By Julie Cazzin, with Doug Robinson
By Julie Cazzin, with Doug Robinson
Q : I’m a 42-year-old engineer and in the top tax bracket. I would like to leverage my home equity line of credit (HELOC) by investing in dividend-paying exchange-traded funds (ETFs). Is this an effective tax savings strategy, and what are the pros and cons of using such a strategy to build wealth? — Mo
FP Answers: The strategy of borrowing to invest comes with increased risks and does not always end well for investors. But before getting into specifics, it’s important to look at your entire financial situation to see if this strategy would be right for you.
First, you need to determine if it’s worth taking the increased risk of borrowing to invest in order to achieve your financial goals. If you take into account all your assets and savings, are you on track to achieve your goals without taking the additional risks of this strategy?
You also need to evaluate this strategy in the context of your overall financial plan. And, Mo, while you don’t provide enough financial details here for me to offer guidance either way, generally speaking, the strategy of leveraging your home equity to invest in ETFs can be an effective tool to build wealth.
The main reason is because you are using very little of your money (just the payments on the borrowed funds) and, at the same time, investing a much larger amount (i.e., the amount of the HELOC), which has the effect of giving you the returns of the entire underlying investment.
Essentially, you are magnifying your gains, but be aware you are magnifying losses as well. Borrowing to invest works well when investment markets are rising. But it’s hurt a lot of investors when markets are falling, and deeply hurt their bottom lines.
You are magnifying your gains, but be aware you are magnifying losses as well
Of course, we don’t have a crystal ball to see into the future. But investors all too often rely on recent experience as their guide and, as a result, leave themselves open to bad outcomes due to excess confidence.
On the plus side, there is good news in regards to taxes. Interest paid to earn investment income is an eligible tax deduction on line 22100 of your tax return. Dividends are considered investment income, so selecting a dividend-paying ETF satisfies this requirement (but capital gains do not).
Remember, for tax purposes, you must keep the debt separate from your other liabilities in order to fully deduct the interest. That means you have to be careful about where you hold the HELOC money, as well as how you use it.
A key point to note is that you’re not eligible for the tax deduction if you invest the money, say, in your tax-free savings account (TFSA). That’s just one detail you have to abide by. There are many others, so I usually recommend to anyone considering this strategy to seek the advice of a good tax professional.
The objective, of course, is to make money on this strategy, and the profits are taxable if you do. You get immediate tax relief, but you will be paying more taxes overall if the strategy succeeds. Although tax savings can seem appealing and are a consideration, they should not be a key driver in making this decision.
You also asked about the cons of the strategy, so let’s explore a few. Ask yourself: if you borrowed $100,000 and markets fell by 35 per cent, would you be comfortable continuing to make your payments knowing you owe $100,000 and only have $65,000 left in your investment account? Even though markets only fell 35 per cent, your money has to now rise by almost 54 per cent to get back to where you started, which may take several years.
Will you be committed to the strategy for long enough to earn back the 54 per cent plus the after-tax cost of your interest payments knowing you will only be breaking even at that point?
It’s best if you’re committed to the strategy for a minimum of five years, but capable of carrying it for 10 years or more. Is your job secure enough for you to know you will always have the same income to make the payments? If you become sick or disabled, is your income insured, and will you be capable of remaining committed to the strategy?
Also, if you sell your home, you have to pay off the debt and lose the tax deduction for the interest you are paying. You can keep the investments, but you will now have $100,000 less home equity to purchase your next property in my example. Will this be acceptable to you?
And let’s not forget about borrowing costs. Many lines of credit have a variable interest rate. Two things happen when rates begin to rise. First, your investments have to earn a higher return to offset the increased cost and, second, you have to have the capacity and willingness to make higher payments in the future. There are clear signals the cost of borrowing will be rising in the future.
As you can see, there is a lot to consider before making your final decision.
Investing in a well-diversified complement of dividend growth ETFs has merit. Companies initiating and growing dividends tend to be high-quality businesses that deliver competitive returns over time.
However, there are many arguments for other types of investments that will improve diversification. I would be comfortable with a dividend-paying ETF as a portion of my portfolio, not the entire portfolio. I would also be looking at other investments to diversify my portfolio before using borrowed funds to build it.
