Leveraged Investing, Today with the markets in perpetual turmoil it has become a bit of a taboo topic, but changes are imminent with the guidelines for Canadians. This may be a great opportunity to take advantage of the depressed market and use your leverage. Once again Aaron Theilade from Investors Group has provided a wonderful article on Leveraged Investments.
Borrowing to invest can be an effective way to reach your financial goals faster William Shakespeare wrote Neither a borrower nor a lender be. And while Will was undoubtedly a great writer, he may not have been such great shakes as an investor – because for many people it definitely can pay to borrow for investment. Some call it ‘borrowing to invest,’ to others, it’s ‘leveraged investing’ or ‘investment leverage’. But by any name, it all boils down to this: You are using someone else’s money to help you reach your investment goals.
Now, you may think that leveraged investing is only for the extremely wealthy - but that isn’t necessarily the case, although it is a strategy that is only suitable if you can afford to sustain any losses associated with your leveraged investments. In fact, you may already be ‘borrowing to invest’ without really thinking about it in terms of ‘leverage’. If you have a mortgage or have ever arranged a loan to make your annual RRSP contribution, you have already borrowed to invest. The strategy of leveraged investing works in much the same way as a mortgage or RRSP loan but takes the concept further. It is a simple, yet powerful tool for helping people achieve their financial goals sooner- but it’s not suitable for everyone. To find out whether or not you should consider borrowing to invest, let’s take a closer look at why more and more Canadians are looking at leveraged investing.
How is the concept of ‘borrowing to invest’ different from traditional investing? With traditional investing you set aside money each month to purchase investments. With leveraged investing, you take out a loan to make investments then you set aside a portion of your income each month to make the loan payment. The monthly payment amounts are likely to be the same in both cases but your leveraged investment has the potential to generate greater wealth for you over the long term as compared to using just your own money.
Leveraged investing can work because it allows you to:
♦ Invest more than you would be able to afford using only your own money. By dramatically increasing the size of your investment, you can also dramatically increase the potential for compound growth of your overall wealth.
♦ Deduct the interest payments on the loan. Based on the expectation that non-registered investments purchased with borrowed money will produce some income, interest costs incurred on investment borrowings are tax deductible1. This effectively lowers your tax bite and your overall cost of borrowing. It also reduces your ‘break-even’ point – the return you must achieve to make leveraged investing worthwhile.
Leveraged investing does not outperform the returns on investment available through traditional investing, and does present higher risk-especially in the short-term. But over the long-term, a ‘borrow to invest’ strategy can deliver a greater increase in your wealth than traditional investing because you have more money working for you than otherwise would be the case. And you don’t necessarily need huge returns for leverage to work.
There is more risk when you borrow to invest There’s no doubt that there is more risk with leveraged investing than with traditional investing. However, you can reduce the risk by:
♦ Investing for the long-term. Mutual fund investments are subject to fluctuations but tend to grow over the longer term. Therefore, you should plan to hold a leveraged investment for at least 6 years so that you can reduce the effect of short term fluctuations.
♦Staying the course. It’s easy to become emotional when your investment encounters short-term volatility. But you must resist the urge to sell at the first sign of trouble – and stay committed for the long term to give the strategy time to work.
♦ Borrowing prudently. Don’t make yourself loan-poor by borrowing more than you can afford. By over borrowing you may be forced to sell your investment early because you can’t make the loan payments.
♦Arranging a no margin-call loan. When you borrow to invest, your lending institution usually holds your investment as security in case you fail to cover the loan. If the value of your investment falls below a predetermined threshold, you’ll be asked to make an additional pledge of collateral known as a margin call. In most cases, you can arrange a no margin-call loan, usually at a slightly higher interest rate, that protects you against having to provide additional collateral.
♦ Diversifying your investments. Your leveraged investment should be part of a well diversified portfolio that balances risk and return according to your risk tolerance and long-term financial objectives.
♦Accelerating your loan payments. You can reduce your financial exposure by choosing to make additional principal payments to accelerate the repayment of your loan.
Let me help you understand whether borrowing to invest is right for you Leveraged investing isn’t appropriate for everyone. Working together, we will:
♦Determine if this type of strategy fits in with your long-term investment objectives.
♦Discuss the long-term time horizon of the investment.
♦ Review whether you can meet all of your loan and income tax obligations.
♦Review your comfort level with taking on long-term debt and added risk.
Borrowing to invest is a proven investment strategy that can accelerate your ability to build a portfolio if you are comfortable with taking on debt and additional risk. For a better understanding of the ‘borrow to invest’ strategy and whether it’s right for you, lets chat, the coffee is on me! Aaron Theilade Investors Group Fraser Valley
This report specifically written and published by Investors Group is presented as a general source of information only, and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide legal advice. Prospective investors should review the annual report, simplified prospectus and annual information form of any fund carefully before making an investment decision. Clients should discuss their situation with their Consultant for advice based on their specific circumstances. Commissions, fees and expenses may be associated with mutual fund investments. Read the prospectus before investing. Mutual funds are not guaranteed, values change frequently and past performance may not be repeated. Borrowing to invest involves risk and may not be suitable in all situations. Speak to your Investors Group Consultant to see if this strategy is suitable for you.
