Leveraging Your Investments - An Explanation
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.
10 years ago, my borrowing habits were what I would call "typical" in today's society. I had a credit card, which ranged between $0.00 to about $4,000.00 in debt. I had a small personal loan which I bought some furniture with and I had a larger personal loan which I financed a car purchase with.
All these debts were used to fund consumables - objects for my pleasure. I learned that there are two issues with this. Firstly, the objects this debt bought all rapidly lost value. They were depreciating assets. Secondly, as I used the debt to purchase things I consumed, the interest on that debt had no tax benefits. I had to pay it all.
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.
Why is it more efficient to use your borrowings for investing then?
When you borrow to invest, you increase your investment earnings potential. As you borrow money, you have more to invest. Therefore, the returns on your investments increase by the net returns on the borrowed money. Obviously the basic key here is to ensure your investment return rate is higher than the interest rates on the loan. If this is the case, you will always make money with the money you have borrowed.
Also, as you are borrowing with the intention of generating an income, there is a direct nexus between the borrowing costs (Ie. interest liabilities) and making money. Therefore, in many cases, the interest payments on these types of borrowed funds are tax deductible. You'll need to speak to your adviser to confirm this, bt typically this holds true. That means you basically get a discount on your loan. This in itself makes borrowing to invest more financially efficient than borrowing to buy consumer items.
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.
So there is definitely an argument for borrowing to invest where you can, instead of borrowing to fund personal purchases. There are risks associated with leverage too though you need to be aware of.
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.
Margin loans are a little bit different. They are set up so you are allowed to borrow a certain proportion of the value of the stocks held in the margin loan. The risk here is that if the value of your stock decreases rapidly and pushes your margin loan outside those boundaries, you will receive a margin call. The margin call will force you to repay a significant part of your margin loan debt, to ensure it is again within the stipulated proportion of your stock values. This can often be difficult as it requires you to fund the debt when you had not budgeted money to do so.
Obviously also there is the risk that your investments will lose, leaving you with an investment loss and a loan. So you need to be confident with your strategies.
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. - 23226
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.
10 years ago, my borrowing habits were what I would call "typical" in today's society. I had a credit card, which ranged between $0.00 to about $4,000.00 in debt. I had a small personal loan which I bought some furniture with and I had a larger personal loan which I financed a car purchase with.
All these debts were used to fund consumables - objects for my pleasure. I learned that there are two issues with this. Firstly, the objects this debt bought all rapidly lost value. They were depreciating assets. Secondly, as I used the debt to purchase things I consumed, the interest on that debt had no tax benefits. I had to pay it all.
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.
Why is it more efficient to use your borrowings for investing then?
When you borrow to invest, you increase your investment earnings potential. As you borrow money, you have more to invest. Therefore, the returns on your investments increase by the net returns on the borrowed money. Obviously the basic key here is to ensure your investment return rate is higher than the interest rates on the loan. If this is the case, you will always make money with the money you have borrowed.
Also, as you are borrowing with the intention of generating an income, there is a direct nexus between the borrowing costs (Ie. interest liabilities) and making money. Therefore, in many cases, the interest payments on these types of borrowed funds are tax deductible. You'll need to speak to your adviser to confirm this, bt typically this holds true. That means you basically get a discount on your loan. This in itself makes borrowing to invest more financially efficient than borrowing to buy consumer items.
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.
So there is definitely an argument for borrowing to invest where you can, instead of borrowing to fund personal purchases. There are risks associated with leverage too though you need to be aware of.
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.
Margin loans are a little bit different. They are set up so you are allowed to borrow a certain proportion of the value of the stocks held in the margin loan. The risk here is that if the value of your stock decreases rapidly and pushes your margin loan outside those boundaries, you will receive a margin call. The margin call will force you to repay a significant part of your margin loan debt, to ensure it is again within the stipulated proportion of your stock values. This can often be difficult as it requires you to fund the debt when you had not budgeted money to do so.
Obviously also there is the risk that your investments will lose, leaving you with an investment loss and a loan. So you need to be confident with your strategies.
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. - 23226
About the Author:
Gnifrus Urquart has had significant success investing over the years. As such, he enjoys discussing investment strategies and offering trading tips to anyone interested in investing
posted by X - Men @ 3:49 AM
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