“Borrow for growth, not Consumption” –Rule quoted by Financial Planner
“Blow it out your ear” –Big Cajun Man
No, I am not saying you should borrow for consumption either, you should not borrow. Buying a house is the only thing I can see as a good reason to borrow money, borrowing money to invest just strikes me as asking for a swift kick in the lower abdomen.
It’s interesting that I tripped across this in my archive of articles that I started and then stopped, as Robb E. over at Boomer and Echo went and asked a whole bunch of folks about this, and got some interesting answers to the Question, Should You Borrow to Invest. Lots of interesting ideas in that article (no I am not condoning the advice, simply saying that it is an interesting read).
Borrowing money to buy a single stock can be viewed as buying on margin (in a simple understanding), the advantage is that you can buy lots more of the stock with your borrowed funds, and enjoy the huge profits, however, the best way to do this is to find a sure thing that will deliver profits that out-strip your borrowing rate, and that stock is? Anyone? In the 90’s it was Nortel, Enron or WorldCom, not sure what they are now. The con of this are you could have borrowed money and end up with a less valuable (or worse worthless) asset at the end of things.
Selling Short is another way to borrow, where you find someone who is willing to sell their stock and you guarantee that you will buy it back for them in a prescribed time period (or when the person who loaned you the shares says they want their shares back). The exciting part on this one is you can lose infinite money with this one (if you believe infinite growth is possible in the market), let me explain:
- I convince Michael James to sell his International Buggy Whip at $10 a share
- The world decides that buggy whips are making a big comeback and the share price sky rockets to $100 a share
- I decide not to buy back yet, because the market will drop out, but it keeps going up, and up….
This will never happen! Don’t know, but I bet there are folks that Short Sold Apple in the 90’s that might disagree with that statement.
I am not sure who devised this heuristic but this is one I subscribe to:
Put no money into the Stock Market that you are not willing to lose
Surprisingly when I started looking at the markets in 1981 that was one of the rules, wonder what happened to it? Anyone hear anyone espouses this “Debbie Downer” point of view of the markets (aside from the sky is falling bloggers like me)?
As usual, different strokes for different folks.
So you are not comfortable “borrowing” to invest. Many good reasons for that, among others, can you afford to lose the money?
But scale does matter at times. I can use my hard earned cash to purchase one stock at $10 and paying 5% per year ($0.50) which is a lot better than what a GIC or CSB will pay. Now it cost me $10 brokerage to buy it and it will cost me $10 to sell it for a total of $20 transaction fees. At $0.50 dividends per year it will take me twenty years to cover the transaction fees alone. Plus if it is in a non-registered account I get to pay taxes on my $0.50 every year. Yes, I know. I would be probably have “0” tax on fifty cents but this is just for illustration.
Now if I have a HELOC @ 3% (which I do) and borrow $10K to purchase 1000 stock, this will pay me $500 per year less my 3% interest charge on the HELOC, which is tax deductible. This leaves me with $200 to pay taxes on at a reduced rate as the money is from dividends. The dividends “pay” my interest charges and, if you are wise pay down the principal owed on the HELOC. So every year there is less interest to pay as the principal pay down accelerates.
A few caveats. If you let the dividends pay down the principal then obviously you are “contributing” every year as you are paying the taxes on the dividends as well. So you are investing (lowering) in the HELOC by paying the taxes due on the dividends you paid.
So what is my situation. Fast approaching retirement at 24hrs per day. HMM! I think every one is in this situation.
Max the RRSP & TFSA every year.
No debts other than the credit card (paid in full every month) and the HELOC
House paid for.
Still working. Have to if I max the RRSP but probably retired mid 2015 at latest.
The HELOC: Have margin of $160K of which $133K is presently invested in equities.
Any equity MUST pay more than 3% to pay the interest charges.
All dividend paying stocks.
I pay the interest charges every month so this is an investment on my part.
I may also contribute any extra monies to the HELOC as, in theory, it pays me 3% to pay down the principal rather than leave it in a low paying bank account. Reminder, I have already maxed the RRSP & TFSA
This also allows more wiggle room if I buy a stock at some time. Recently HSE
Using this payment scheme I have built the non-registered account to over $260K (less the $133K owed to the HELOC)
Interest charges for 2014 will approximate $3K. Again tax deductible.
