Borrowing to invest is for the rich, say advisors

Borrowing to invest is for the rich, say advisors

Borrowing to invest is for the rich, say advisors Borrowing to invest for retail clients is a conclusive ‘no, no’ for some advisors.

In response to IIROC’s announcement Wednesday – warning advisors and dealers to ensure their clients are fully aware of the implications from borrowing money to pay for stocks and other securities – advisors feel the risks outweigh the profit.

“I think it is a bad idea at the retail level,” says Reg Jackson of the JMRD Wealth Management Team. “I don’t think the risks are adequately understood. When you’re investing in the stock market where nothing is guaranteed your capital is at risk.”

Doug Swanson, an advisor and owner of the Douglas E. Swanson Assurance Agency, agrees with Jackson, though there was a situation where one of his clients did so, ignoring his advice. Swanson says the client attended a seminar and decided to pursue the loan endeavour on the advice of another advisor.

"If I was not prepared to do it, they would have considered moving their existing investments. I did not provide the loan, but I did provide the investment and the reporting format," said Swanson. "Their circumstance changed dramatically and there was insufficient time to come out with a positive experience or in dollars. I nursed the client back to financial health."

According to Swanson, both clients are now 'gold' clients, follow his advice, and have since provided him with numerous referrals.

Both Swanson and Jackson feel the volatility of the stock market is the primary reason retail investors should steer clear of this practice, and advisors should not encourage them to do so. Market disruptions and unexpected pull backs can come out of left field, says Jackson, leaving a client at a standstill.

“Losing capital is one thing, but losing capital and then being forced to also make payments on money that is borrowed … you can get into a very difficult position in real hurry,” he says. (continued.)

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  • Leo Durand 2014-02-20 2:21:05 PM
    I am amazed that advisors are allowed by their sponsoring firms to introduce this advanced investment strategy. It may be only my opinion that the level of risk to the client and the advisor is really not understood by either. Years ago I managed to figure out the saying “Sounds too good to be true” means in almost every case it is! Unfortunately for some they’re not willing to listen, just have to learn or experience the impact themselves
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  • Bob T 2014-02-20 3:23:06 PM
    I agree with Leo. I have had to rescue too many people who have come to me from other (usually MFDA) advisors with huge loans and huge losses. In my opinion every one of them should have sued the advisor who recommended borrowing to invest.
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  • Bob White, CLU 2014-02-20 7:31:15 PM
    Leveraging is not bad, we do it every day when we buy a home with a mortgage or a car with a loan.

    What is bad from the investment perspective is how it is positioned. I have seen the good the bad and the ugly when it comes to leverage investment loans.

    First off should be the why and what. What is the purpose of the loan and why does it work. It has to be part of a financial planning, Estate planning, tax planning process and it has to be low/medium risk managed money, fee for service (tax deductions) and long term. The client needs to be in a higher tax bracket, and has the higher risk tolerance. And the Goal should be to be as tax efficient as possible using Corporate class structures, so not to be triggering taxable events when changes need to be made.

    Recently I took over my brother in laws leverage account. It was nasty to say the least, seg funds that paid the highest DCS fees and compensation to the advisor, and in 7 years is underwater. Not managed, it was just a sales job by the salesman who holds himself out as a financial advisor.

    My own personal leverage was done Sept 2008 and then the market took an additional correction a 20% drop, but, at this point in time I have made 79% growth in 5 1/2 years. The intent was to achieve 1% over the gross cost of borrowing. With the cost of borrowing is deductible and simple interest.
    So there is 30% in tax savings, which with out question forms part of the overall return, and the fees of 1% are also deductible for another .3% benefit. Add up all the benefits and the realized gain is significant.

    You need to have a sensativity spread sheet to be able to illustrate to the client what happens with drop on investment return, increase in interest charges and changes in tax rates. If this is not done, then there should be no leveraging, it is just a sale ploy to sell a bigger investment. An advisor would do due diligence and make sure it was crystal clear as to the pros and cons.

    If there is no planning, then there should be no leveraging.

    It is not rocket science, If the advisor does not know the math, the tax laws, the investment risks, the costs associated with the investments, the historical data on the investments in detail, the Standard Deviation, the up and down side of the markets, the tax consequences of the investments, for buy selling and switching, then they should never even consider putting the client at the risk of the crap shoot.

    To blanketly state leverage is bad, is because too many have harmed too many people through no planning, no real advice and a lot of sales tactics, and this has made it difficult for planners to use leverage to the benefit of those who can benefit by the planning, because now the regulators deem that all leverage is bad.

    Just my thoughts.


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