Business Concepts Group’s Chris Reed, Sarah Power, and Domenic Suleman discuss gearing strategies within SMSF. Let’s join BCG’s dynamic trio in SMSF-Series-Podcast-4 (Episode 4) as they talk about the details of gearing.
Gearing simply means borrowing money to invest. You should be probably wondering, “Why Borrow?” and then “Is It Suitable?”
We borrow to invest to get some leverage, which means we’ve got more exposure to the market. And it’s important to remember though that whilst we’re getting more exposure to the market that also means more exposure to risks in the event that markets go down.
You need to make sure that you are actually investing in quality assets, the same as you do if investing outside of super. We want assets that are going to give you some longer term capital growth, going to produce a bit of income along the way as well We certainly don’t want to be taking on excessive risks.
Gearing may be used to hasten the process of wealth creation by allowing you to make a larger investment than would otherwise be possible. The borrowed money can be invested in a number of ways including direct shares, property and managed investments.
There are some more advance strategies that can be done around gearing; but the first two points that you really need to consider are the questions — why would my fund do it and is it suitable to my fund and my particular circumstances.
Consistent income flow is a key factor in commencing a geared investment strategy. If your income should cease or reduce for any reason you may be unable to continue to meet the loan repayments. In this instance, you may be forced to sell the investment at the wrong time and realise a capital loss rather than the desired gain.
Banks, ideally, prefer SMSFs to have a corporate trustee. You would tend to favour a corporate trustee anyway and the reason why you would do that from a lending point of view is that you’ll find that banks tend to lend you a little bit more than what individual trustees will be able to lend. Some banks will not lend to individual trustees.
Although some banks advertise that they’ll lend to super fund, Dom stresses the difference between a home loan and Limited Recourse Borrowing Arrangements (LRBA).
Limited Recourse Borrowing Arrangements
An SMSF must comply with a number of SIS requirements, and its own trust deed rules, to borrow on a Limited Recourse Borrowing Arrangement (LRBA) basis. An LRBA may be arranged with a related party (including an SMSF member) as lender to the SMSF.