With interest rates still near historic lows, borrowing money to invest continues to look like an attractive portfolio investing strategy.
Today, you can borrow for as little as 3.5% if you use your home as collateral. Over long periods, the total return on a well-diversified portfolio of high-quality stocks runs to as much as 10%, or around 7.5% after inflation. So you have a good chance of earning more than your borrowing cost.
Even so, borrowing to invest isn’t for everyone (see below for six ways to tell if this approach makes sense for you). But if you do choose to follow this portfolio investing strategy, we recommend that you cut your risk by sticking with well-established, dividend-paying stocks.
For example, you could pick from the 19 companies we recommend in our Canadian Wealth Advisor newsletter’s Safety-Conscious Stock Portfolio. It’s one of three portfolios the newsletter offers to conservative and income-seeking investors (the other two are the Index Fund and ETF Portfolio and our Safety-Conscious Income Trust Portfolio). We continually monitor and update all three portfolios.
2 ways to maximize your portfolio investing profits when borrowing to invest
Here are two other advantages of borrowing to invest as part of your portfolio investing strategy:
You can use your dividends to pay your investment loan interest: If you borrow to buy well-established, dividend-paying stocks, like those we recommend in our Canadian Wealth Advisor newsletter, these investments will give you regular dividend income and cash flow to pay the interest on your investment loan.
Borrowing to invest can cut your tax bill: Borrowing to invest can be a highly effective tax shelter. That’s because you can deduct 100% of your interest expense against your current income. Plus, the investment income you earn comes with three key tax advantages: you get the dividend tax credit on qualified Canadian stocks and you only pay tax on 50% of your capital gains.
In addition, you are only liable for capital gains when you sell; if you focus your portfolio investing on high-quality stocks, you’ll wind up holding some of them for as long as you live. It’s a great tax-deferral technique. And it’s perfectly legal.
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6 ways to tell if borrowing to invest is right for you
Borrowing to invest is not without risks. The amount you owe on your investment loan will stay the same, regardless of what the market does, so every dollar your portfolio loses will come out of your equity. In addition, if you take out a variable-rate loan, the interest rate you pay could eventually rise.
That’s why we think this portfolio investing strategy only makes sense if all six of the following apply to you:
You are in the top income-tax bracket and expect to stay there for a number of years;
Your income is secure;
You have 10 or more years until retirement;
You follow our low-risk investment approach;
You have the kind of temperament to sit through the inevitable market setbacks without losing confidence at a market bottom and selling out to repay your loan;
You have already made your maximum RRSP contributions.
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