Leveraging Your Investments - An Explanation
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.
This article covers the general principles of leveraging your investments. If it is something you are considering but have never done before, discuss your ideas with a licensed financial adviser. They will ensure you are structured correctly and can minimise your risk and exposure.
10 years ago, my borrowing habits were what I would call "typical" in today's society. I had a credit card, which ranged 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.
The problems with these types of debt are two fold. To start with, the items I bought when I borrowed are all depreciating items. That is, their value decreases as they get older. The second thing is, due to the fact that I borrowed to buy things I could use personally, (as opposed to a money making use) I could not claim the interest on the borrowings for tax purposes.
Today, due to the many benefits I found you get when you borrowing 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 a successful stock trading strategy. And finally, as per all foreign exchange trading accounts, I have an account which is leveraged out (and heavily too, at 400:1 - so every $1 I put in allows me to invest $400). My debt on consumables on the other hand is negligible.
Why is it more efficient to use your borrowings for investing then?
Firstly, when you borrow to invest, you are "using other people's money" to earn more money in the investment markets. A great example of this is in our FX Trading strategy. If I invest $10,000.00 and leverage it out at 400:1 that means I have $4,000,000 invested. This 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.
Also, as you are borrowing with the intention of generating an income, there is a direct nexus between the borrowing costs (Ie. interest liabilities) and making money. Therefore, in many cases, the interest payments on these types of borrowed funds are tax deductible. You'll need to speak to your adviser to confirm this, bt typically this holds true. That means you basically get a discount on your loan. This in itself makes borrowing to invest more financially efficient than borrowing to buy consumer items.
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.
A margin loan is treated a little bit differently. If you borrow too much or the value of your investments drops suddenly, you will be at risk of paying margin calls. This means your lender will ask you to pay off a portion of the loan, so that the outstanding loan is in a reasonable level when compared to the reduced level of collateral. This can be quite a large issue if your investments drop by a long way. If you cannot meet the margin call obligations, your lender has the right to sell your investments.
Obviously also there is the risk that your investments will lose, leaving you with an investment loss and a loan. So you need to be confident with your strategies.
All risks with investing can be mitigated with strategy. That is why it is so important to speak to a licensed financial adviser before you invest and especially before you borrow to invest. So if you are considering leverage, speak to an adviser about risk mitigation. Leveraging your investments can definitely be financially rewarding, but only when you properly understand and manage your risk and when it is backed up by a consistently high performing investment strategy. - 23223
This article covers the general principles of leveraging your investments. If it is something you are considering but have never done before, discuss your ideas with a licensed financial adviser. They will ensure you are structured correctly and can minimise your risk and exposure.
10 years ago, my borrowing habits were what I would call "typical" in today's society. I had a credit card, which ranged 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.
The problems with these types of debt are two fold. To start with, the items I bought when I borrowed are all depreciating items. That is, their value decreases as they get older. The second thing is, due to the fact that I borrowed to buy things I could use personally, (as opposed to a money making use) I could not claim the interest on the borrowings for tax purposes.
Today, due to the many benefits I found you get when you borrowing 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 a successful stock trading strategy. And finally, as per all foreign exchange trading accounts, I have an account which is leveraged out (and heavily too, at 400:1 - so every $1 I put in allows me to invest $400). My debt on consumables on the other hand is negligible.
Why is it more efficient to use your borrowings for investing then?
Firstly, when you borrow to invest, you are "using other people's money" to earn more money in the investment markets. A great example of this is in our FX Trading strategy. If I invest $10,000.00 and leverage it out at 400:1 that means I have $4,000,000 invested. This 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.
Also, as you are borrowing with the intention of generating an income, there is a direct nexus between the borrowing costs (Ie. interest liabilities) and making money. Therefore, in many cases, the interest payments on these types of borrowed funds are tax deductible. You'll need to speak to your adviser to confirm this, bt typically this holds true. That means you basically get a discount on your loan. This in itself makes borrowing to invest more financially efficient than borrowing to buy consumer items.
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.
A margin loan is treated a little bit differently. If you borrow too much or the value of your investments drops suddenly, you will be at risk of paying margin calls. This means your lender will ask you to pay off a portion of the loan, so that the outstanding loan is in a reasonable level when compared to the reduced level of collateral. This can be quite a large issue if your investments drop by a long way. If you cannot meet the margin call obligations, your lender has the right to sell your investments.
Obviously also there is the risk that your investments will lose, leaving you with an investment loss and a loan. So you need to be confident with your strategies.
All risks with investing can be mitigated with strategy. That is why it is so important to speak to a licensed financial adviser before you invest and especially before you borrow to invest. So if you are considering leverage, speak to an adviser about risk mitigation. Leveraging your investments can definitely be financially rewarding, but only when you properly understand and manage your risk and when it is backed up by a consistently high performing investment strategy. - 23223
About the Author:
Gnifrus Urquart has enjoyed impressive success investing for many years. As such, he enjoys reviewing investment strategies and giving trading tips to others interested in investing
posted by X - Men @ 1:59 AM
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