Negative vs Positive Gearing

In investment terms, gearing means borrowing to invest.

Negative gearing occurs when the income from the investment, for example rental from property, is less than the expenses incurred in owning that property. Expenses include the interest on the loan and not the principal repayment. They also include other running expenses such as for example insurance and maintenance.

If you borrow to buy shares your investment will be negatively geared if the dividends are less than the interest on the loan.

As you can see, negative gearing means you are making a cash flow loss, which you will need to find from other sources. The attraction for some is that they can claim that loss for tax purposes against other income such as their salary.

The only reason anyone should be prepared to make a cash flow loss on their investments is if they are expecting a capital gain greater than that loss. That is, the value of the investment grows sufficiently over time so that on future sale the net capital gain covers the cash flow loss and then some to have made it all worth the risk.

Positive gearing is where you borrow money and the income from the investment such as rental or dividends is greater than the interest cost of the loan and other running expenses in the case of property.

Positive gearing means you are making a cash flow profit, and will need to pay tax on that profit. You may also make a capital gain on future sale.

Too many people pay too much attention on the tax benefits of negative gearing, without considering the cash flow loss, and without enough consideration of the risks of inadequate capital gain in their investment.

Borrowing to invest will amplify your returns for the right investment, and amplify your losses for the wrong one.

If you are considering borrowing to invest, do your cash flows based on positive vs negative gearing, talk to your accountant about the tax issues for you, and consider your overall options with a Certified Financial Planner.