24 Feb Negative gearing in a pandemic
You may have heard the story of the ‘Two Greedy Bears’ when you were a child. They fought for a bigger slice of cheese, while a sly fox ended up eating most of the block. One day, the fox came back to them and asked, ‘If you give me $100, you will get back $45. Will you do that?’
‘Of course not! Do you want to cheat us again?’ the cubs shouted angrily.
‘Then if you can get back $45 now and $200 in ten years, will you give me $100?’ the fox asked again.
There was a short silence. One of the cubs asked suspiciously, ‘How do we know you will give us back $200 in ten years? You may disappear by then.’
The cubs were smarter this time and the fox had to wag his tail and walk away.
No one would willingly give away $100 to get back $45; however, people do that all the time in real life. How? They do it with negative gearing.
Negative gearing happens when you borrow to invest, and the investment income is less than the cost of the investment. Investors negatively gear because they can claim a tax deduction for the investment loss and it will reduce their taxable income. If you are at the highest marginal tax rate of 45%, that means you will get back $45 for every $100 loss you make. If your taxable income is under $180,000, you will get back even less.
When David came to see me, he owned two negatively geared investment properties. Although he makes more than $200,000 in the mining industry, he has been struggling with money all of the time because of the expenses of his investment properties. The value of his investment properties hasn’t increased much, and one of them even decreased in value in the last five years.
When I asked why he wants to keep these properties, his answer was simple—to save the tax. A few months ago, he lost his job in the turmoil of the pandemic and was not able to keep those properties any more. The loss from negative gearing and capital loss from selling the property will not be likely to produce a positive financial outcome for him.
When we look at investment options, tax saving should not be the main reason for investing. Tax benefits are intended to encourage you to act in a way that the government wants, but the government’s reason should not be your reason for investing. Your investment strategy should be based on your own goals and needs so that the possibility of achieving them can be maximised.
In negative gearing, investors speculate that the value of the property is rising over time and expect potential profit down the road. However, when housing prices are falling, it horrifies those highly geared investors as their investment timeframe may have to be extended by many years. The question is, how long they can grit their teeth and hang on with reduced cash flow?
The pandemic shut down the world economy on a scale never seen before. After we’ve witnessed how quickly jobs can disappear and businesses can shut down, what lesson have we learned for the future? When we regret our financial mistakes and look for the solutions for our struggles, we realise the key to successful money management is providing and maximising one factor in our life—our INCOME.
Building multiple streams of income is one of the best ways to increase your financial security if your primary income reduces or drops to zero. In this scenario, an investment that costs money from your pocket will not provide the client with the security and freedom that they seek. Only positive cash flow from an investment can do that for you. So, a positively geared investment might be the best option to eventually provide you with financial freedom. It might just be the best preparation for whatever life throws your way.
The bear cubs learned their lesson the hard way. Have we learned our lesson from the pandemic?
General advice disclaimer
This information has been provided as general advice. We have not considered your financial circumstances, needs or objectives. You should consider the appropriateness of the advice. You should obtain and consider the relevant Product Disclosure Statement (PDS) and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.