I do buy and sell in this account so the HELOC principal varies through the year
Will receive aprox $14K in dividends so, again, I support the HELOC by also paying the taxes on $11K. But as they are dividends, at a reduced rate.
So, to recap. If you pick the right stocks (doesn’t everyone?) and they pan out for you then you will receive increasing dividends as well as, hopefully, increasing stock value. IPL just increased their dividend 14%. But you have to be prepared to accept that stocks can just as easily go down as go up and hopefully your picks will rise from the occasional trough. I have stocks below my purchase value as well as stocks that have appreciated but they ALL pay me something.
Where have I really lost money in the past? Non-dividend paying stocks. Being a good Canadian, think NT. As I read somewhere, if you get dividends then you can not lose everything. I have sold at a lose as well as gains. In a non-registered account at least the lose can be applied against any gains.
So that is it for me gentlemen. It has worked so far. I may change this once I am retired.
What reason would you stop, if for the most part you have a track record of coming out ahead? If the energy you put in is rewarded at a reasonable rate of course… Glad to hear I’m not alone on this Ricardo – Cheers
I think this is the most interesting non-trollish comment argument I have seen on my site and I applaud all sides for their excellent points. I still think the Stock Market can be a scary place, and that for 99.9% of folks borrowing money to then invest is a game they should stay away from (maybe they should work on their debt load), but a very interesting set of comments (so far).
I’m a true believer on your statement – Put no money into the Stock Market that you are not willing to lose. I know a few people that lost big buying stocks on margin. When things are going well they’re confident and talk about how much money they are winning; when things are not going well they are in a big whole and need to sell other assets to cover their loses. It’s not a pretty piture.
Nope I knew many “paper millionaires” at Nortel that never actually got around to SELLING and ended up going down in a financial ball of flames. If you can’t lose it, don’t risk it.
My bank advisor once asked me if i was not nervous borrowing to invest in equities. As I responded to him – Only when they are going down! LOL
But like I said, if the dividends are covering the interest on the HELOC as well as paying down the principal you have to take that step back and look at what you are doing, what the stocks are doing and what you are invested in.
Jumping in and out of non-dividend paying equities is gambling, in my opinion. I like farly stable dividend paying equities for a hold of mid to long term. I have held IPL since 2003, I sold JNJ after 18 months. All stocks can be sold. Whether or not that is a wise choice is another matter but at least you are getting paid to hold them for however long.
Each to his own, certainly, but I think the evidence is overwhelming that stock picking and market timing is a mugs game, and unless you have the skills of Warren Buffet, you are better off in index funds, as he himself advises.
Some people like to pick stocks as a hobby, but most would be better off finding a less expensive form of entertainment.
Very true, like chainsaw juggling or pit bull taunting, both seem a little less dangerous 🙂
To each his own I guess. I have been quite successful at borrowing to invest. Caveat here is that I have no other outstanding debt, so take for example this past year… In January I took a HELOC out in the amount of $50K (@4%), I did my research, picked a few stocks and “invested” it all. each month I paid back a bit of the loan on top of paying interest from the account each month… In July most of it was paid back and I was up, well lets call it comfortably. As we entered September, I was finding the markets finicky, so I opted to hold zero loan… Mid October rolled around as we all watch the “correction” in the market happen… mid October I took back out that $50K loan and started bargain shopping, and as the markets have risen, again I will start paying back my loan. The key here is to understand that the markets are not within your control. Time and research into “quality” holdings, and a little market understanding that when things all fall, across the board, bargains will appear, point 1. Point 2 is that when something rises in value, you need to take some of the money off the table since it is not yours… Buy low, sell high. It is do-able if you take the time and effort to understand how the herd works. I will also suggest I am a rare breed, in that I am not fazed at loss of 40+% on a stock I believe, per MY research suggests should be a good investment. A recent example of this is AVO… Took a payday on some today. As to quality low volatility stocks, there are many out there, just most don’t take the time to look. So in summary, as much as I agree that for most, borrowing to invest IS a bad idea, at least let those who might look at things differently know that there are some of us who have been successful at it… – Cheers.
To your rule “Buying a house is the only thing I can see as a good reason to borrow money,” I’d add that if you extend your mortgage, you really aren’t borrowing for a house. When extending a mortgage (or consolidating), you’ve borrowed to invest or consume, but just because it’s on your mortgage doesn’t make it “borrowing for a house.”
