You’ve probably heard hype surrounding the concept of gearing. Gearing is basically borrowing to invest. More often than not people borrow to invest in property, but you can also borrow to invest in shares in the form of a margin loan. The hype is all about negative gearing, but what is it and what are the other forms of gearing? Below is a quick explanation of gearing.

Positive Gearing

Positive gearing is when you make a profit on your investments (and have to pay tax on that profit). A property investment is positively geared when the rent more than covers all of the expenses associated with the property. A positively geared investment generally means that you are earning a passive income and don’t have pay expenses related to the property out of other income (like your salary).

Negative Gearing

Negative gearing basically means that the expenses of an investment are higher than the income generated and you make a loss. In the case of a property investment, the rent doesn’t cover all expenses and you need to make up the difference through other income streams such as your salary.

As far as property investment goes, negative gearing is generally the easiest and most common investment option. It enables you to purchase an investment that you would otherwise not be able to afford with the bonus that the yearly loss is tax deductible against your other income, reducing the amount of yearly tax that you pay.

There are circumstances where negative gearing is a good option and circumstances where it is not a good option. The effectiveness of negative gearing at reducing your tax will depend on the tax bracket that you’re in. Personally, I’m not a fan of making a loss on purpose purely to get a tax deduction but that’s just me, and that’s not the only reason a person may choose to negatively gear.

The idea behind negative gearing is that its a long term strategy: you hope the capital value of the property will rise at a higher rate than the annual after tax loss. The downside to negative gearing is that the amount that you can increase your investment portfolio is limited to how much you can spare from your regular income.

Neutral Gearing

Neutral gearing means that your investment income covers your investment expenses but no more. You make neither a profit or a loss on your investment. There is no tax paid nor is there a tax benefit. Finding a property with neutral gearing is harder unless you invest more capital upfront (pay a bigger deposit to reduce interest expense). The hope is that either it will become a positive geared investment in the future, or the capital value of the investment will rise and you make a profit on its sale.

The ‘Other’ Gearing

I’m not sure the name of this, many writers refer to this as positive cash flow (Margaret Lomas is one of the best on this topic). Personally, I like this gearing the best, but an investment geared this way is also the hardest to find.

Positive cash flow combines both positive and negative gearing. Basically, your income is more than your expenses meaning that you make an actual cash flow profit and have extra in your pocket every week. However, as far as tax goes, the investment makes a paper loss. An example of this is where the rent from a property investment covers all expenses, but once you factor in depreciation, it turns the profit into a loss. This loss is then a tax deduction against your other income.

For more information on the ins and outs of property investing and tax, the Australian Tax office has a detailed PDF info sheet to download.

Disclaimer: This is general information not financial advice. Seek professional financial advice when deciding what investment options are best for your circumstances.

Have you read these articles?:

1. The Timeless Principles of Wealth Creation
2. good debt v bad debt – is there such a thing?
3. An Easy Place to Start Investing in Shares

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One of the easiest options when starting out in share investing is investing in an index fund.

An index fund is a managed fund that aims to replicate the movement of a specific index. For example, the S&P/ASX 200 is an index that represents the top 200 companies listed on the Australian Share market by market capitalisation. The rise and fall of this index reflects the movements of the top 200 companies. An index fund based on the S&P/ASX 200 holds shares in the top 200 Australian companies and will follow the trend of this index and match its total return.

Features of an Index Fund

• Investing in an index fund gives you exposure to a high range of companies. If your fund tracks the S&P/ASX 300 then you are investing in all of the top 300 Australian Companies. This is instant diversification.
• An index fund is an easy, hands off option. You don’t need to choose the best fund manager, worry about analysing share indicators, selecting the best shares or tracking the market.
• Investing in an index fund is best suited for long term investment strategies, 7 years or more.
• Index funds generally have lower fees than other managed funds. In Australia most active retail managed funds have fees around 2%. Index funds have fees below 1%.
• Index funds can be tax effective. Franking credits on dividends reduce your taxable income. Also active managed funds continuously buy and sell shares improve investment growth, and you have to pay capital gains tax every year on this activity even if you don’t withdraw any money. This can be a bit of a shock at tax time. Index funds buy and hold shares. They have much less activity and therefore you pay less capital gains tax every year.
• While active managed funds try to beat the index, an index fund will track it. This makes an index fund less volatile. While it won’t earn much more than the index, it won’t earn much less either. In an index fund, you’re not going to “beat the market” so for any given year, other funds may outperform an index fund. However, it is rare that an active managed fund will consistently outperform the index.
• The short term risk is the same as any other investment. The last year has definitely demonstrated that.

In the 1996 Berkshire Hathaway Annual Report, Warren Buffett wrote:

“Most investors, both institutional and individual, will find that the best way to own common stocks [shares] is through an index fund that charges minimal fees. Those following this path are sure to beat the net results of the great majority of investment professionals.”

