Borowing to invest within your Self-Managed Super Fund (SMSF) has the potential to boost your super and help you reach your retirement goals sooner. In September 2007, the government opened the door to gearing within SMSFs – meaning it’s now possible to borrow to invest in a broad range of investments inside a SMSF.

These changes and the opportunity they present received significant press at the time they were enacted; however, it has taken some time for product manufactures to come to market with suitable offerings. Through our association with Asgard Wealth Solutions we can now offer you an easy and simple to operate gearing structure for your SMSF. Given the recent falls in the markets, now represents a good opportunity to develop a long term accumulation strategy that incorporates gearing to help you maximise your potential returns.

We discussed this topic in detail in our Summer 2008 edition; however, we have recapped these rules briefly below along with looking more specifically at the opportunity that this presents.

How it works
Firstly, you need cash within your SMSF, or the ability to convert existing assets into cash. Your SMSF then borrows an amount from a lender. You then use this combined purchasing power
to invest in assets. Under the rules, this asset could be shares, property, managed funds,or even art or antiques – bearing in mind the rules around your choice of asset
are quite specific.

The ‘beneficial ownership’ of the asset is held in trust. This gives the trustee the right to receive income from the asset, and the right to take legal ownership through the payment of instalments. Ongoing, any income earned by the asset goes into your SMSF, which is also responsible for paying the bank interest on the loan.

What are the benefits?
Consider the simple example (Figure 1) below of a $100,000 initial investment geared to 50 per cent with borrowings of $100,000, giving $200,000 to invest. If we assume a rate of return of 12 per cent and an interest rate of 9 per cent, over 20 years the investment could look like this.
If this investment had no gearing it could grow to around $575,000 over 20 years, which compares to $735,000 with gearing (and regular repayments through the term), or $770,000 if the borrowings are paid off in a lump sum at the end.



Whilst this is a simple example, it demonstrates the power of gearing and how it can be used as a long term wealth accumulation strategy. In addition, gearing your investment can also provide the following benefits.

• Diversification - with more money to invest, you can buy assets you otherwise couldn’t afford. This can provide diversification benefits to your portfolio.
• Tax effectiveness - as opposed to gearing outside super, you can take advantage of the tax-effectiveness of the superannuation environment – including the ability to make tax-free withdrawals after age 60. Interest on the borrowed money is generally tax-deductible too.
• Your exposure is limited - legally, the loan from the bank must be ‘limited recourse’ in nature – meaning the bank only has rights against the asset purchased with the borrowed money, not your other super or personal assets.

What are the risks?
• Magnified losses as well as gains - just as gearing magnifies your potential returns, it also magnifies your potential losses.
• Your loan does not change with the markets - a fall in the market doesn’t change the amount you owe the lender, or the amount you are required to pay in interest.
• Interest costs may outweigh investment returns - if interest costs significantly outweigh investment returns, this shortfall must be funded. It may be covered by the income from non-geared investments or you    may need to contribute additional funds into your SMSF.
• A margin call may occur – if the value of your investment drops below a ‘buffer’ set by the lender, a ‘margin call’ may occur – whereby you must have cash available to top-up your investment, or sell some
  of your investments to reduce the loan to value ratio (LVR).
• Interest rate changes - changes in interest rates can impact the effectiveness of your gearing strategy.

Who is gearing suitable for?
Because of the risks, gearing in super is rarely suitable for conservative investors, but having an appetite for investment risk is only part of the equation. Generally speaking, you
need to have at least a $200,000 balance before you would consider gearing in super. To help mitigate the risks, you also need to maintain adequate cash flow – so it’s most suitable to those who are still working.

Most importantly, gearing in super should be seen as a long-term strategy. Typically an investment timeframe of at least seven to ten years is recommended to help you ride out the inevitable highs and lows. With
so many rules and regulations around gearing in super, it’s essential to get the details right from day one.

So if you think a gearing in super strategy might be suitable for you, you should speak to us.

Daniel Minihan
Director
dminihan@moorestephens.com.au