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Investment

Leveraged Investing

You should realize that, when you borrow to invest, you could win big if your investments perform well. On the flip side, a decline in the value of your investments could leave you kicking yourself. Leveraged investing in a bear market could cause any man to weep.

The Rules of Thumb

  1. Leveraged investing works best if you’re in the highest marginal tax bracket (46.4%). While you’ll incur the same interest costs as those in the lower tax brackets, you’ll experience greater tax savings from the interest deduction.
  2. The lower your interest costs, the more profitable leveraging can be. You’ll also find that, where your investments decline in value, your losses won’t be as severe as your interest costs are reduced. .
  3. The loss from negative returns in a leveraging scenario are more magnified than the gains realized from positive returns (refer to the table below). Stick to more conservative investments when leveraging. Higher risk investments simply become that much riskier when adding borrowed money to the equation
  4. Focus on equity investments. It is important to earn high enough returns to make leveraging worthwhile. The fact is, many interest-bearing investments may not cut it in this department.
  5. This is a longer term investment strategy. If you’re holding equities as part of your leveraging program, you should take a longer term view.
  6. Keep your interest deductible. Once you’ve invested the borrowed money - keep it invested. This will preserve the deductibility of your interest. Where capital has been borrowed, you run the risk of losing some of the interest deductibility if you later use that invested capital for personal purposes, including paying down debt or interest on the debt.
  7. Be sure you can sleep at night - don’t borrow to much. As a guideline keep your leveraged borrowing at 30% of your net worth for investing. 

No Leverage

Leveraged:
Profits Earned

Leveraged:
Losses Incurred

Personal funds invested

$ 10,000.

$ 10,000.

$ 10,000.

Borrowed funds invested

-

$ 10,000.

$ 10,000.

Total Invested

$ 10,000.

$ 20,000.

$ 20,000.

Return on Investment

$ 1,000.

$ 2,000.

($ 2,000.)

Less: Interest costs

-

(800)

(800)

Plus: Tax savings from

-

400

400

interest deduction
Net return on total investment

$ 1,000.

$ 1,600.

($ 2,400.)

Return on personal investment

+ 10.0 %

+ 16.0 %

(- 24.0 %)

Assumptions:
Return on investment

+ 10.0%

+ 10.0%

(- 10.0%)

Rate of interest on debt

+ 8.0 %

+ 8.0 %

+ 8.0 %

Marginal Tax Rate

+ 50.0%

+ 50.0%

+ 50.0%


E.&O.E.