Things to Consider

• There are a few options if you are looking to invest in an index fund, but the two main alternatives in Australia at the time of writing are the unlisted Vanguard Index Australian Shares Fund, which follows the S&P/ASX 300 index, and the listed SPDR S&P/ASX 200 exchange traded fund. The main difference for the investor is in the fee structure. The fees for the SPDR are generally lower, but they charge brokerage fees. If you want to dollar cost average (invest small amounts every month) then the brokerage fees will add significantly to the fees you pay. Vanguard doesn’t charge entry and exit fees making a better option for dollar cost averaging, and they offer a wider range of funds to choose from.
• Many financial advisors don’t recommend index funds because they tend not to get commissions. If you decide to invest in an index fund, it may be advantageous organising it yourself rather than go through an advisor. It’s a matter of filling out a few forms, so you can save yourself the extra fees by doing it yourself.
• Many investors choose to use an index fund as their core investment and add specialist funds or direct share share holdings in specific companies to their portfolio to enhance market return.

Note: This information is general in nature and not tailored to your situation. It is not financial advice. Your personal situation will dictate whether and what investment is right for you. You should consult a qualified expert and read and consider the Product Disclosure Statement of any investment fund before deciding whether to invest.

Have you read these articles?:

1. Introduction to Buying Shares Online
2. want to save but don’t know where to start? start small–it’s worth it
3. how to make saving money as easy as doing nothing

Some personal financial advice is timeless, which explains why George S. Clason’s book The Richest Man in Babylon (originally published in 1926) is is still in print today.

The book is a collection of parable like narratives set in ancient Babylon, renowned as the wealthiest city of the ancient world. In the book, Arkad shares with his friends the secrets of wealth (below) and tells of how he went from having no money to his name to being the richest man in Babylon.

Despite the antiqueness nature of the narrative, the basic principles of wealth are just as relevant today as they were when the book was written (and indeed in ancient times) albeit that we may need to  consider modern investment strategies.

The Richest man in Babylon offers the basic underlying principles of wealth creation, and is a good introduction into the world of personal finance before moving on to more specific and detailed information about modern investment strategies. The principles are basic, the effort lies in the execution of the details.

The Seven Cures for a Lean Purse

1. Start thy purse to fattening

Arkad recommends that for everything that you earn, save at least 10% of your income for investment/savings. In other words, pay yourself first. To make this easier, set up an automatic transfer to a high interest savings account every pay day that way you don’t miss what you don’t see.

“For every ten coins thou placest within thy purse take out for use but nine. Thy purse will start to fatten at once and its increasing weight will feel good in thy hand and bring satisfaction to thy soul.”

I did some quick calculations, and found we save about 2% of our gross income for investment/savings. We need to do some work. To save more we need to:

2. Control thy expenditure

Controlling your expenditure boils down to one principle: spending less than you earn. Use a budget to control your finances. Consider what necessary and discretionary expenses you have and cut down or prioritise your discretionary expenses. Our discretionary expenses often rise in proportion to our earnings. Controlling your expenses gives you more money to invest with.

“Budget thy expenses that thou mayest have coins to pay for thy necessities, to pay for thy enjoyments and to gratify thy worthwhile desires without spending more than nine-tenths of thy earnings."

3. Make thy gold multiply

Once you start your purse to fattening, invest your money. Investing may include putting your money in a savings account to accrue interest, or investing in the stock or property market, or investing in your own business, or a combination,  depending on your personal circumstances.

Wealth multiplies at a greater rate when we take advantage of compounding. Adding to your savings account for instance, and reinvesting the interest every month accelerates wealth building.

“Then, make your treasure work for you. Make it your slave. Make its children and its children’s children work for you.”

4. Guard thy treasures from loss

Investing today can be complex and there are plenty of shysters wanting to take your money. It’s important to get sound advice from qualified experts when choosing an investment strategy.

"The first sound principle of investment is security for thy principal. The penalty of risk is probable loss. Study carefully, before parting with thy treasure, each assurance that it may be safely reclaimed. Be not misled by thine own desires to make wealth rapidly…Counsel with wise men. Seek the advice of men whose daily work is handling money."

Investment diversification, appropriate structuring (family trusts etc) and adequately insuring your assets can also protect your wealth against loss. Talk to a qualified financial planner to work out the best investment strategy for you.

5. Make thy dwelling a profitable investment

"Thus come many blessings to the man who owneth his own house. And greatly will it reduce his cost of living, making available more of his earnings for pleasures and the gratification of his desires."

Of course, this is once the mortgages is paid off.

6. Insure a future income

There are several things that you can do to insure a future income:

• Build your superannuation.
• Create a retirement plan
• Write a will
• Invest in long term assets
• Consider life and income protection insurance. Talk to a professional about the right options for you.

“…it behooves a man to make preparation for a suitable income in the days to come, when he is no longer young, and to make preparations for his family should he be no longer with them to comfort and support them.”

7. Increase thy ability to earn.

Continual education and self improvement is a key to improving your employment or business.

“Cultivate thy own powers, study and become wiser, become more skilful, and act as to respect thyself."

