Gearing Portfolios

This should not be condemned as irrational but it does raise risk of course. The extent to which one’s investment portfolio should be geared depends on the appetite for returns and the tolerance for the higher volatility that gearing inflicts on those returns.

Say mortgage rates are 6.5%. On a tax rate of 33% that means that an investment has to garnish 9.75% pre-tax or 6.5% after-tax to exceed the cost of gearing. Interest rates above 9.75% are for now rare except where there is significant risk, while share returns above 6.5% do occur.

So tolerance of volatility will determine whether you gear a portfolio. Given that long term, after-inflation gains in the sharemarket have been of the order of 7%, a funding cost of 6.5% or around 5% after-inflation does indicate some scope for gearing in suitably structured portfolios for aggressive investors.

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