Don’t own a home? There’s another way to build wealth

One of the enduring myths about Australia is the role of property as the only pathway to wealth creation. Like much of the Western world, property ownership is ingrained in Australia’s psyche as the best way to secure our financial future.

Over the past 10 years, the median house price has increased by 80 per cent nationally, and by 100 per cent in Sydney. However, like many myths, reality is not always as it seems.

The price appreciation of a broad global equity index over the past 10 years is 170 per cent,

Compared with other asset classes, the performance of residential property looks quite pedestrian. The price appreciation of a broad global equity index over the same period is 170 per cent – that is before considering dividends. So where is all this property wealth coming from?

It’s not so much price appreciation that has created so many property millionaires, but rather something called “leverage” or “gearing”.

For Australians who own property, the leverage provided by their mortgage has allowed their equity in a house to increase at a rate much faster than the value of the property itself. This outcome, in combination with other tax and policy settings, seems to have stacked the deck in favour of home ownership over other forms of wealth creation.

While record prices seem to have pushed property ownership beyond the reach of many Australians, the same strategy of gearing can be considered for share ownership.

It’s not so much price appreciation itself that has created so many property millionaires, but rather something called “leverage” or “gearing”.

To illustrate this point, we looked at the potential benefits of investing in an Australian share portfolio using a “moderate” level of gearing. Using long-term simulated historical performance data from September 2010 to July 2024, we compared the returns of a portfolio representing the top 200 Australian shares, with leverage maintained at a loan-to-value ratio (LVR) of 30 per cent to 40 per cent on a given day, to the returns of an equivalent ungeared portfolio.

The results showed an initial $10,000 investment in the ungeared strategy would have increased to around $31,400, while the moderately geared strategy would have been worth around $38,800 at the end of the comparison period. In addition to these gains, the franking credit entitlement for the geared investment strategy would have been about 1.5 times the ungeared investment strategy (subject to an investor’s eligibility to those franking credits).

Of course, it’s important to remember that gearing magnifies gains and losses and may not be a suitable strategy for all investors. Such an investment strategy is only appropriate for an individual with a higher risk tolerance and a view that, while markets can go up and down in the short term, they will appreciate over a longer investment horizon.

Two ways investors could seek to reduce the additional risk or volatility associated with gearing are to limit the amount of leverage, for example capping your LVR at 40 per cent, and invest in a well-diversified portfolio, which will tend to have a lower volatility than if you were using a margin loan to buy individual shares.

One practical application of a geared investment strategy is a dollar cost averaging (DCA) approach, which may be particularly useful where an individual has little or no initial capital to invest but is able to put aside say $500 a month to invest in the equity market using a moderately geared strategy.

Importantly, to ensure more money stays in the market, investors considering this approach should look to limit brokerage fees and automate their investments as a way to help grow their long-term portfolio value.

Gearing increases the investor’s exposure to the market’s compounding power right from the start of their investment period. Obviously, over the short term, market selloffs are inevitable, but if you have a long investment time horizon and stick to the DCA approach, the use of gearing can help accelerate your recovery of capital after a market fall.

In simple terms, for gearing to accelerate your wealth creation you need to invest in an asset with the potential to generate capital growth and income in excess of the interest burden. A cost-effective, “moderately” geared exposure to a diversified portfolio of shares provides the power of leverage without the need for a $200,000 upfront commitment. This is perhaps one investment strategy that can help bridge the great Australian property wealth divide.

Cameron Gleeson is senior investment strategist at Betashares.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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