None of this is rocket science, the devil, as they say, is in the detail. By just doing the basics: spending less than you earn, investing some money each week in a savings account or other investment vehicle, you will significantly reduce financial stress and enjoy wealth, no matter what your income is.

Have you read these articles?:

1. a guide to gearing
2. good debt v bad debt – is there such a thing?
3. Generating Passive Income: An Overview

If you love a bargain, now may be the best time snag a bargain buying shares. And buying shares has never been easier – shares can be bought and sold at the click of the mouse and in the comfort of your own home. If you are unfamiliar with the process, then here is an outline of how to go about buying shares online.

1. Choosing an online stockbroker

To trade in shares you need a stockbroker or a brokerage service.

There are many options available when choosing an stockbroker. Firstly, you need to choose the level of service that you want your stockbroker to provide. A full service stockbroker or financial planner will not only buy and sell on you behalf, they will offer advice, investment recommendations, investment plans and retirement planning as well as have available research on various investment options.

Alternatively, you could choose a non-advisory or online discount trading service that will buy and sell on your behalf, but will not offer any investment advice. However, many non-advisory services have research tools available free of charge to enable you to make more informed investment decisions. They offer “live” stock quotes, charts, indicators and market commentaries.  Some offer investment options in managed funds.

The up-side to an online non-advisory service is that the fees are much lower than full service stockbrokerage. If you are comfortable in making investment decisions yourself, a non-advisory service is the cost affective alternative.

Many banks offer online non-advisory online trading services. If you already have a bank account, then signing up for an online share trading account is just a matter of filling out a few forms – and it’s usually free to sign up. Banks often offer both a discount service and a premium service at a cost. Before signing up for any online trading account, compare brokerage fees, services are on offer and recommendations, so that you choose the best service for your circumstances at the best price.

2. Set up your online account

To get started, you will need to set up an account. This will be a matter of filling out an online form with your personal details. You will also need to establish a cash account or direct debit or credit facility with your bank account. If you choose to use your own bank’s online trading facility, then your trading account will be linked with one of your bank accounts.

When you set up an account, you will usually be registered with the Clearing House Electronic Sub-Register System (CHESS) and given a personal holder identification number. This is the ASX’s central register for electronic transfer of share ownership. Basically it keeps a track of who owns what – you don’t need to do anything with this, it’s all done for you.

Once all the paperwork is completed, you’re ready to go.

3. Decide which shares to buy

This is the hardest part of the process. How to choose shares is beyond the scope of this article, but it is obviously the most important part of the process. If you have chosen to go with a non-advisory service, check out the resources below to help you with choosing which companies to invest in.

4. Place your order

To place your order you will need to know the three letter ASX code for your company. For instance, Woolworths’ ASX code is WOW. Usually your trading screen will have a look up tool to find out the code for your company, otherwise, have a look at the ASX website.

Secondly, you will have to tell your broker how many shares that you want. If you have $1,000 to invest and want to buy into XYZ company who’s share price is $4.36 then you can afford to purchase 229 shares. Your trading account will provide you with a calculator to work all this out for you. Don’t forget though, to factor in brokerage costs. The cost of brokerage will vary depending on your stockbroking provider, possibly around the $15 – $30 mark for a discount service.

Finally, you will have to specify whether you want to purchase the shares “at market” which means you will accept the price at or about the current market price of your shares, at the time you are placing your order; or “at limit” which means you indicate the highest price you are willing to pay for the shares. If you select at limit, you will need to also specify whether this is trade good for a day or good until cancelled.

5. Ensure that the funds are available to fill the order and cover the cost of brokerage fees.

When you place your order, you will need to ensure that there are enough funds available in the specified bank account to be able to fulfil the order. Some brokerage services will not go through with the order until the funds are cleared. Again, don’t forget to factor in brokerage costs. Prior to placing your order, your online service will show you a summary preview of the order including all brokerage costs.

When the order has been filled, you will receive a CHESS statement of ownership confirming how many shares you own and in which company.

6. Keep good records

It is essential to keep your trading records safe and in order. When it comes to tax time, too much information is better than not enough. You will need to keep records of any dividends received and all information regarding the purchase and sale of shares for tax purposes. Brokerage fees are tax deductible, so you will want to keep records of these too. Speak to your accountant regarding any other deductions that are available, and information they might need to do your tax.

Free Online Tools and Information

ASX – The Australian Stock Exchange website has up to date share prices, plus a whole range of information and services.

Australian Financial Review – Online newspaper (or read it in print) for share information, indicators, stock tables and general financial information.

MSN Australia Money – Shares and Funds for current and historical data on shares, company information, financial ratios and other information.

For learning how to invest in the share market ASX offers free Online courses on just about everything to do with investing in the stock market. ASX also offer classes and books. Participating in the ASX share market game is a good (free) way to get your feet wet when it comes to trading shares, without putting a cent in the market – and there is prize money for the winner.

Have you read these articles?:

1. An Easy Place to Start Investing in Shares
2. Shopping Online for Bargains in Australia
3. Australian Online resources for money management