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investment leveraging

Investment Leveraging

Leveraging is a strategy of using borrowed money to invest. The use of leveraging can be applied to real estate, stocks, bonds, and other investments.

 

When used properly, it can be an amazing financial tool as it allows the investor to employ a limited amount of money towards a larger investment than would be possible through a direct purchase made with available cash.

 

 

 

Compound Returns. Leveraging allows you to invest more money now, and gets this money working for you right away. The effect of compound returns is much stronger with this strategy and can result in better investment returns over the long term. This may be a great solution for investors looking to get a boost on their retirement savings.

 

Interest payments may be tax deductible. While the interest you pay on a loan essentially reduces your investment return, interest paid on an investment loan is generally tax deductible. CRA has very strict rules about what types of investments qualify for interest deductions, so it is important to understand those rules in detail.

 

Boost your effective returns. Leveraging can magnify your returns, both on the upside and the downside.

 

Leveraging can significantly magnify your returns, both on the upside and the downside. It’s important to be aware of the risks associated with leveraging.

 

Higher risk tolerance. Due to the risks associated with leveraging, this strategy may not be appropriate for conservative investors.

 

Borrowing to buy an investment fund has a higher risk than paying with cash because the interest charges on the borrowed funds must be paid irrespective of how well or how poorly the investment fund performs. If the investment suffers a loss, the full amount of the loan must still be paid, plus the accrued interest.

  • For example, if $50,000 of investment funds are purchased with the investor’s own equity and the investment declines in value to $40,000 over 10 years and then sold, the investor will have lost $10,000.
  • However, if the same $50,000 investment is purchased with an investment loan at an interest rate of 5.0% and the value declines to $40,000 over 10 years and then sold, the investor will be in a worse financial position. This is because to repay the loan they must raise an additional $10,000 and, in addition, they will have paid over $25,000 in loan interest over 10 years. In other words, they will have lost $35,000 with this strategy.

Interest rate risk. The key to successful leveraging is to have your after-tax investment return exceed your after-tax cost of interest. Of course, we cannot predict investment returns, nor can we control rising interest rates.

 

Margin calls. If the market value of your investment drops below a certain margin, the lender may issue a margin call where you will have to put in more money to make up the difference. To help minimize this risk, the loan can be secured with another asset.

 

Taking out a loan to purchase investment funds will increase your Debt Service Ratio, which may impact your ability to borrow money for other purposes.

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About Ciccone/Mckay

Ciccone/McKay Financial Group is an independent financial services firm with over 75 years of combined experience in the areas of risk management, wealth management and employee benefits.

 

We specialize in providing insurance and investment solutions for our clients, helping businesses, individuals and families grow, manage, protect and transfer their wealth.


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