Debt Management and Leverage
Gearing into investments
Third gearing example
This example assumes we invest our $10,000 (as in the previous example) and also invest $10,000 of borrowed monies.
Notice how increased borrowings magnify the returns in both directions – bigger gains and bigger losses. You will note that the losses are magnified to a greater extent than the gains due to the impact of interest payable on the borrowings.
This is a simplistic example as the impact of taxation has not been included, but shows you how borrowing can increase your risk but also your potential profits.
The magnification of positive returns is possibly the key benefit of gearing, or borrowing to invest.
And with the potential downside it is important to consider other important investing factors, including how long you intend to hold an investment for and associated liquidity and cash flow implications.
