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The Wise Investor

4.8 Gearing
Kate sat in silence and thought over the things
John had said about Contrarian investing. She had to
admit that he had a good point. Like most people,
she assumed that a popular investment was popular
for a good reason, and she would be inclined to
invest in the same things as her friends and
acquaintances. John, however, was suggesting the
opposite. Although she could simply hold
investments for many years and receive a good
profit, she also saw the sense in selling when prices
reached ridiculous peaks, and buying when an
investment had returned to good profits but was still
unpopular and cheap. She looked across at John,
curious about what he would have to say next. "Go
on, grandfather," she said. "What is our next
John was pleased. He had feared an endless
flurry of questions, but it seemed that Kate had
accepted the sense in what he said and was ready
to move on.
"Next, we have 'gearing'. This is something that
all investors should be aware of, and a strategy that
I suggest you incorporate into you own investment
plan. Gearing simply means borrowing money and
investing it. As long as the profit from the
investment is higher than the interest on the loan,
then you will make a profit on the overall deal.
Assume that you borrow money at 8 percent
interest, and invest it for a return of 11 percent.
Overall, your income is 11 percent of the amount,
and your expenses are 8 percent of the amount, so
your profit is 3 percent of the amount that you have
borrowed. Now, the more you borrow, the greater
your profit will be.