# NEGATIVE GEARING

## Chapter 4 - Example of negative gearing - Share portfolio

###

Agnetha owns a hairdressing salon which earns her about $100,000 a year after expenses. Her marginal tax rate is 37%. Agnetha owns one home, valued at $600,000. She has a debt of $200,000 on this home, meaning she has $400,000 in equity. Here is how her assets look:

Home: $600,000

Loan: $200,000

Equity: $400,000

Agnetha decides to make some share market investments. She comes to see us and we discuss the benefits of dollar cost averaging into an index fund. (We won’t go into the details of that here). Agnetha decides that she will establish a line of credit loan against her home to the value of $200,000. She will use this to make a series of monthly purchases of units in an index-tracking Exchange Traded Fund (ETF). At the end of two years, she has purchased $200,000 worth of units (including brokerage). Her net assets now look like this:

Home: $600,000

Units in ETF: $200,000

Total Assets: $800,000

Home Loan: $200,000

Investment Loan: $200,000

Total Debt: $400,000

Equity: $400,000

Her preferred ETF pays a distribution that is equal to 4% per year. This equates to $8,000 per year on the holding. The interest rate is 5% (the loan is secured against Agnetha’s home). This equates to $10,000. Agnetha therefore makes a loss of $2,000.

Agnetha’s marginal tax rate is 37%. This means that her income tax reduces by $740 due to the new loan. The effective loss is now $1,260. This is 0.63% of the amount she has borrowed – meaning that if the units rise by more than this, the capital gain will more than offset the short term loss. As with the example of Andy above, the capital gain may be taxable, but at a discounted rate. In order for Agnetha to make a profit after CGT. The capital gain needs to be 0.77% in order for there to be a gain after CGT.

The long-term performance on the Australian share market (which an index-tracking ETF will largely follow) is well in advice of this. If history even goes close to repeating itself, Agnetha will make a profit on her transaction.