Monday, August 15, 2011
Leverage – borrowing money to invest – is one of the biggest
problems in our industry and subject to much abuse. Most financial
advisors get paid partly on the assets they manage, and some
try and sell the idea of leverage to their clientele in an effort
to boost their “assets under management” (and hence the fees
they get) without spending much time discussing the negatives
with their clients.
I have seen many clients sold on leverage who were not good
candidates for the strategy, but they trusted their financial
advisors and went ahead with it anyway. Years later, they still
have less than they borrowed – especially when markets become
volatile or take a steep downturn, as they did last week. And
they’ve been paying interest to boot. Yes, the interest is tax-deductible,
but most people who have come to me with this problem wish they
could get out of it. To add insult to injury, many people were
also sold a fund or plan with a deferred sales charge (DSC),
which would impose additional penalties if they collapse their
These are some important aspects to think about if you are
considering borrowing money to invest.
1. You should maximize your RRSP contributions every year and
have no available room. There is no point in looking at complicated
strategies when you haven’t first covered the basics.
2. To benefit from the interest deduction, your income should
be over $60,000 a year. You have to consider risk/benefits.
3. If you are borrowing as a couple, one of you must have a
job that is very stable. To be out of work and stressing about
a loan and an investment that may be under water isn’t worth
the potential benefits from the strategy.
4. Do not buy funds with a deferred sales charge. You don’t
want potentially high fees forcing you to hold on in a bad situation.
5. Pay off non-deductible debt. If you have a mortgage, for
example, you would normally pay it off (or nearly so) to reduce
risk. Again, why be risky with a complicated strategy when the
basics haven’t been covered?
6. A stable marriage is essential if you are entering into
leverage, because it’s a long term plan (five to 10 years).Going
through a divorce is complicated enough, and this again could
cause the leverage to collapse early.
7. If your advisor is pushing (selling) hard for you to borrow,
ask to see realistic projections. Do the projections show, for
example, steady 7% growth every year? When have we last seen
steady 7% increases every year? I’ve been in the business over
16 years and I’ve never seen it. Ask your advisor to revise
the 7%-plus every year and show one minus 35% in the first two
years and see how that alters the projections.
8. If you are retired and comfortable, do you want the stress
of leverage in order to save some taxes? Retirement should be
a time of enjoying the fruits of your labours, not worrying
about the markets.
9. Know how much you will save in taxes every year, because
that is the only sure thing. Investment performance is conditional
on a great many factors, most of which are out of your control.
10. If you worry about the markets under normal conditions,
having borrowed money will only add to your stress. Avoid using
leverage if you are in that camp.
My advice: If you your financial advisor pushes leverage or
other complicated strategies too strongly, get a second opinion.
Generic Mutual Fund Disclaimer
Commissions, trailing commissions, management fees and expenses
all may be associated with mutual fund investments. Please read the
simplified prospectus before investing. Mutual funds are not
guaranteed and are not covered by the Canada Deposit Insurance
Corporation or by any other government deposit insurer. There can be
no assurances that the fund will be able to maintain its net asset
value per security at a constant amount or that the full amount of
your investment in the fund will be returned to you. Fund values
change frequently and past performance may not be repeated.
Personal Opinions & Recommendations Disclaimer
The foregoing is for general information purposes only and is the
opinion of the writer. This information is not intended to provide
specific personalized advice including, without limitation,
investment, financial, legal, accounting or tax advice. However,
please call the author to discuss your particular circumstances.