Gearing can magnify your investment returns, but it can also increase your risk of financial loss, which is why it makes sense to understand the different types of risk involved, and how to manage them.

The risks of gearing include:

• Margin calls (read more about margin calls explained)
• Added exposure can increase losses
• Sharemarket risks
• Interest rate risks
• Changes to taxation legislation

How to manage the risks of gearing
Gearing does have its risks, but there are ways in which you can manage your investment to maximise the benefits while minimising the potential downsides:

Gear conservatively

• Don't overextend your borrowings. Consider your ability to meet interest payments and possible interest rate changes.

Diversify your investment portfolio

• Never rely exclusively on one investment, or one type of investment. Aim for a balance across sectors - don't put all your eggs in one basket.

Invest for the long term

• To ride out the unpredictable characteristics of the sharemarket, invest for a minimum of five years, and preferably seven or more years.

Have a reasonable cashflow

• A stable, regular income is essential to meet your interest expenses. You should never rely solely on dividend income.

Build in some flexibility

• Don't get forced into a position where you have to sell when you don't want to. Build in some flexibility to cope with unexpected personal or job-related changes.

Seek professional financial advice

• Gearing can be very effective, but you should always seek professional advice to help develop a plan that suits your individual circumstances.