Record-low interest rates are encouraging for investors thinking about borrowing cash to invest in the stock market.
Advisors should oversee any of these so-called “smart debt” strategies, says Talbot Stevens, author of The Smart Debt Coach.
Stevens tells Advisor.ca that he estimates the level of borrowing to invest is about 10% of what it was 10 years ago, before the 2008 crash. Still, there are opportunities to do it smartly and safely, he argues.
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“Note that just as borrowing to invest is very high risk-reward for investors, the same is true for advisors. Using the strategy allows advisors to build their business much faster,” he says. “The MFDA is very closely addressing this, and IIROC. Some advisors prefer borrowing to invest using seg funds to reduce regulatory [and] compliance red tape.”
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Stevens advocates a “responsible amounts, responsible strategies, and responsible timing” approach. The following are some of his suggestions:
- Your client should set aside cash, and then do nothing with it until the markets drop at least 10%. “Recognize that those who actually build wealth fast wait for that sale, when the market is down ten, twenty, 30%, and then start [with] a comfortable, responsible amount of borrowing to invest.” Importantly, Stevens cautions: “Don’t jump in when we’re in the eighth or ninth inning [of a bull market].”
- If your client wants to borrow $100,000, tell them to start with a fraction of that: “Start with ten to 30% of what you think you can handle, because I don’t think there’s any emotional risk assessment on the planet that’s going to accurately tell you how you’re going to react when you’re in the fire.”
- The most common form of loan for investing is a securities-backed loan, or credit taken out against investments. Others might take out loans against their home equity.
- Be cautious, he warns: “If not done properly, it can hurt the investor, advisor, dealer, sometimes the lender, and the reputation of the industry.”
- Clients can deduct the interest charged for investing in a non-registered account. He adds by email that this makes borrowing to invest, for equity investors, an effective tax-deductible alternative to RRSPs: “Everyone knows that contributing $4K/year to an RRSP produces a tax deduction, but many don’t know that using $4K/year to finance a $100K investment (assuming 4% interest) produces the same tax deduction.”
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