Online guide to leverage (borrowing to invest)
Leveraging is a popular concept promoted by the financial industry. It’s common to hear financial advisors or other so called experts highlighting the benefits of leveraging. To put it in simplest terms, leveraging is simply using someone else’s money to make money.
Most of us have leveraged in our lifetime, for example buying a house. You can put down 5%, 10%, 25% and the bank lends the rest of the value of the house to you. It is your responsibility to pay back the loan in the form of a mortgage.
Investment leverage is where you borrow money (typically though a line of credit) and use that money to invest in stocks, bonds, mutual funds or other types on investments.
Because I get a lot of people asking me if leverage is a good way to invest, I thought I would put together this resource to help people make the decision to leverage or not
The benefits of leverage
There is no question that leverage can have merits by helping people boost returns, create tax deductions and replace a forced savings plan. When used properly leverage can be a powerful tool to help grow wealth
For more information read The Benefits of Leverage
What are the risks of leverage?
Leveraging can be an extremely productive financial concept but it is not for everyone. Leverage comes with risks and before anyone considers leveraging as part of their wealth building strategy, be sure to understand these risks.
For more information read The Risks of Leverage
When is leveraging appropriate
Leverage has both good points but also bad ones. Before you jump in and borrow money to invest it, here are some thoughts around some ideas situations where leverage may be appropriate.
For more information, read when is borrowing to invest appropriate
Be cautious when pitched to leverage
Leverage is a concept that has been popularized by the financial industry. As much as it can be productive for the client, it also can be very lucrative for the financial advisor or institutions. Check out this real example of where leverage was ‘sold’.
For more information, read Be cautious when pitched to leverage
Leverage can be a conflict of interest
Leverage is one of the many potential conflicts of interest that exist in the financial industry. Investors must be careful when considering a leveraged investment especially when it is being sold hard by financial sales people.
For more information, read Conflicts of interest in the financial industry
Different forms of leveraging
Leverage can be used in many different ways like buying a house or investment leverage. RRSP meltdowns are another form of leverage. This article highlights some of the different forms of leverage.
For more information, read Leverage comes in different forms
Be aware of phony math when borrowing to invest
This article is pretty technical but it’s a great dissection of the math around leverage and borrowing to invest. Before your leverage, it’s important to know the math of leverage.
For more information, read Be aware of phony math when borrowing to invest
4 ways to borrow to invest
Get Smarter About Money has a great little primer on leverage outlining 4 different ways to borrow money and invest it. The article finishes with 8 great questions to ask yourself before you take the plunge.
For more information, read ways to borrow to invest
My five cents
Leverage is not a new concept. It has been around for years and people have used leverage to buy homes and start businesses. Borrowing to invest is also not new but it has been popularized by the financial industry as a sales concept. While leverage has a place, investors should proceed with caution by making sure they really understand the risks associated with leveraged investing.
When it comes to illustrations from financial advisors, be careful about the assumptions. Far too often the assumptions show the good results without helping the client understand the risks and the potentially bad outcomes.
What do you think of borrowing to invest? Have you done it and if so, what’s your experience?