Although leveraged investing is, by nature, a riskier play, you can temper the downside by keeping a few basic principles in mind.
“If you’re going to do this, make sure the loan-to-asset value is quite low,” advises Laura Wallace, VP and portfolio manager with Scotia Private Client Group. “That gives [clients] the option of just paying the loan off if interest rates go up sharply.” She suggests no more than 30% of an investment should take the form of a loan. “So if you’ve got a $100 investment, you could get a $30 loan,” she explains.
Read: Beware leveraged loans
Diversification is key
Don’t correlate investments to a client’s core business. “If you own a company in the energy sector,” Wallace contends, “you probably shouldn’t be borrowing money to invest in Suncor. If something goes wrong, you’ll be doubly exposed.” You might also want to avoid buying property in Calgary, because if the price of oil drops, so does the price of real estate in that city.
Similarly, the investment itself should be diversified. Betting the farm on emerging market stocks is probably not wise in any case, and certainly not if a client’s leveraged to the hilt.
Think long term
Studies have shown the odds are great that returns from leveraged investing will exceed the costs of borrowing if investments are held for 10-or-more years.
“For responsible leveraging, I generally recommend a long-term horizon of eight-to-10 years, or more,” says financial expert Talbot Stevens. “You may have to hang on that long for things to work out. But if you try to be more strategic and buy low, it may pay off sooner.” The rate on a 10-year loan right now is approximately 6%.
Aim for quality
Stay away from penny stocks or anything that’s highly volatile or has a risk of going down sharply, advises Wallace. “You want to make sure you’ve got some quality to protect you in case things don’t unfold as you expect.”
Also, make sure clients can cover losses. If they have other debts and/or limited cash flow, it’s not a good option.
This article was originally published on capitalmagazine.ca.