By Tom Bradley
With interest rates so low, one of the most common questions we get from investors is whether they should borrow to invest. It comes mostly from, but not limited to, young investors. Last week, I was asked about it by two impressive young people within an hour of each other.
As regular readers will know, I’ve written on this topic a number of times, most recently in a March post. Needless to say, the complacency around debt scares the hell out of me.
I’m in the middle of converting my thoughts into math (because it’s the math that’s precipitating these questions – i.e. past returns are far in excess of borrowing costs), but in the meantime, I want to lean on no less an authority than Warren Buffett. In his Letter to Shareholders this year, he talked about long-term investing, volatility and borrowing to invest. For anyone who is considering using borrowed money to invest (and/or is being hounded by the banks and Investors Group to do so), it’s required reading.
“Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money has no place in the investors’ tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator - and definitely not Charlie [Munger] nor I –can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.”
I know the math can work, but I’m a firm believer that there are very few investors who should be borrowing to invest. As I said in the earlier post, there are two situations where it might be applicable.
1. Investors who are short the money to make an RRSP contribution, but can pay back the loan or line of credit within six months.
2. Sophisticated, well-healed investors who understand the worst case scenarios and will not abandon the strategy when hit by a severe market blow.
Call me hard line, but investing is hard, and it gets a whole lot harder when leverage is involved.