Prime Time Financial Counsellors Pty Ltd: Gearing Risk

Gearing Risk

Gearing is borrowing to invest, or investing in leveraged assets such as installment warrants or options.

It can dramatically change the level of risk in an investment strategy.

You should ask your financial planner to fully explain how any gearing or leverage will change the risks of your investment portfolio and, in particular, what the worst case scenario is if things do not work out as expected.

What types of investment risk are there?

You have the advantage, when mapping out your investment journey, of being able to spread your funds across several classes of business to take advantage of capital growth, liquidity and fluctuating markets. We have outlined here a brief rundown of the four major asset sectors - cash, fixed interest, shares and property - each of which has a different risk profile.

Cash

This covers on-call deposits with banks, building societies and credit unions, or overnight money market investments. These are usually described as liquid assets, meaning that they can be converted to actual cash very quickly.

Fixed Interest

Basically you lend your money for a fixed term and in return you receive regular interest payments which are usually fixed until they mature. There are generally three types - government bonds, private company debentures and fixed term mortgages.

Shares

These are stocks or a part ownership (your share) in a business, which can be traded on the Public Stock Exchange. In effect, you buy into a company's earning power. Historically, investors have benefited more from shares than from any other form of investment over the long term.

Property

This means real estate, usually residential, commercial, retail, industrial and rural. One of the major risks with investing directly in property is that it cannot be easily converted to cash. In other words, it is not a liquid asset. However, if you choose to invest in listed property securities that are traded on the stock exchange, and which do not require so much capital outlay, your investment is more liquid.

What investment would suit my needs?

The table below shows the key features of the four main asset sectors and some of the potential risks associated with each asset sector.

Investment Class	Features	What do I need to know?
Cash	The capital is safe relative to other asset sectors. You have immediate access to your funds.	There is no protection from inflation. The returns are highly variable. Low returns are expected in the long term. Returns are fully taxable.
Fixed Interest	Generally secure. You know exactly how much income you will be getting and when.	Interest rates can vary and may not keep pace with inflation. You can't cash it in easily in an emergency.
Shares	Growth above inflation in the long term. Growing income. Potential for tax benefits. Easily cashed in. Easy to divide up the assets. Can diversify internationally. Can invest via dividend plans.	Stock market volatility could lead to losses if forced to sell. Market slumps can be prolonged. Companies can underperform or go out of business. Difficult for the direct investor to get sufficient diversification.
Property	Capital value and income should rise with inflation. Potential for tax benefits. Rent is a stable form of income. Emotional security of "bricks and mortar".	You can't cash it in easily in an emergency. Can't divide up the asset very easily. Can be easily destroyed (eg through fire). Possible problems with tenants. High personal management input. Capital concentrated in one single asset.

Reproduced with the kind permission of FPA and Macquarie Investment Management Limited