Gearing: Using Debt To Increase Risk And Reward

by humagaia

Gearing is the use of debt (borrowed money) to increase your risk and potential reward. If you own property you have used gearing.

Invest with other peoples money to increase the percentage profit on your initial investment. But be aware that this strategy increases your risk as you will need to pay back the money. If the investment goes wrong you may find that you have lost money, after paying off the debt. But if you make the correct risk assessment the potential gain can seriously increase your wealth potential. Gearing is the name of the game. Gearing and time are your path to wealth. Gearing is your motivator to boost your investment portfolio returns. Gearing means you keep your cash, and use debt to finance the purchase of investments.

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What is Gearing?

Use debt to increase risk and reward

Gearing gives you the ability to aspire to even greater reward for any given level of risk.

What is gearing?

Gearing is the use of borrowed money to increase your risk and potential reward.

Why does gearing increase the risk?

Because you are introducing another element into the risk equation that has a potential to be negative.

If used properly gearing can seriously increase your wealth. And as an investor you have probably used gearing without even knowing it.

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Using Gearing

How do you think you have used gearing in your wealth management strategy?

If you own property then you have almost certainly used gearing.

If you used a mortgage to purchase your house then you 'geared' your purchase.

Let's consider this in an example:

  • How much (in percentage terms) did you make when you purchased your home with a mortgage of £200,000, a deposit of £50,000 and then sold it for £500,000?

A quick calculation gives a profit of £250,000 or a 100% profit on the £250,000 paid for the property. Yes?


You've hit the jackpot!

With gearing the calculation is:

Your profit divided by your investment multiplied by 100 (to give it in percentage terms).

Which equals (250,000 / 50,000).X 100.

Hey Presto! It's 500% not 100%.

Of course there are charges to be deducted as there always are with any investment - but no tax (in the UK, if it is your main residence).

So, thanks to the power of gearing, you can make a large profit by banking all of the capital benefit accrued from the borrowed money.

The lender gets his percentage interest, but none of the benefit of the investment you made.

So, from now on, in investment terms, you should think of borrowing as gearing, as opposed to debt.

Next Investment Article

Long term investment incorporates time into the equation for the key to future wealth. A long-term investment strategy beats short-term trading strategies every time.

Conclusion To All Of This Risk

You should take onto your investment strategy only the level of risk with which you, as an investor, are comfortable.

Each investment type has a level of risk associated with it.

Within those investment types there are factors unique to individual investments that increase or decrease the level of risk, in comparison to other investments, within the investment sector, and outside, in other investment types.

In order to determine the level of risk associated with a single potential investment, all criteria that could affect the investment must be analysed with a cool head. You as an investor must not be swayed by psychological factors, such as 'fear of loss', 'fear of regret' and 'aversion for risk'.

In order to increase your percentage reward from a particular investment you should use, where possible, other peoples money.

This is the art and science of gearing.

But be aware that gearing can add an element of risk to the investment that must be analysed to see if the level of risk is still within your investment risk parameters.

Updated: 02/05/2021, humagaia
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humagaia on 10/07/2012

A very good example.

Sheri_Oz on 10/07/2012

I agree with this. It is a way people have of making money in real estate - buying with a mortgage and the rent pays off the mortgage and, depending on the payback schedule, leaves a little aside each month as well.

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