Borrowing Money to Invest – Is The Strategy Back In Black?

by Mike Holman

This post has been written by Mike from Green Panda Treehouse. He is a financial planner and run several finance blogs within his online company. If you like this post, make sure to stop by Green Panda Treehouse and subscribe to his RSS feed.

When I contacted Mike to write a guest post at Money Smarts Blog, he asked me if I could share my vision on leveraged investing. I thought it would be a great idea to share my experience, as I bought my first house through leveraging and I also implemented the Smith Manoeuvre Strategy with my HELOC.

A few years ago, I was working as a banker in a very special sector; we were granting investment loans. I started in this new department back in 2003 and left at the beginning of 2008 (sounds like I may have known something back then ;-)). During those four years, I had helped structure financing for at least 200M$ in investment loans across Canada. During the last 2 years of work, I was working exclusively on investment loans over  500K.

Making money with the stock market was as easy as picking berries during summer time, the interest rate charged on investment loans was extremely low (prime +0% in most cases) and the only fools were the ones who were getting 5% on their GICs!

Only a few months after I started, I opened a 20K line of credit for myself and started my leveraging strategy. Between 2003 and 2006, I made enough money to put a nice cash down payment on my first house. Fortunately for me, I had stopped while the markets were still high.

2008 – The Year When People Cried when They Learned What a Margin Call was

I left the lending side in 2008 switching to a financial planner career opportunity. I remember the discussions I had with the guy I had trained to be my replacement as senior advisor on the leverage team. All he was doing, day in & day out, was margin calls. What is a margin call anyways? This is the worst call you can get apart from the police calling to tell you that your wife is dead:

“Hello, may I speak to Mr. Leveragedboy?”

“Yeah, it’s me”

“My name is Mr. Bad Ass Banker and I am calling to request the amount of $75,000 to be deposited in our account by the end of the week. If you don’t we will have to sell all your (losing) positions to pay off your investment loan”.

Silence on the phone…

A margin call is basically when the value of your investment goes lower than the level required by the bank. For example, if you have a margin clause at 0.90 and you invested $100,000, you will be required to maintain (at any moment) a minimum of $90,000 in your investment account. What happens when the market loses 10% within a week?…. well this is when you get a margin call!

In fact, this is what had caused a part of the high volatility levels of the market investors suffered during the last months of 2008 as Hedge Funds received margin calls for several millions of dollars.

After the Storm, the Sun Rises Again

Capitalism almost died of a heart attack in 2008, but survived the ride and was reborn sooner than expected in 2009. Now that we are slowly emerging from the fear of seeing the old continent going bankrupt, we can hear the evil words “borrowing to invest” coming back to our ears like an old Beatles song.

Markets are low as investor hesitation is still present and interest rates are still low too. This sounds like the perfect match for another investment loan rally! In any case, I seriously think it is a good time to borrow money to invest.

Why I think it is the Right Time To Leverage?

While people who had borrowed money in 2006 are still paying interest without really understanding why they had done such a “stupid” thing since their investments are still in red, I think it could be the perfect time to start a new investment loan. I agree that this technique is not for beginner investors, but if you know what you are doing, leveraging should be considered.

Here’s why:

  1. US companies are showing strong results but investors fear the market so they still undervalued.
  2. We have a strong dollar which allows us to invest in both Canadian and US currencies.
  3. Interest rates are still low.
  4. There are several high paying dividend Canadian stocks on the market. Enough to build a strong investment portfolio where dividends will pay more than interest costs.
  5. The level of liquidity (i.e. money sitting in cash accounts or money markets) is still very high. Once the fear is gone, we might see another peak in the markets.
  6. You now know what losing money means (if you were in the market in 2008) and have seen what happens if you stay in while people are selling (during 2009). You are now fully prepared to live with the leveraging risks.
  7. The most important reason of all: because everybody thinks it’s stupid to leverage! Buy when there is blood on Wall Street… and that’s all I e to say folks ;-)

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