Generally speaking, it’s good to take full advantage of your registered retirement savings plan (RRSP) and TFSA limits before considering a strategy such as borrowing to invest.
As well, I like to see investors have stable family incomes and be saving money outside the payments necessary to fund the loan. Finally, it’s extremely important to have experienced volatile and declining investment markets to prove you have the ability to remain invested through a prolonged downturn.
For the past 13 years (or since you were about 29 years old, Mo), markets have been advancing with only a few brief setbacks. The last real test of investor fortitude was in 2008. You may well meet all of these criteria, but I include them to help you decide if borrowing to invest is right for you.
I would be remiss if I did not comment on timing and share how I use this strategy in my life. It is best to commence this strategy when markets are at low points. However, we have no idea if the markets are high or low until we benefit from hindsight. But we do know we are in a bull (upward-moving) market right now. Likewise, we will know when we are in a bear (downward-moving) market.
In general, I feel much better about entering into a strategy such as this after I can see six to 12 months of a bear market in the rear-view mirror. Mo, you are going to experience many more bull and bear markets in your lifetime. A common driver of entering into this strategy right now is fear of missing out. I am not participating in that. In the past, this strategy has been part of my financial plan, and it probably will be in the future. However, I am not using it right now.
Mo, I wish you happiness and success in your finances and life.
Doug Robinson is a certified financial planner and chief executive of Veritable Wealth Advisory Inc. based in Peterborough, Ont.
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(Bloomberg) — SoftBank Group Corp. plans to expand the Japan investment team for its Vision Fund, adding staff and stepping up deal-making after putting little of its money into its home country in the past.
Founder Masayoshi Son raised about $100 billion for his first Vision Fund and has allocated $51 billion for a second, but he has made most of his investments overseas, particularly in the U.S. and China. Only two of his investments have been in domestic startups.
That is beginning to change however. The Vision Fund team in Japan, overseen by Kentaro Matsui, is actively hiring to expand beyond its current size of four members. It’s looking to fill positions for analysts, associates and vice presidents, although there is no fixed target for the number of hires in the future, according to a spokesperson for SoftBank Investment Advisers.
The regional breakdown of SoftBank’s portfolio is 42% in the Americas, 28% in Europe, and 15% in China. However, the Chinese government has increasingly tightened regulations on technology companies and SoftBank will likely need to diversify its investments in the future.
“Japan is the world’s third largest economy and presents a compelling opportunity for high-growth tech companies,” Matsui said, in written response to questions. “We believe Japan is emerging as a center of technology innovation, particularly in sectors such as biotech and frontier tech, which are poised to drive growth in the modern economy. We are tracking its growth closely and will continue to look for opportunities to grow our team and presence in the region.”
SoftBank’s made one investment in Japan by taking a stake in the pharmaceuticals startup Aculys Pharma LLC. It also invested in SODA Inc., a startup that operates an online marketplace for sneakers and streetwear.
In an interview with Bloomberg, Aculys CEO Kazunari Tsunaba said the investment by the Vision Fund was important and valuable for the startup. He said the firm is considering an alliance with a U.S. sleep-focused company that Vision Fund has invested in, without specifying the target name.
©2022 Bloomberg L.P.
ESG funds, as they are known, promise to invest in companies with better environmental, social and governance attributes, to save the planet, improve worker conditions or, in the case of the US Vegan Climate ETF, prevent animals from being eaten.
Money has poured into ESG funds as noisy lobby groups push pension funds, university endowments and some central banks to shift their investments. The United Nations-supported Principles for Responsible Investment says signatories have $121 trillion of assets under management; even assuming lots of double-counting, that is most of the world’s managed money.
Over the next few weeks, Streetwise will explore the explosion of ESG investing and why I think it is mostly—but not completely—a waste of time. I will also offer up some solutions and discuss how to use your money to make a difference, while understanding the inevitable trade-offs.
ESG supporters can point to what look like successes: Their pressure has encouraged many companies to sell off dirty power plants, mines and, in the case of Anglo-Australian miner BHP, its oil business. It has even forced board changes at Exxon Mobil.
Sadly, selling off assets or shares by itself does nothing to save the planet, because someone else bought them. Just as much oil and coal is dug up and burned as before, under different ownership. And there are plenty of people out there to buy the assets, because never before in history has there been so much private capital operating without the public reporting requirements brought by stock markets.
