Borrowing to invest, or leveraging, can be a way of boosting returns. But be careful! This method of investing is risky and not for everyone.
How does leveraging work?
You borrow money and use some or all of the funds to buy investments. This allows you to make a larger investment than if you only use your own savings.
Leveraging can by very risky
Here are some important points to consider:
- Check whether your representative and the firm where he works are authorized to offer the financial products being proposed. You can do so by contacting the AMF Information Centre.
- Carefully read through the documentation you receive on the risks of using this strategy.
- Determine your tolerance for risk. Understand the risks and ensure that this strategy fits into your risk profile.
- Make sure that your investment horizon is long enough (for example 5 to 10 years).
- Understand the tax impact of this strategy.
- Borrow only what you can repay without having to sell your investment. Don’t borrow more than the amount you can pay back.
- Estimate how much money you would lose in a worst-case scenario. For example, would you be able to handle a 30% decline in the value of your investments?
- Note the main points discussed (pdf - 1 MB)This link will open in a new window with your representative so that you can refer to them if necessary.
Ask yourself these 7 questions
Before you borrow in order to invest, make sure your representative has asked you the following questions:
- Do you have high risk tolerance?
- Do you have the required knowledge?
- Do you have long-term financial goals?
- Do you have the necessary cash resources?
- Are you able to repay the loan?
- Are you in good financial shape?
- Is your tax rate high enough to benefit from the tax deduction?
1) Do you have high risk tolerance?
You must be comfortable with the risks that go along with leveraging. This strategy is generally not appropriate for conservative investors, who are looking for low-risk investments.
2) Do you have the required knowledge?
Normally, you should already be familiar with the financial markets and have a certain amount of investment experience before you adopt a strategy that involves leveraging.
You need to be aware of the risks associated with leveraging. For instance, you might have to sell your investments at a loss if the securities bought through this strategy fall in value. Also, remember that despite these losses, you’ll have to pay back your loan.
3) Do you have long-term financial goals?
This strategy is better suited to investors with long-term investment horizons (for example 5 to 10 years). It might not be suitable for investors who are approaching retirement or are retired.
4) Do you have the necessary cash resources?
If you are having problems paying your debts (mortgage, credit cards, etc.), leveraging is probably not suitable for you. Increasing your debt level could be risky.
5) Are you able to repay the loan?
If your investments decline in value, the financial institution that loaned you the money may ask you to reimburse the loan. In that case, you would lose some invested money and would have to pay back the loan. Are you comfortable with that?
6) Are you in good financial shape?
You should be able to repay the loan (and the interest on the loan) without incurring financial problems.
Generally, a loan for investment purposes should not exceed 30% of your total assets (minus debt)Total assets are what a person or company owns (their assets: money in the bank, buildings, furniture, etc.) minus their debts (their liabilities: mortgage loan, etc.). and 50% of your liquid assets (minus debt)Total assets are the assets that a person or company has (money in the bank, buildings, furniture, etc.) minus their debts. Liquid assets (minus debt) are the portion of the assets that can be quickly and easily converted into cash.
Liquid assets (minus debt) can include shares that are traded on a stock exchange (which can be sold very quickly), but not buildings (whose sale extends over a longer period). . For example, if your net assets total $200,000, you shouldn’t take out a loan for more than $100,000 for investment purposes. The budget tables on the AMF website may be useful.
But be careful! It’s not because you meet these limits that leveraging is right for you.
7) Is your tax rate high enough to benefit from the tax deduction?
One advantage of this strategy: The interest paid on funds borrowed for investment purposes can generally be deducted. This makes the strategy particularly suitable for investors with fairly high tax rates.
However, do not use a leveraging strategy based solely on tax benefits. You should not consider only this criterion when deciding whether or not to use this strategy.
Once you’ve taken out a loan
Notify your representative if your financial situation is declining or has undergone major changes. For example, divorce, loss of employment and retirement are events that should prompt you to review the suitability of leveraging. Monitor interest rates because when they rise, the cost of borrowing usually increases.
- The return on your investments may be lower than the borrowing rate (after income tax is taken into account).
- Your investments may lose value.
- Your financial institution may demand repayment of the loan if your investments shrink in value. For example, if you borrow $100,000 to purchase an investment that declines in value and is worth no more than $60,000, your financial institution may demand that you repay all or part of the loan immediately. And, even if the value of the investment rises, you won’t be able to recover the money you’ve invested.