Effectively manage your debt

Debt, or borrowed money, plays an important role in helping you to achieve your lifestyle goals and objectives, like buying the house of your dreams, taking the holiday of a lifetime and giving your children a select education. To minimise borrowing costs, you need to effectively manage and structure your debt. Otherwise, unnecessarily high costs could hamper your ability to achieve your lifestyle objectives.

 

‘Efficient’ Versus ‘Inefficient’ Debt

The way debt is managed may depend on whether it is considered ‘efficient’ or ‘inefficient’. In most cases, debt used to purchase assets that produce income qualify for a tax deduction in relation to interest costs. Where these income-generating assets also grow in value, this form of debt is considered to be ‘efficient’.

On the other hand, loans taken out to purchase services or assets that do not generate income, for example, purchasing a principal residence, a car or funding a holiday, do not qualify for that tax deduction. In these cases, the debt is considered to be ‘inefficient’ from a wealth creation perspective and, when not managed properly, is often draining on your long-term wealth accumulation capacity.

 

Reducing Inefficient Debt

We believe that, in most circumstances, you should try to accelerate the repayment of your inefficient debt. This can be a valuable strategy as the interest rate of your loan is effectively an after-tax investment return on your money and higher repayments reduce future interest expenses. There are some circumstances where other wealth creation strategies may be more appropriate. We can help you understand when these strategies may apply.

When looking at ways to reduce inefficient debt, you need to manage and understand your cashflow position to ensure that you are making the maximum possible loan repayments. We can assist you to develop an accurate understanding of your cashflow position through the use of our Cashflow Management Service.

 

Choosing Loan Structures

You also need to choose the loan that has the best structure for you. A lower interest rate does not necessarily mean that you will pay less interest over the life of your loan. Often, it is the flexibility and the features offered in a loan that will determine how well various strategies can be put in place to reduce the outstanding loan as quickly as possible, and minimise the amount of interest payable. At Strategic Wealth, we can help you identify the right loan structure and can refer you to a specialist to help source the most attractive debt provider from the majority of Debt Lenders in the marketplace.

In some cases, it may be appropriate to consider replacing inefficient debt with more efficient debt structures that can be used to create wealth tax effectively. This strategy is known as ‘Debt Recycling’ but should only be undertaken after a thorough analysis of your financial situation.

 

Accelerate Wealth Through Gearing

The use of efficient debt, or Gearing, can be an effective strategy to accelerate your wealth creation, particularly in the earlier part of your working life. With the recent reduction in the superannuation pre tax (Concessional Contribution) limits, gearing can also play an important role for wealth accumulators in the later stages of their working life.

A gearing strategy involves borrowing funds and using the proceeds to buy growth assets, such as shares or property. It is important that your investment timeframe is sufficiently long enough to allow for the dramatic moves that may occur in the market cycles for growth-type assets. We believe that your investment horizon should be a minimum of seven years.

 

Diversify

At Strategic Wealth, we also believe that the investment portfolio implemented using the borrowed funds should be highly diversified across a range of growth assets to provide protection against the failure of a specific asset class or investment asset. You should also consider the level of gearing and ensure that you do not become overly aggressive, which may have adverse consequences in times of market downturns. We believe that it is better to adopt a more conservative approach in this area and to be patient. Finally, quality records should be maintained to ensure that you can substantiate the claims for tax deductions associated with the gearing strategy.

We can assist you with the development and implementation of an appropriate gearing strategy, and a referral regarding the sourcing of funding for the program. For further information, please refer to our Understanding Debt Management article.