Have you heard the term “leverage” when people are discussing their investments? This can be quite a confusing and daunting concept for many people. But all leverage really means, is borrowing to invest.
The reason people call it “leverage” is because typically existing assets are used as the security or basis of the borrowing. That is, you leverage off the value of a current investment or asset, to borrow more money to invest.
If you have not borrowed to invest before, but are considering it, you really should discuss this with a licensed financial advisor before you do. The concepts provided in this article are general in nature and should not be taken as specific advice to be applied to your specific circumstances. A financial advisor will be able to tailor a borrowing structure that perfectly matches your goals. And if you don’t have one submit a request for a free consult at our financing page here: Investment Financing Advice
10 years ago, my borrowing habits were what I would call “typical” in today’s society. I had a credit card, which typically ranged from between $0.00 to about $4,000.00 in debt, I had a small personal loan which I bought some furniture with and I had a larger personal loan which I financed a car purchase with.
There are 2 problems with this type of borrowing. Firstly, all the assets I bought with the borrowed money were depreciating assets. This means that as I paid off the debt, the value of the things I bought decreased. Secondly, as I purchased “consumables”, the interest I paid on these loans was not tax-deductible. This makes for a very expensive borrowing.
Today, due to the many benefits I found you get when you borrow to invest, my debt profile is anything but typical. I now have much more debt, but I have borrowed to buy appreciating and income-generating assets. For example, I have a massive debt on a property in Victoria, Australia. I also have a reasonable size margin loan helping me make money in the stock trading strategy described here: Finally, as per all foreign exchange trading accounts, the one I have set up to trade our Foreign Exchange trading strategy is leveraged out 100:1 (so every $1 I put in allows me to invest $100). My debt on consumables is now negligible.
So what are the benefits of borrowing to invest?
Firstly, when you borrow to invest, to coin a well know phrase, you are “using other people’s money” to earn more money in the investment markets. A great example of this is in our FXTrading strategy. If I invest $10,000.00 and leverage it out at100:1 (the strategy actually allows leverage of 400:1) that means I have $1,000,000 invested, just by putting up $10,000. The beauty of this strategy is that it is structured so that even before you earn on your FX trades, you earn interest on the money you have on the market. So by investing $10,000 in this strategy, you will earn cash interest on $1,000,000.
As a hypothetical, if the interest rate applied to your account is a conservative 2%, the interest earned over 12 months would approximate $20,000, and all you put in was $10,000. For more information on how our strategy works visit the summary page here: Foreign Exchange trading strategy
The above example describes very well, the first benefit of leverage. By accessing more money, to invest, you can earn way higher returns on your investments than you otherwise would have been able to.
The second benefit you can get from borrowing to invest is a possible tax benefit. For example, in my situation where I have borrowed to purchase an investment property in Victoria, as rent out that property and earn an income from it, the interest payments on that mortgage become a cost associated with that income. As such, in my circumstance, I can claim those interest payments as a tax deduction.
This means that while my asset is making me money, the tax office is actually giving me a discount on my borrowing (by paying me back a proportion of my interest payments in my tax return)
This works exactly the same in the margin loan I am using to help with my stock market investments. I have borrowed some money in a margin loan (I usually try and keep the leverage hereat about 1:1, so every dollar of my own I invest gives me another to invest) and pay interest every month on that loan.
My stock market strategy pays me my consistent income every month, which is more than the interest on the margin loan. And then, at the end of the tax year, I deduct the interest payments from the money I earned, gaining a tax advantage. To read more about this strategy, a summary is posted here: Stock Market Trading Strategy
So there are definite advantages you can gain from leveraging your investments. There are risks also though, which is why you should seek proper financial advice prior to moving down this path.
What are the risks? Basically, there is 1 risk associated with borrowing to invest and that simply is the risk of over-extending yourself. When you borrow, you need to do so in a way that does not leave you unable to meet your funding requirements.
In a normal loan (like a mortgage, or investment loan) this means you need to be able to fund all your repayment responsibilities. If you cannot meet these payments, your lender has every right to take your investments off you.
This is not good. In a margin loan situation, it is a little different. If you borrow too much here, you may breach the allowable % of assets to the debt you are given, and if this happens, you will be expected to put more money in to put the loan back in “good order”. This can be quite difficult if the market swings strongly against you.
There are strategies to protect yourself against these risks though which your financial advisor can help you with. In my experience, it is definitely worthwhile borrowing to invest, but only if you manage your risk, and cashflow responsibilities properly.
So the one piece of specific advice I will give you here is to speak to a licensed financial advisor or accountant about whether this is an appropriate strategy for you, and then how to structure it to match your personal circumstances.
If you don’t have an advisor, visit our financing page and submit a free loan quote. A licensed advisor then will contact you to discuss your needs. Here is the link to our financing page: Investment Financing Advice
Investigate leveraging as a method of improving the value of your investments, the rewards are definitely worth it. But only apply a strategy that you are comfortable with, where you can manage the risk, and you will reap the rewards.
ABOUT THE AUTHOR: Damian Papworth, B.Ec. A.S.I.A. is the owner and editor of the only wealth creation website that promises you every strategy listed on it, is being actively used successfully by the team today TheOnlyWay.com.au