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Borrowing to invest: Not a strategy for everybody

What is leveraging?

Leveraging is a strategy that consists of borrowing money for investment purposes. This allows you to make a larger investment than if you only draw on your own savings. Borrowing for investment purposes can involve significant risks.

Before you use leveraging:

  1. Check whether your representative is registered by calling the AMF Information Centre.
  2. Read the documentation received on the risks of this strategy.
  3. Determine your tolerance for risk. Make sure you have fully understood and evaluated the risks of borrowing for investment purposes and that this strategy fits into your risk profile.
  4. Make sure that your investment horizon is long enough (5 to 10 years minimum).
  5. Make sure you fully understand the tax impact of this strategy.
  6. Borrow only what you can repay without having to sell your investment. For example, do not borrow more than you can repay.
  7. 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?
  8. Note the main points of conversations with your representative so you can refer to them if necessary. The form Take Notes When Talking to Your Representative can be useful.

Before using the leveraging strategy, make sure your representative has checked that:

  • You have a medium to high tolerance for risk.
  • 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 decide to adopt this strategy.
  • You have long-term financial goals.
  • You have the required liquidity. For example, if you are having problems making payments on your loans (mortgage, credit cards, etc.), leveraging is not for you.
  • You are able to repay the loan. For example, if your investments decline in value, the financial institution that loaned you the money may call the loan.
  • You are in a healthy financial position.
  • Your tax rate is 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.

Some of the preceding points are discussed in greater detail below:

You have a medium to high tolerance for risk
You should be comfortable with the risk of borrowing for investment purposes. This strategy is not appropriate for conservative investors, whose profiles call for investments with a low level of risk. This strategy is more suitable for investors with long-term investment horizons (5 to 10 years). It is not suitable for older investors or those approaching retirement who seek to maximize income and preserve capital.

Your tax rate is high enough to benefit from the tax deduction
Borrowing money for investment purposes is particularly suitable for investors with fairly high tax rates because the interest payable on the loan is generally tax deductible. However, borrowing is not necessarily a good strategy based solely on tax benefits. You should not consider only this criterion when deciding whether or not to use this strategy.

You are in a healthy financial position
You should be able to repay the loan (and the interest on the loan) as stipulated in the loan agreement. Generally, a loan for investment purposes should not exceed 30% of your total assets (minus debt) and 50% of your liquid assets (minus debt). For example, if your net liquid assets total $200,000, you should not take out a loan for more than $100,000. The budget tables available on the AMF website can be useful

You have the required knowledge
You should be aware of the risks associated with borrowing for investment purposes. For instance, you could be forced to sell your investments at a loss if the securities bought through leveraging fell in value. Be careful! If you rely on the return generated by the securities you have purchased to cover the cost of the loan, you might be required to sell your investments at a loss to repay the loan.

Once you have taken out a loan:
Notify your representative if your financial position changes. For example, a divorce, loss of employment or 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.

 

Risks of borrowing for investment purposes:

  • The return on your investments may be lower than the borrowing rate (after income tax is taken into consideration).
  • Your investments may lose value.
  • Your financial institution may demand repayment of the loan if your investments lose 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 immediately repay all or part of the loan.

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