What is leveraged investing?

October 11, 2018 | Gary Weatherup


Share

Leveraging is using someone else’s money to make money. Because you’re borrowing money, your return will be amplified either positively or negatively.

RBC Financial Planner London Ontario

What is leverage?


Leveraging is using someone else’s money to make money. The most common structure is through a mortgage. You put down a certain amount of money (i.e. 10%), and the bank lends the rest of the value of the house to you (i.e. 90%). It is your responsibility to pay back the mortgage loan over time. Because you’re borrowing money, your return will be amplified either positively or negatively. Say for instance you bought a $400,000 home putting down 10% ($40,000). If two years later it was worth $420,000, your unrealized gain before costs would be $20,000 which is 50% of your $40,000 original investment! On the flip side if the market dropped 8% because of rising interest rates, your original principal would almost be gone. $40,000 - $32000 would only leave you with only $8,000 of equity (i.e. an 80% loss!).

What is investment leverage?


Investment leverage is where you borrow money (typically though a line of credit/margin account) and use that money to invest in stocks, bonds, mutual funds or other types of investments.

What are the benefits:


The main three are boosting returns/net worth,  it is a forced savings plan, it can provide tax deductions (interest payable on an investment loan is tax deductible).

What are the risks of leveraged investing?


It should be noted that leverage is NOT FOR EVERYONE. When done correctly it can work well, but when done incorrectly it can lead to amplified losses. Because of this, before you implement any leverage strategy, you MUST discuss your financial situation with a qualified financial planner. I will be writing a separate article on this topic, in the mean time, I've attached an article from the Globe and Mail.

When should you leverage?


There can be good entry points and bad entry points. Ideally you should look at a leverage strategy if the following have occurred:

  • There has been a significant drop in the market (now is not the time
  • You have large free cash flow

How do you leverage?


There are many different forms of leveraging. I will discuss these options in a future article.

Lastly, should you do leverage investing?


That depends. You must discuss your financial situation with a qualified investment advisor. You may or may not be a fit. While the strategy can work well for certain people, it can be sometimes be pushed heavily as a way to gather assets for a financial advisor/institution.

This is the first article in a new series – if you have any questions, feel free to reach out to myself, Vito or any member of the team.

All the best,
Gary

 

See other blog posts

Our story
 

This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under license. © 2018 RBC Dominion Securities Inc. All rights reserved.