Borrowing to invest—the pros and cons

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While interest rates remain near historic lows, borrowing money to invest continues to look like an attractive investment strategy.

We believe that this strategy works best if you borrow to buy well-established, dividend-paying stocks. For instance, you could select from the companies we recommend in the 2016 Income-Seeking Investors Portfolio of The Successful Investor newsletter.

Investing advice: Borrowing to invest can trigger significant tax advantages

We’re in the middle of a tumultuous 2016, but loan interest rates haven’t changed much in the last three years: you can borrow for as little as 3.2% if you use your home as collateral, for example. Over long periods, the total return on a well-diversified stock portfolio runs to as much as 10%, or around 7.5% after inflation. So you can expect to earn more than your borrowing cost.

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Borrowing to invest can also be a highly effective tax shelter. You can deduct 100% of your interest expense against your current income. What’s more, the investment income you earn brings three key tax advantages: you get the dividend tax credit on qualified Canadian stocks and you only pay income tax on 50% of your capital gains.

In addition, you are only liable for capital gains when you sell; if you buy high-quality investments, 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.

Investing advice: 6 keys to make the most of borrowing to invest

As appealing as low rates and the undoubted tax advantages of this strategy are, borrowing to invest does entail 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.

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That’s why we invariably advise that you only consider borrowing to invest if all six of the following apply to you:

  1. You are in the top income-tax bracket and expect to stay there for a number of years;
  2. Your income is secure;
  3. You have 10 or more years until retirement;
  4. You follow our low-risk investing advice and stick with quality investments;
  5. 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;
  6. You have already made your maximum RRSP and TFSA contributions.

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This article was last updated on July 15, 2016.

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