Bad words, right? Most of us struggle a good portion of our working lives to pay off debt whether it be in the form of car loans or mortgages so the word tends to have an air of negativity surrounding it. Debt, however, is a great enabler of our economy. Without it most of us could not afford the nice homes we live in or the opportunity to own our own vehicle.
What about the financial planning debt consideration “borrowing to invest”? If you borrow to invest Canada Revenue Agency allows you to write-off the interest charges. Sounds great, eh? Like ‘free’ money almost….but wait! There are risks associated with this strategy that you must know before you put this consideration into practice. Most of the pitfalls and, conversely, the potential gains, are all based on market timing and performance. If you borrowed, let’s say, $100,000 back on March 10th of last year and invested it in almost any market then you, most likely, would have seen this strategy work wonderfully for you. With the market at it’s all time low (in the most recent of years) and the exact day of the turnaround you may have fared….as an example….10% and the loan was, maybe 5%. Of course, dependant on your marginal tax rate, you still would have done more than OK.
The pitfall, however, is if you borrowed to invest that $100,000 and the market drops. Even with the advantage of being able to write-off the interest on your annual tax return you would still be paying for a loan (less cash flow) to pay for an investment that was devalued considerably. Then, my guess is, you would not be too happy with this strategy.
Borrowing to invest is OK for people who understand the potential pitfalls and how are willing to take on the additional risk associated with this strategy. For those who are good at market timing it can be very rewarding…