While borrowing to invest is a solid longer term strategy for people who are behind on their savings or who are net worth driven – I want to stress that it does have risks because returns are never certain, and even the most stable of asset classes do fall in value. However, this is also true if you invest without using any leverage. Before you make any decision consider the real math and consider your psychological profile carefully. To do this well… it is always a good idea to run the conservative math.
As an example, if funds are borrowed at an after-tax rate of 2.5% annually and the invested funds earn and after-tax rate of 5% annually, the client’s net worth will increase over time; but while clients may expect to earn 5% annually after tax over the long term, their return in some years may in fact be much lower. Conversely, there will also be years where the returns are much higher.
Also it is important to note that a long-term successful borrow-to-invest strategy requires an expected after-tax return that is greater than the after-tax cost of borrowing. A tax accountant should be consulted before implementing this type of strategy to optimize your outcome.
Considering the ‘Big Picture’
Here are some key things to keep in mind before executing a borrowing to invest wealth strategy:
- Borrowing to invest carries risk to the borrower / investor because the cost of borrowing may outweigh the return on the investment, but this risk can be mitigated over the long run by buying stable and diversified investments.
- Clients should have some familiarity with the different types of borrowing options before they borrow to invest as the cost and impact of the borrowing is central to long term success.
- Borrowing to invest offers the tax advantages of tax-deductible interest expense as well as tax deferral and tax minimization through capital gains based tax efficient investment returns.
- People should be familiar with borrowing-to-invest risks and strategies and they should consult a tax accountant before borrowing to invest to ensure they have are appropriately structured for their needs and understand the record keeping requirements to maintain interest deductibility.
Borrowing to invest is largely a strategy designed for middle and higher income earners as the interest deductions are more advantageous to people in the top tax brackets (yes – finally a benefit to being at a high marginal tax rate). It is also only suited for people who have a longer investment horizon. This is by no means a short term or speculative strategy… ever.
If you want to see whether this strategy is something that will be consistent with your fianncial goals and risk tolerance – there is no team that has executed this more successful borrowing to invest plans in this country than ours.
Call 416-410-9905 / 1-855-410-9905 for a complimentary financial analysis so you can understand the math of this strategy, and so I can supercharge the quality of your advisory team!