Recent Budget proposals have reignited debate around negative gearing, property investing and wealth creation.
While much of the discussion has focused on residential property, I believe we may be asking the wrong question.
The real question is not whether Australians should use leverage. Australians have been using leverage to build wealth for decades. The better question is whether investors should rethink where they apply that leverage.
For many Australians, borrowing hundreds of thousands of dollars to purchase an investment property has become a normal wealth creation strategy. It has helped many people climb the property ladder and build long-term wealth.
However, what is often overlooked is that this approach usually involves a significant amount of debt attached to a single asset, in a single location, that is highly illiquid.
In cities such as Sydney, investors have often accepted relatively low rental yields while relying heavily on capital growth to justify the strategy. That has worked for many people historically, but it is still concentration risk. Investors are effectively making a highly leveraged bet on one asset.
If Budget changes encourage investors to consider a diversified investment portfolio instead, I do not necessarily see that as a negative outcome.
A diversified portfolio can provide exposure across multiple sectors, asset classes and geographic regions. It can also provide greater liquidity and flexibility than property. But that does not mean it is risk-free. It simply means the risks are different.
A geared investment strategy must also have a source of income. The investment needs to produce income, such as dividends, distributions or interest, because this is a key part of how the strategy works from both a cashflow and tax perspective. The income, the borrowing cost, the investor’s tax position and the expected long-term return all need to be considered together.
This is why financial advice is so important.
A geared strategy should never be viewed as borrowing money to “get rich quick”. That is the unicorn strategy, and in most cases, it is unlikely to work.
Like property, a geared investment portfolio should generally be approached as a long-term strategy. Many property investors hold assets for 20 to 25 years or more. Investment markets can also reward long-term investors, but the experience is different because market movements are visible every day.
That visibility can create emotional pressure.
Property investors often benefit from a level of forced discipline because their asset is illiquid. They cannot usually sell part of a property quickly in response to market noise. Investors with liquid portfolios can react much faster during periods of volatility, and that can work against them if decisions are driven by emotion rather than strategy.
Liquidity can also create temptation if circumstances change. If cashflow comes under pressure, investors may be tempted to access part of the portfolio to meet short-term needs. While that flexibility can be useful, it can also compromise the long-term strategy, reduce the capital available to generate future returns and dilute the intended outcome of the investment.
One of the biggest misconceptions about gearing is that the success of the strategy is determined by the loan itself.
In reality, the success of a geared strategy is often determined by the quality of the portfolio sitting behind it.
When leverage is involved, portfolio construction becomes critical. Investors need to consider diversification, income generation, asset allocation, downside risk management and how the portfolio may behave during periods of market stress.
Tax outcomes also matter. Where funds are borrowed for investment purposes, interest is generally deductible. However, the existence of a tax deduction should never be the reason for implementing a strategy. The strategy needs to make sense based on the investor’s goals, objectives, cashflow, tax position and long-term investment outcomes.
Volatility is another key consideration.
Many investors assume the answer is simply to choose lower-risk investments, but I believe the conversation is more nuanced than that. The real issue is not whether a portfolio contains volatility. The real issue is whether that volatility is understood, intentional and appropriate for the investor’s circumstances.
In the current environment, I do not believe investors should take a completely passive approach to risk. Inflation, interest rates, geopolitical uncertainty and market volatility all need to be considered. This is where active portfolio management can play an important role, particularly when borrowed money is involved.
The objective is not simply to maximise returns. It is to generate strong long-term outcomes while carefully managing downside risk.
Investors often focus on the debt. I believe they should focus on the portfolio.
The Budget may change the vehicle investors use, but it does not change the fundamental principles of successful investing. For the right investor, with the right structure, the right portfolio construction and the right advice, gearing can remain an effective wealth creation strategy.
The question is not whether leverage works.
The question is whether the strategy is appropriate, whether the investment has the right income profile, whether the investor can stay the course, and whether the portfolio is capable of justifying the risk being taken.
This article is general in nature and does not take into account your personal objectives, financial situation or needs. You should seek personalised financial advice before making any investment or borrowing decisions.