Both excellent points, thanks MJ.
I suggest that folks should consider borrowing to invest only if all six of the following conditions are true:
1. You are in the top income-tax bracket and expect to stay there for a number of years;
2. Your income is secure;
3. You have 10 or more years until retirement;
4. You follow a low-risk investment approach and stick with quality investments;
5. You have the kind of temperament to sit through the inevitable market setbacks without losing confidence at a market bottom and selling out to repay your loan;
6. You have already made your maximum RRSP and TFSA contributions.
Very few folks are going to meet all these conditions, so in general most of us should not borrow to invest.
Re Put no money into the Stock Market that you are not willing to lose, that’s certainly true of the penny stock you brother-in-law recommended. If you stick with a diversified portfolio of high-quality dividend stocks, market values will vary. But over time, as management grows the businesses, dividends will increase. As dividends increase, other investors are willing to pay more for the stocks. It’s about time in the market, not timing the market!
I still don’t think it is a good idea, but I am in the minority on this. I do like your list of 6 though, very nicely put (especially point 5).
I’m not certain what Robert means in his rule #4 by a “low-risk investment approach,” but there is no such thing as a low-risk stock or stock index. Those who think some stocks are safe are deluding themselves. To make leverage work, you need to take on risk.
Michael, perhaps I should have said a “LOWER-risk investment approach.” Speculative small cap stocks–mining and high-tech startups–can run out of cash and go out of business, so there is a significant risk of a 100% loss for investors. Large cap, well-financed companies–think of banks and utilities–can survive business turn-downs. The market values of these companies will vary across the economic cycle, but the business value do not vary much. In fact the business value of well managed companies tend to grow over time.
If you hold these kind of stocks, the risk in not that you will ‘lose’ money, but that there will be times when the market value declines. You have to be able to take a long-term perspective and understand that what really matters is the business value. The best measure of that is a rising dividend stream over time. Remember, market gains come and go, dividends are yours to keep forever!!!
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes”. Warren Buffett
Jack Bogle, founder of the Vanguard Group: “As I have said before, the daily machinations of the stock market are like a tale told by an idiot, full of sound and fury, signifying nothing,” Bogle added. “One of my favorite rules is ‘Don’t peek.’
http://www.marketwatch.com/story/jack-bogles-advice-to-worried-investors-shut-your-eyes-and-let-the-indexes-work-2014-11-03?link=sfmw
I can live with the “Don’t Peek” rule.
@Robert: Would General Motors and Kodak have satisfied your rule of being large cap and well-financed before they went under? My main point is that if you’re not Warren Buffett you need broad diversification to protect against business failures. Even Canada’s banks could fail in the face of the right competition. This isn’t a prediction. It’s just recognizing the possibility.
Sorry for this in advance… When someone goes fishing, do they cast a line out and then leave the rod and not pay attention to it in hopes it will catch a fish? Think about float fishing in a river verses a lake… When you cast a line into a river you need to have a target rich space with fast flowing water, which means you need to check on your line frequently and re cast regularly in hopes to catch a fish, because if you don’t your float will make it’s way along and then snag the side, there by defeating what you are trying to accomplish, catch a fish. casting it a lake may take more time to catch a fish, but time can be on your side as you can cast out the line and wait for that fish to find it… do you understand what I am saying? If you are investing you cannot just cast your line out and leave. You need to do proper research to have a good idea of where the fish might be, be aware of where you are fishing (river or lake) to know what type of techniques will be necessary to catch the type of fish you want and YOU MUST PAY ATTENTION at all times to what your line is doing. You can lose your fishing gear and the possibility of catching fish, if you do not pay attention. same for stock investing my friends… I could go on here about when is the best time to fish so to optimize the catch… hope you get what I’m saying here. If you have a plan, have done the research, you are most likely going to catch fish- Cheers.
Trust no one but your own level of skills… as much as I agree that it is time in the markets that makes you the dough, understanding how to time your buy and sells of quality companies can add significantly to your returns, so unfortunately I don’t buy that market timing can’t work. I attempt to market time any entry to and from the market… I think it also depends with how much money you are playing with on this and what type of investor you are. 1K vs 10K or 20K, you know timing a buy/sell can pay my borrowing costs for an entire year… Just saying, it can be done… – Cheers.