Borrowing money to invest can be a good strategy, but experts say you’d better know your stuff, or you could end up in a bad financial situation.
The government sets a limit to RRSP contributions and if you haven’t reached it, you might consider taking a loan to top it up.
Talbot Stevens, a financial expert specializing in leveraging, explains it heightens potential reward but also danger, as you could lose money in your investment and have to pay back the loan.
“You’re magnifying your financial results, both good and bad, and you’re magnifying your emotional situation,” Stevens says. But leveraging, or a “forced savings strategy,” can work. “Once you make that one-time decision, you don’t really have any choice but to continue to execute that plan.”
Because of that, you should only commit to a plan you can follow in the worst of times. If it’s done right, borrowing to invest in your RRSP can be like borrowing to invest in your house via a mortgage. If you borrow to invest, long-term planning RRSPs are the way to go. “When people borrow to invest outside of RRSPs, too often they are getting greedy and want to make a lot of money fast.”
That leads to shortcuts and ill-informed decisions.
Patricia Lovett-Reid, senior vice-president at TD Waterhouse, sounds a more cautious note. The risk is getting caught in a volatile market during a margin call. A margin is collateral that the holder of a position in securities, options, or futures contracts has to deposit to cover the credit risk of his lender (for example, your broker).
“Responding to a margin call and being sold out of a position at exactly the inopportune time suggest that you really do need to have the cash. Not just for the interest requirements, but also to satisfy a margin call in the event the stock turns against you,” she says.
You have to really know what you’re doing before borrowing to invest is a good idea, she said. “Proceed with caution. It is such a legitimate investment strategy, but it’s not for the novice.”