Almost everyone that starts a business needs to borrow money and owning a business is an equity. My point is that is similar to leverage into equities (except no diversification).

For example, Bill Gates borrowed money when he was young to start a small business that eventually grew into a huge business. That is leveraging into an equity.

Note that most of the super-rich leveraged into only 1 or a small number of companies – which is quite risky.

I agree that perception of risk varies (and usually at the wrong times), but my point is that, in general, most people have an exaggerated view of how risky the stock market really is. That is what often part of what stops people from accumulating the nest egg they need for retirement.

For example, let’s say you would need $1 million in any equity-focused portfolio averaging 8%/year long term to have the retirement income that you want. It would take $1,500,000 to have the same income with a bond/GIC-focused portfolio averaging 5%/year long term.

For many people, they would be scared to ever have $1 million in equities, but they also would never be able to accumulate $1.5 million. So, what options do they have?

Besides working longer, retiring on less or investing more now, one other viable option is to understand the real risk level of equities and how to manage the risks.

The risk of equities does reduce a lot if you stay invested for a long period of time. This would be at least 15-20 years.

We do agree that leverage does increase both risks and returns. So, it is not for everyone. That is how virtually all rich people made their money though.

Ed

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[...] Million Dollar Journey has a two part post on “Myths about levering” [...]

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A house is not an investment, the primary purpose is to provide shelter for the family. An investment portfolio aims to earn a return. Therefore, it is not surprising that the leverage is not equivalent in people’s minds. You can also see the difference between a house and a stock in behaviour toward profits (or losses). Based on whether they are greedy or fearful they will be quick to realize their profits (or losses) in their portfolios. How many times have you heard someone selling their home because it went up 30% and couldn’t possibly go any higher?

It is meaningless to say that people overestimate risk. The perception of risk is not static. To confuse matters even further, actual risk isn’t static either. It varies over time and typically investors believe risk to be low when a bull market is topping out (and actual risk is very high). In other words, investors underestimate stock market risk when a bull market is topping out and overestimate it when the bear market is ending.

I guess the key point I am trying to make is that while leveraged investing boosts returns, it also increases risk. Leveraged investing is no free lunch – any extra return is earned by assuming more risk. While you are seduced by the extra return, don’t forget the downside.

What data did you use for the 43% drop in the market? When I look at the NASDAQ – I know not very diversified – it dropped from about 5000 down to 1000. People who were sucked into that tech bubble experience something closer to 80% and not 43%.

But if the loan was specifically directed at an investment then, from the bank’s perspective, wouldn’t an investment loan be the same (or better) than lending you money for a mortgage?

This line has a familiar ring to it :)

Pretty good post, I disagree about the riskiness of the stock market since I think it is risky over the short/medium term (up to 15-20 years?).

There definitely is a big disconnect between the perception of leverage with respect to equities vs other items like big houses, loaded SUVs and big screen tvs. I think a lot people think equity leveraging means speculating on junior mining stocks using margin loans. The (obvious) reality is that using a line of credit to buy bank stocks (as I do) is far less risky than using a line of credit to buy a big tv but you might have trouble convincing some people otherwise.