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| Leverage - Is This A Strategy For You? |
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| Written by Gnifrus Urquart |
| Sunday, 26 April 2009 10:00 |
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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. If you have not borrowed to invest before, but are considering it, you really should discuss this with a licensed financial advisor before you do. The concepts provided in this article are general in nature and should not be taken as specific advice to be applied to your specific circumstances. A financial advisor will be able to tailor a borrowing structure which perfectly matches your goals. 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. There are 2 problems with this type of borrowing. Firstly, all the assets I bought with the borrowed money were depreciating assets. This means that as I paid off the debt, the value of the things I bought decreased. Secondly, as I purchased "consumables", the interest I paid on these loans was not tax deductible. This makes for a very expensive borrowing. My debt profile today is very different to the one I had when I started learning about money. Today I use my credit card merely as a float which I pay off each month and all my personal loans are paid off. Despite this I carry much more debt than I did back then. I have a massive debt on a rental property I purchased. I have a reasonable sized margin loan for stock trading and I have an ever growing FOREX trading account. Most of my debt now funds investments, practically no debt funds consumables. What is the logic then of borrowing to invest? Firstly, when you borrow to invest, you are "using other people's money" to earn more money in the investment markets. A great example of this is in our FX Trading strategy. If I invest $10,000.00 and leverage it out at 400:1 that means I have $4,000,000 invested. This above example describes very well the first benefit of leverage. By accessing more money to invest, you can earn way higher returns on your investments than you otherwise would have been able to. The second benefit you can get from borrowing to invest is a possible tax benefit. In my situation where I have borrowed to purchase an investment property in Victoria, as I rent out that property and earn an income from it, the interest payments on that mortgage become a cost associated with that income. As such, in my circumstance, I can claim those interest payments as a tax deduction. This means that while my asset is making me money, the tax office is actually giving me a discount on my borrowing by making it tax deductible 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. Those are some of the benefits you can gain by borrowing to invest. There are risks too though, so it is very important to get independent financial advice if you are thinking about leverage. There is the risk of over-extending yourself. When you borrow, you need to do so in a way that does not leave you unable to meet your repayment obligations. In a normal loan (like a mortgage, or investment loan) this means you need to be able to fund all your agreed repayments. If you cannot meet these payments, your lender has every right to take your investments off you. This is not good. 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. Finally there is the investment risk. When you borrow to invest, you do so with the intention that the income earned from the money you invest, exceeds the interest the borrowing accrues. If the interest is higher than the investment earnings, you are losing money. One of the reasons its important to speak to a licensed financial adviser is that these risk can be managed properly with the correct strategy. This will make managing your risk much easier and making money on you borrowing much easier. With the right strategy, leveraging your investments can be extremely beneficial. 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 who enjoys investing Grab a totally unique version of this article from the Uber Article Directory Kindly provided by LJ-Marketing.dk You are welcome to use this article on your own website, if you include the link just before this text. |
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