Leveraging Your Investments - An Explanation
Leverage is a term used in investment circles to explain a type of borrowing. Its investment jargon, so it may sound complex. Its simply describes the process of borrowing to invest, where there is some kind of security underpinning the borrowing. This could be a house in a property loan, or stocks in a margin loan.
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 which perfectly matches your goals.
When I started investing, my borrowing habits where the same as most peoples. I had a floating credit card debt which varied to my whims. I had a small personal loan for some household items and a bigger one which enabled me to buy my car.
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.
Things have changed over the years. I learned that debt is much more efficient when spent on investments. So now my credit card debt is negligible and paid off every month. My personal loans are completely paid off. Despite this, I have a lot more debt. I have a massive debt on an investment property. I have a margin loan for share trading. And I have a FOREX investment account which is leveraged at 400:1 (Which means I borrow $400 for every $1 I put in)
What is the logic then of borrowing to invest?
Borrowing to invest increases your ability to earn investment returns. Its simple maths really. You have more money to invest because you borrowed some, so when you invest the money wisely, you'll earn more returns. There is one additional variable to this equation though to keep in mind, the interest on the loan. Your investment strategy must be strong enough that the additional earnings are higher than the interest on the borrowings. Otherwise your net position is actually going backwards. Ie. Overall, you are losing money.
Generally speaking also, interest payments on investment borrowing are tax deductible (get advice from your accountant on this point). As the borrowings have been made to increase your income, the interest payments on the loans are a direct cost of your income production. This typically makes the interest payments a tax deduction. For example, as my investment property creates a rental income, the borrowing are a cost associated with producing that rental income.
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 usuall try and keep the leverage here at 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.
Those are some of the benefits you can gain by borrowing to invest. There are risks too though, so it is very important to get independent financial advice if you are thinking about leverage.
There 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 repayment obligations. In a normal loan (like a mortgage, or investment loan) this means you need to be able to fund all your agreed repayments. 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 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. So you need to know that in extremely adverse market conditions (2007 - 2009 are a good example of this) you can generate enough income to cover such margin calls.
Finally there is the investment risk. When you borrow to invest, you do so with the intention that the income earned from the money you invest, exceeds the interest the borrowing accrues. If the interest is higher than the investment earnings, you are losing money.
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 speak to a licensed financial advisor or accountant about whether this is an appropriate strategy for you. Only then should you work out how to structure it to match your personal circumstances. - 23314
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 which perfectly matches your goals.
When I started investing, my borrowing habits where the same as most peoples. I had a floating credit card debt which varied to my whims. I had a small personal loan for some household items and a bigger one which enabled me to buy my car.
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.
Things have changed over the years. I learned that debt is much more efficient when spent on investments. So now my credit card debt is negligible and paid off every month. My personal loans are completely paid off. Despite this, I have a lot more debt. I have a massive debt on an investment property. I have a margin loan for share trading. And I have a FOREX investment account which is leveraged at 400:1 (Which means I borrow $400 for every $1 I put in)
What is the logic then of borrowing to invest?
Borrowing to invest increases your ability to earn investment returns. Its simple maths really. You have more money to invest because you borrowed some, so when you invest the money wisely, you'll earn more returns. There is one additional variable to this equation though to keep in mind, the interest on the loan. Your investment strategy must be strong enough that the additional earnings are higher than the interest on the borrowings. Otherwise your net position is actually going backwards. Ie. Overall, you are losing money.
Generally speaking also, interest payments on investment borrowing are tax deductible (get advice from your accountant on this point). As the borrowings have been made to increase your income, the interest payments on the loans are a direct cost of your income production. This typically makes the interest payments a tax deduction. For example, as my investment property creates a rental income, the borrowing are a cost associated with producing that rental income.
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 usuall try and keep the leverage here at 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.
Those are some of the benefits you can gain by borrowing to invest. There are risks too though, so it is very important to get independent financial advice if you are thinking about leverage.
There 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 repayment obligations. In a normal loan (like a mortgage, or investment loan) this means you need to be able to fund all your agreed repayments. 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 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. So you need to know that in extremely adverse market conditions (2007 - 2009 are a good example of this) you can generate enough income to cover such margin calls.
Finally there is the investment risk. When you borrow to invest, you do so with the intention that the income earned from the money you invest, exceeds the interest the borrowing accrues. If the interest is higher than the investment earnings, you are losing money.
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 speak to a licensed financial advisor or accountant about whether this is an appropriate strategy for you. Only then should you work out how to structure it to match your personal circumstances. - 23314
About the Author:
Gnifrus Urquart has had impressive success investing over the years. As such, he likes discussing investment strategies and giving trading tips to others interested in investing
posted by Mr. Forex at
4:10 AM
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