Ed Rempel, a CFP and CMA, has been a regular guest poster on Million Dollar Journey. He has graciously written another great article for you to enjoy while I’m away on business. This Part 1 of 2.
For this post, I am borrowing heavily from Talbot Stevens, whose writing about leverage was inspirational to me since the early 1990’s. I’ve always been fascinated by commonly held beliefs that just aren’t true. When you start talking about leveraging into equities, there are many. Here are the most common myths:
1. Leveraging is only for the wealthy
- One of my last articles asked the question: “Is leveraging into equities the ONLY source of wealth” and showed that all super-rich made it there by leveraging into equities (businesses). What is more is that almost all moderately wealthy also made it there the same way.
- The vast majority of wealthy people did not start out that way. They made it themselves by borrowing to start their own business or borrowing to invest in a portfolio of equities.
- If you want to become wealthier (and who doesn’t?), why would you not use the wealth-building strategies used by the wealthy and the moderately wealthy? Even if all you want is to pay off your mortgage, save for your kids’ education and save for retirement, you can still get there much quicker using the strategies of the wealthy.
2. All debts are bad and should be avoided
- A huge part of our Canadian psyche is this part of our “sacred cow” beliefs. This is mostly true, since with most debt, you would be better off if you did not have it. With leverage debt (an investment loan), however, you are usually better off having it than not having it. Why?
- If you borrow money to invest where the interest on the loan is fully deductible every year, and you invest in equities that make a higher rate of return and you pay little or no tax on the equities as they grow, why would this debt be bad? You can of course pay it off any time by selling your investments, but you are better off keeping the loan and the investments.
3. Leverage is too risky for me
- I always find it strange when homeowners are uncomfortable with borrowing to invest in equities. This is because they have already leveraged in a far worse way. When they bought their home, they were leveraging into an asset with no diversification, poor liquidity and low future growth prospects – and the interest is not even tax deductible.
- Leveraging into equities with far higher long term growth, good liquidity and diversification – and where the interest is tax deductible – is obviously a far better strategy.
- We also find that most Canadians vastly over-estimate the risks of the stock market and vastly underestimate the risks of real estate. The facts, however, show that real estate has 2/3 the downside risk of the stock market. The worst decline in the stock market from top to bottom in the last 50 years was 43% (2000-2002) and the worst decline in real estate (Toronto) was 28% (1989-1996) – which is 2/3 the downside!
To be continued… Stay tuned!