Leverage - Is This A Strategy For You?
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.
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.
Before I understood money, my debt profile looked very similar to most peoples. I had a credit card which I always struggled to get back to zero, I had a large personal loan for a car I bought and a smaller loan for some furniture.
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.
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.
What is the logic then of borrowing to invest?
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.
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.
So what are the risks associated with borrowing for investment purposes? One of the obvious risks relates to your financial capacity. There is the risk you over-extend yourself and cannot meet the repayment obligations on your loans. When taking out a loan, you need to be sure you can pay the loan repayments.
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.
There is alway also the possibility that your trading strategy loses money. If this happens, because you borrowed so you could invest more, you lose more money.
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.
Before I understood money, my debt profile looked very similar to most peoples. I had a credit card which I always struggled to get back to zero, I had a large personal loan for a car I bought and a smaller loan for some furniture.
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.
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.
What is the logic then of borrowing to invest?
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.
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.
So what are the risks associated with borrowing for investment purposes? One of the obvious risks relates to your financial capacity. There is the risk you over-extend yourself and cannot meet the repayment obligations on your loans. When taking out a loan, you need to be sure you can pay the loan repayments.
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.
There is alway also the possibility that your trading strategy loses money. If this happens, because you borrowed so you could invest more, you lose more money.
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 significant success investing over the years. As such, he likes reviewing investment strategies and offering trading tips to anyone interested in investing
posted by X - Men @ 11:11 PM
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