3 ways to profit from borrowing to make stock market investments (and 6 ways to tell if you should)

Investors often ask us for our opinion on borrowing money to invest in stocks. We think that borrowing to make stock market investments can be a good strategy for some investors under certain circumstances. You’ll benefit most from this strategy by sticking with well-established, dividend-paying stocks, like the ones we recommend in our Canadian Wealth Advisor newsletter.

Here are 3 ways you can benefit from borrowing to invest. (We’ve also compiled a list of 6 ways to tell if your personal circumstances favour this strategy. See below.)

1. Today’s low interest rates favour borrowing to invest: Today, you can borrow for as little as 3.25% if you use your home as collateral. Over long periods, the total return on a well-diversified portfolio of high-quality stock market investments runs to as much as 10%, or around 7.5% after inflation. So you can expect to earn more than your borrowing cost.
2. You can use your dividends to pay your investment loan interest: If you borrow to buy well-established, dividend-paying stocks (or mutual funds that invest in these stocks), like those we recommend in our Canadian Wealth Advisor newsletter, these investments will give you regular dividend income and cash flow to pay the interest on your investment loan.
3. Borrowing to invest can cut your tax bill: Borrowing to invest can be a highly effective tax shelter. That’s because you can deduct 100% of your interest expense against your current income. Plus, the investment income you earn comes with three key tax advantages: you get the dividend tax credit on qualified Canadian stocks and you only pay tax on 50% of your capital gains.

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

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Borrowing to invest is not without 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.

That’s why borrowing to invest only makes sense if all 6 of the following apply:

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 investment approach;
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 contributions.

For our latest views on lower-risk investments suitable for borrowing to invest, you should subscribe to our Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.