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July 15, 2018 | Should I?

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

At 48, Tyler should be a rock star. Engineer, two kids, a 2017 3-series, paid-off house he figures is worth $1.2 million. Happy wife, too. Even a Softail. All’s good.

But Tyler worries. Otherwise, why write me?

“I may have screwed up,” he says. “For the last seven years I did what Sharon wanted most and paid down the house with everything I had. So now the mortgage is gone, but we have nothing else – no savings, no TFSA and just a crappy work RRSP. I read your pathetic blog and wonder. You’re scaring me, buddy. Should I borrow to invest?”

So typical. The maple thing to do. A one-asset strategy. But when middle-age arrives, with three people dependent on you and no financial cushion for the future, having all the eggs in one basket – one house at one address in one city – may not be the best plan.

So, T wrote to follow up on some comments made here a few days ago about borrowing to invest. “Is this for me? How would I justify taking on a new mortgage when we just paid off the last one? She might kill me.”

Maybe she will. But let’s run some numbers.

Historically, houses have gained 3% a year in value (although those days may be behind us for a while). If that happens, in 12 years when Tyler wants to retire the place might be worth $1.76 million. Nice. But it’s all tied up in one asset which then needs to be sold. If interest rates have risen, the housing market weakened or the economy’s cycled down at that time, the place could be illiquid or worth less. Risk.

Now let’s assume Tyler took out a HELOC for 40% of his home’s value – $480,000 – and invested that in a balanced, diversified portfolio for the next 12 years and earned the historical average of 7%. The interest charge would be (at 4%) $1,600 monthly, or just over $19,000 a year. But it’s tax-deductible, so T gets to write off about 40% of it, reducing the annual cost to $11,500.

That $480,000 in 12 years would become $1.1 million, of which $629,000 would be growth. To earn that money would cost $230,000 in interest over a dozen years, and the $480,000 would have to be paid back upon retirement. Total cost of the portfolio then would be $710,400, for a gain of $400,000. Or, Tyler could keep the loan in place, and have the $1.1 million portfolio pay the interest – a small ask since it would generate about $75,000 a year in returns. The interest would still be tax-deductible.

The advantages: more money, obviously, with which to retire. More diversification since everything would not be in the house. Liquidity, as the portfolio can be converted into cash almost instantly (unlike real estate). More balance. Increased flexibility. Less financial risk in case the housing market tanks just when you need to bail.

The risks: Financial market gains disappoint (although 12 years is a long time and corrections are typically brief). Interest rates and loan costs rise (but are still tax-deductible). Stock markets crash (2008 was a good example and a balanced portfolio lost 20% but recovered in one year). The real estate market takes off again (but T would still own the place). Tyler loses his nerve when markets dip following Trump’s impeachment and sells out at a loss. The feds change rules and disallow interest deductibility (kiss of death for financial markets, so unlikely). Sharon kills him.

Make no mistake: borrowing to invest is not a slam-dunk. It magnifies gains, but also losses. Yes, it takes unproductive house equity and converts it into growth assets. But that growth is no more assured than real estate values.

So, never borrow to invest, unless you (a) have seriously thought about this and concluded you can ignore portfolio fluctuations (because they’re common), (b) invest in diversified assets that are balanced in a way that reduces volatility, (c) have a time horizon that’s long – years and years – to smooth out market gyrations, (d) keep good records in order to prove interest charges to the CRA, (e) ensure your portfolio is 100% liquid in case of an asteroid attack, rate spike or marital setback, (f) have time to manage this portfolio or have a smart guy do it for you and (g) are confident and courageous.

It’s a strategy. Not for everyone. But he asked.

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July 15th, 2018

Posted In: The Greater Fool

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