Borrowing to invest can magnify the returns on assets. Here’s how it works.
From MoneySense Magazine
Interested in using leverage to boost your returns? We have news for you: if you have a mortgage, then you’re already doing it. Buying a home is one of the best uses of leverage, says Al Feth, a fee-only adviser in Toronto. “Your gain will be tax-free and you won’t become as emotionally affected in times of market downturns.”
Let’s say you saved $50,000 and you want to buy a condo for $250,000. To make up the difference you borrow $200,000 in the form of a mortgage. If the value of your condo rises by 33% over the next five years, it will be worth $332,500. That’s a great return. But remember, you only put $50,000 down in cash. So, if you sold your condo for $332,500, you’d walk away with $82,500 in cash, for a gain of $32,500 on your original investment. That’s a 65% return. Of course, you’d still have all of the transactional costs involved in buying and selling your home, so you wouldn’t get the full 65% return, but it’s a good illustration of how leverage works.
“The best part is that the entire gain will be completely tax-free,” says Jason Heath, a fee-only certified financial planner with Objective Financial Partners in Toronto. “Other than perhaps investing in your education, you really couldn’t make a better leveraged investment than this.”
Borrowing to invest in stocks works in much the same way, but the risk you take on is far higher. If you want to use leverage to increase your investment returns, be sure to consult a tax expert as well as your adviser before borrowing any money.