Investment

What are the pros and cons when borrowing money to invest?

Published

1 year ago

April 6, 2023

You need a high risk tolerance, low investment fees and a long time horizon to make it worth considering

Borrowing to invest is a financial strategy that presents opportunities, but also pitfalls. Photo by Getty Images/iStockphoto

Q: My wife Karen and I are 45 years old and each of us earns $100,000 annually. We have one child, a son, who is 14 years old. We also have $200,000 each in registered retirement savings plans (RRSPs), but no employer pensions nor other savings except for $25,000 in a chequing account for emergencies. We are considering borrowing money to invest. What are the pros and cons of doing this? We have no consumer debt, but still have a $150,000 mortgage at 2.5 per cent on our principal residence, which is worth about $1 million. — Miguel

FP Answers: Borrowing to invest is a financial strategy that presents opportunities, but also pitfalls. It would be prudent to review your overall financial planning before choosing to implement a leveraged investment strategy since it can add a significant amount of risk to a financial plan and is not appropriate for all investors.

The most common leveraged investment for Canadians continues to be real estate. Most of us are comfortable taking out a mortgage to buy a home, but would shy away from borrowing money to invest in a securities portfolio.

The main reason why borrowing to invest in real estate is so much more common is that the underwriting process involved in buying a home is much different. There are credit checks, income confirmations and a home appraisal before any dollars are borrowed for a purchase.

Borrowing to purchase other investments, most typically a portfolio of stocks, mutual funds or exchange-traded funds (ETFs), is different. A home’s value is unlikely to significantly drop, although it can go down, but there are no restrictions on an investor putting their money into risky investments. Real estate is also less liquid. A stock or other publicly traded investment can be sold with a screen tap on a smartphone.

In most cases, you will have the ability to deduct interest payments that are related to the debt used for the investment. These will help lower your overall cost of investing. It bears mentioning that interest is only deductible if used to buy taxable non-registered investments. Borrowing to invest in RRSPs or tax-free savings accounts (TFSAs) does not allow you to deduct the interest on your debt.

Given your income and age, Miguel, I’m guessing you have RRSP room. You should probably max out your RRSPs before building a non-registered account. You both likely have $88,000 of TFSA room if you have never contributed, and that should be used before building a non-registered portfolio.

Let me outline the most common way a leveraged investing strategy would be set up. First, a source of funding is determined. In your case, since you own your home, it is most common to set up a secured home equity line of credit (HELOC), which could then be used to advance the funds to purchase the investments. Investors will use their home as security because it usually allows them to obtain better interest rates.

Once you have your borrowing source, then the reasonableness of the strategy should be reviewed. For most of the past 10 years, interest rates have been low. That has changed in the past year, and interest rates have significantly increased while the market has been low to flat after a volatile 2022. Given this development, borrowing to invest has become much less appealing.

The prime rate is often seen as a benchmark for borrowing rates across the retail banking sector and this has been in the range of five per cent to six per cent over the past six months, and could rise further. Given that rates are this high, the breakeven point on the expected investment return would have to exceed that amount to make the strategy reasonable. It’s no use borrowing to invest if you pay more in interest than what you could expect to earn on the investments.

Could you borrow at six per cent and get an investment return of eight per cent? Maybe. But is earning $2,000 per $100,000 of leverage life-changing? Probably not. You also have a $150,000 mortgage at 2.5 per cent that is going to come up for renewal at a much higher rate in the next couple of years.

If you do want to proceed with borrowing to invest, you need a high risk tolerance, low investment fees and a long time horizon to make it worth considering. At age 45, I suppose you have some runway to consider this. Just be careful and be mindful of some of the other considerations raised.

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Economy

S&P/TSX composite down more than 200 points, U.S. stock markets also fall

Published

7 days ago

September 6, 2024

Anne Joseph

TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.

The S&P/TSX composite index was down 239.24 points at 22,749.04.

In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.

The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.

The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.

The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.

This report by The Canadian Press was first published Sept. 6, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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Economy

S&P/TSX composite up more than 150 points, U.S. stock markets also higher

Published

2 weeks ago

August 29, 2024

Anne Joseph

TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.

The S&P/TSX composite index was up 171.41 points at 23,298.39.

In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.

The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.

The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.

The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.

This report by The Canadian Press was first published Aug. 29, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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Investment

Crypto Market Bloodbath Amid Broader Economic Concerns

Published

1 month ago

August 5, 2024

Harry Miller

The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.

The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.

Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.

The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.

Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.

Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.

Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.

Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.

The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.