Read more
No matter which circles you move in – financial, investment, real estate, or otherwise – the investment strategy debate is ever present, with opinions varying greatly about borrowing to invest, and the argument for positive cash flow over negative gearing.
At Elston, it’s a commonly asked question from our clients. Many want to know how negative gearing will impact their investment choices when considering property or shares. Damon Bensein, Head of Private Wealth, explains, “The tax benefits of negative gearing apply in the same way to both property and shares. The major difference is between the underlying investment itself, and the taxable nature of the income generated from the asset. Shares have franking credits attached which makes the income more attractive from an after tax perspective, while the income generated from a property is not as tax effective as there are no franking credits attached.”
As well as not being as tax effective, negative gearing is also considered a high risk category for a number of additional reasons. In its simplest form, negative gearing is when income from an investment is less than your interest and other expenses. Your investment operates at a loss, which you hope to recover with a capital gain at time of sale. While the loss can be used as a tax reduction, ASIC is quick to point out that you’re only reducing your tax because the income from your investment isn’t covering your expenses. You still need to cover the negative cash flow from other sources.
One of the big banks compounds this disadvantage by warning you’ll need enough cash flow to cover the losses yourself before tax time each year. They caution that running properties at a loss can make it harder to build a portfolio; and the more highly geared you are the more vulnerable you’ll be to rate rises.
Ultimately Elston’s view is that borrowing to invest decisions should be made with the clear mandate of generating capital growth over time and not as a strategy to reduce tax. Says Bensein, “The merits of the investment should stack up with the idea to better a client’s position over the long term and not put the client at risk of loss due to poor investment choice or ability to fund repayments”.
As such, we recommend our clients borrow for investments that are positively geared, and believe this strategy is far less risky as it means the income generated from the investment exceeds the cost of borrowing as opposed to negatively gearing. “In our eyes we would prefer people to make money and pay tax, rather than purposefully losing money to save some tax in the hope that the investment increases in value,” explains Bensein.
“We look at the investment based on fundamentals such as long term growth prospects, probability of generating a return, affordability in terms of cash flow, and the ability to fund repayments if there’s a loss of income from the investment or if an investor is unable to work,” says Bensein. “We work with clients to help them make a decision as to whether gearing is appropriate and, if so, put in place strategies to reduce the impact if there was a loss of income both in terms of investment or employment.”
Elston take a considered approach to risk management, ensuring clients have a clear understanding of what’s at stake, and have a plan to counteract potential hazards when they borrow to invest. “Some key things to consider are diversifying, managing cash flow, managing interest rate risk, and borrowing a manageable amount,” says Bensein.
With the government yet to make a formal announcement on whether to curb negative gearing, it is inevitable that the positive vs. negative gearing debate will continue for some time, with new opinion pieces and articles being published weekly. With such a vast amount of information to navigate, it’s important to make sure you get the right financial advice before you make the important decision to borrow to invest.
Elston’s financial planners specialise in personalised service and tailored investment advice. To discuss your investment choices, call Elston on 1300 ELSTON (357 866).