Rich people who want to make the world greener could make a difference, by buying and closing dirty businesses even when they are profitable. So far, though, this hasn’t happened in any significant way. The pitch from Wall Street fund managers is the exact opposite—that by going green investors can change the world and make more money, not less.
“A lot of [clients] only really get enthusiastic if they get comfortable that they are not sacrificing return,” says Valentijn van Nieuwenhuijzen, chief investment officer at fund manager NN IP, which is being bought by Goldman Sachs.
Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable.
It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change.
Some of the biggest sources of fossil fuels are immune to shareholder pressure anyway. Much of the world’s oil is pumped by government-controlled companies, led by Saudi Arabia and Russia. Exxon can be forced to change its approach, but the global supply of oil is still determined by OPEC, as President Biden’s appeal to the cartel to pump more to keep fuel prices down has demonstrated.
There are three big pro-ESG arguments, which sound reasonable, but have major flaws.
First, if companies treat the environment, workers, suppliers and customers better, it will be better for business. This could work where companies have missed something to boost profits, such as add solar panels on a sunny roof or create a better employee retention program. Early ESG activists plucked the low-hanging fruit here, but management has become painfully aware of changing customer and employee expectations, so there is less opportunity ahead.
Adding costs to reduce a company’s carbon footprint, or paying staff more, should only help the stock price if it also raises revenue or reduces other costs, by say generating more loyalty from carbon-conscious consumers, lowering staff turnover or improving relations with regulators.
Otherwise profits can only be maintained by passing the higher costs through into higher prices, and—unless the firm has monopoly power—eventually customers who don’t care will go elsewhere. The alternative is to reduce profits, but ESG investors are almost universally against this.
The second ESG point is that by shunning stocks or bonds of dirty companies, and embracing those of clean companies, it will direct capital away from bad things and toward good ones. After all, a lower stock price or higher borrowing cost in the bond market should make it less attractive for dirty companies to expand, and vice versa for clean companies.
In practice, there has been a very weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project.
That is not to say there is no link. Tesla, with extremely expensive shares, has repeatedly taken advantage of its ability to issue new stock to invest in factories and research. The high prices earlier this year for clean-energy stocks might encourage similar corporate investment. The flip side of course is that buying wildly overpriced shares isn’t a good way to make money, as losses of a third or more from this year’s peaks for clean-energy stocks shows. Shifting the cost of capital just might help save the planet, but after the short-term shift in valuations is over, it should lead to underperformance.
The third claim from some ESG investors is that they are just trying to make money, and that involves shunning firms that are taking unpriced risks with the environment, workers or customers. Since they call themselves “sustainable” or use “ESG integration,” funds doing this look very like the rest of the ESG industry. The selection principle of the most popular ESG indexes, for instance, those from MSCI, involves identifying only risks that are financially material.
I would say, sure. If you think the government is going to, say, raise fuel taxes, don’t buy manufacturers of gas-guzzlers. If you think the government will impose more restrictions on coal plants, then coal generation will be an even less attractive investment.
Equally, if you think customers will be willing to pay more for brands that cut their carbon use, by all means bet on their shares. Just don’t fool yourself that you are making much difference to the world with your investment decision. Red-blooded capitalists chase these profits just as much as any green-minded investor. There is no need to try to persuade capitalists to have a conscience; they will do what you want if you make it profitable via customer demands or government intervention (or, if we are lucky, new technology).
There is one way that ESG investing does, sort of, work. Shareholders can push companies to stop lobbying governments in favor of fossil fuels. Conceivably this might help push customers and governments to do the things that would really make a difference.
My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself.
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Trucker convoy: Industry group condemns protest – CTV News
Canadian scientist examines melting Antarctic glacier, potential sea level rise – Globalnews.ca
Cheeky social media posts from City of Prince George resonate with residents – CBC.ca
The Metaverse Is The Web3 Wave That Democratizes Buying And Building Real Estate, Hosting Fashion Shows, And Monetizing Video Gaming – Forbes
The Microsoft-Activision acquisition targets Google and Meta more than Sony – Android Central
Cruise ship changes course after U.S. judge orders seizure – CTV News
Why the sustainable investment Craze is flawed – Livemint
Raven Software ends QA strike action in light of unionisation – Eurogamer.net