You Don't Have To Be Rich To Become Richer

Sydney Morning Herald

Friday June 23, 1995

Jocelyn Eastway

ONE of the biggest problems with so-called "gearing packages" is that you need a decent lump of money to get started. Unless you can put up $20,000 of your own money, no-one wants to lend you anything.

But a new facility from fund manager Advance Asset Management makes the benefits of gearing accessible to people with as little as $1,000 to invest. And it's a facility unlikely to be offered by your local bank manager, no matter how friendly.

Gearing, or borrowing money to invest, can be a tax-effective way of speeding up wealth creation, provided your long-term return exceeds the cost of borrowing.

Wealth creation is sped up because you have more money working for you. And the strategy is tax-effective because, provided the assets are income-producing, you can usually claim a tax deduction for your interest costs.

And with negative gearing, where the borrowing costs exceed the income from the investments, you get an excess tax deduction that can be offset against other assessable income.

The Advance Instalment Gearing Plan is a cross between a regular savings plan and an instalment loan facility. You contribute your own funds on a monthly basis, instead of making one big deposit upfront; and you borrow money on a monthly basis, instead of drawing down a loan all at once (see accompanying example).

Interest is payable on the outstanding loan balance at the lender's 30-day variable rate, currently 11 per cent. So as the loan balance gets bigger, your interest bill gets bigger.

Your choice of investments is limited to a list of "permitted" managed funds, offered by a range of fund managers. In contrast, most gearing packages are designed for investment in direct shares.

You can choose a maximum of three different funds from the list of permitted investments - which includes a mix of equity trusts, property securities funds, balanced funds, capital stable funds and income funds.

But it is possible to change your investments.

"Financial advisers have been asking for something like this for so long," says the manager of lending at Advance Asset Management, Paul Johnston.

"After researching it over 18 months and finding out what was the interest in it, we took the bit between the teeth."

A rival fund manager, Norwich, had a crack at instalment gearing a few years ago. But after running into some administration problems, it chose to discontinue the product.

An associate director of Norwich Trusts, Stephen Reed, says the manager has fixed up all the problems and is thinking of relaunching its instalment gearing facility within the next couple of months.

Says Johnston: "With (Advance) instalment gearing, you are buying possibly three securities each month ... that's 36 transactions per year. You've got to worry about (administering) all the distributions and the capital gains tax."

Advance has set up a new computer system to cope with these hassles, so administration should not be a problem. And the instalment gearing plan caters to all sorts of investors, Johnston says.

"For people earning reasonable money, who want to do some savings, the problem is they don't have $20,000 lying around to put into a lump-sum-type (gearing) scheme," he says. "You can start with $1,000 with this (instalment gearing plan)."

Instalment gearing can also be a great way to supplement your retirement savings outside the superannuation environment, Johnston says, with the commitment and discipline of a regular savings plan.

The general manager of research at Pembroke Financial Planners, Tony Nash, thinks the new Advance product is a great idea for someone who does not want to make a major commitment to gearing at one particular time.

It represents an opportunity to "progressively control your level of exposure", he says.

"It is quite restrictive in that you can only gear into three unit trusts, but that's the price you pay for the facility," Nash says. "It combines the best features of gearing and regular saving."

By investing the same amount at regular intervals, you also get the benefits of Dollar Cost Averaging (DCA), Nash says.

When the market is rising, your units cost more, but the ones you own are worth more. And when the market is falling, the value of your units also falls, but each regular investment will buy you more units.

So by keeping up your investments through thick and thin, you can actually "average out" the price you pay for each unit. But there's no guarantee you will achieve a higher return than someone investing all their money at once.

"Philosophically, for someone who does not have investable wealth, it (instalment gearing) is in their interests because it represents a wealth creation program," says Max Weston, the executive director of KPMG Peat Marwick Financial Services.

And, given they are investing regular small amounts, the principles of DCA will necessarily apply. But if you do have a lump of money to invest, you could do much better investing it all at once, Weston says, rather than bit by bit.

In other words, by picking a good time to enter the market - which is possible with professional advice - you could do much better than someone adopting an instalment gearing strategy, he says.

Weston is also concerned by the inclusion of "diversified" funds in Advance's list of permitted investments.

(A diversified fund has its money spread across a range of asset classes, including shares, property, fixed interest and cash.)

"There is a case for saying that it's totally inappropriate to be gearing into a balanced fund, given that the underlying fund has a component of fixed interest," Weston says.

"Why would you want to be borrowing at 11 per cent to get a running yield of 8.5 per cent (from the fixed interest)?"

And given the Advance product is accessible to people with as little as $1,000, "the person who goes into this sort of program is likely to be a simple, non-sophisticated investor who is probably not familiar with the mechanics of gearing and the implications of it".

A vice-president at Bankers Trust, Ishbel Smith, echoes these concerns.

"When you are gearing, you are multiplying your losses as well as multiplying your gains," Smith says.

So you really need a long time horizon of at least five to 10 years.

"The thing that investors must remember is that their investment is not guaranteed," Smith warns.

"Falls in the market could mean they have to sell when their units are falling in value ... or they could have to come up with extra funds for a margin call."

But the risk of margin calls is less likely with an instalment gearing program, argues Peeyush Gupta, a director at research and advisory house IPAC Securities.

"For people who want to save regularly, who have a long time horizon and don't necessarily want to borrow a lot upfront, it's a good way to gradually go about gearing," he says.

Gupta recognises the danger in making such a product so accessible and reminds investors that "the normal risks of gearing still apply".

Meanwhile, some promoters of traditional margin loans are looking closely at replicating the instalment gearing strategy for investors in direct shares, rather than unit trusts.

An associate director at Bain & Co, Mitchell Hurley, says his company has been looking at the idea for the past 12 months.

The challenge is in working out at what level it becomes worthwhile for both the lender and the investor, he says.

Advance's Johnston is not convinced the strategy would work with direct shares, mainly because of administrative problems in dealing with small parcels of shares.