Poll

should I use HELOC to buy stock ETF ?

Don't do it you Dumbass !!!!!
12 (35.3%)
Look risky to me...
9 (26.5%)
Worthless exercise. Sum of this will probably be zero anyway
2 (5.9%)
You may be on something here
7 (20.6%)
It's definetly the next step for you mate !
4 (11.8%)

Total Members Voted: 31

Voting closed: October 09, 2014, 02:52:57 PM

Author Topic: Borrow to invest  (Read 6186 times)

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Borrow to invest
« on: September 29, 2014, 09:39:35 AM »
I procrastinate to use my HELOC to invest for a while. I long think to get some shares in private company (the one where I work for 5 years now) or maybe local real estate (fixer upper or foreclosure). Both plans would mean 100K$ to 200K$ investment, mostly from HELOC. But after waiting (for opportunity) and thinking (about collaterals) I'm now thinking about investing in the Canadian stock market instead.

Here's my situation: First, I'm in Canada, so, consider the taxes are quite different than the US in many ways. I’m 42 years old, + Mrs. and 2 kids (11 & 7). RRSP maxed out (425K$) and RESP (70K$). TFSA 5K$ (58K$ room). We bring 120K$ (gross) and put everything we can toward RRSP, RESP and mortgage principal (but nothing in TFSA). House value 340K$, mortgage 95K$ @ 3.5% with 5 years to go. HELOC available 125K$ @ prime (3%) and another personal credit line of 50K$ @ prime+2%. No other debt now and never in the future unless for investments purposes (cars and many others things are always bought used and for cash). When plan to be FI in 5 to 7 years.

Since buying some shares in a private company is very interesting because I'm an insider and taxes would be great, it’s a kind of commitment and I'm not sure anymore I'm willing to do it because of my early retirement plans. For the real estate, the market is expensive compared to the rent. I can find opportunities in the 150K$-200K$ bracket but the rent will just cover the loan and expenses (no positive cash flow) so I get exposed to debt just to build capital. I think this plan may be great in 5-10 years from now when the boys get older and it could be fun to do it together if they want to do so...

Since we have 500K$ in investment, all in low cost index ETF (25% bonds, 20% Canadian stock, 5% REIT, 25% US stock and 25% int. stock) and went through the market ups and downs with a grin over the years, I think when could handle a little leverage just fine. As an example, for the next 5 years, we can buy 20K$ of Canadian equity (XIU or ZCN) with the HELOC and claim the interest expenses. The total would be 100K$ when the mortgage principal is repaid. Domestic stock mean low taxes and over time, I would decrease their % in non-taxable accounts, increasing bonds or other stock ETFs.

Does this worth or it's just performance chasing?

Everyone around me, with same or lower salaries, have 2 car loans (2 x 25K$) and 200K$ mortgage, no money invested anywhere (no RRSP and no RESP), no pension plan and they don't know what is a TFSA! They complain about gas price but drive 2x to 3x more than us (wtf!), they head south every year, plan to get a RV (on credit) you see the picture? Their "leverage" is probably something like 5:1 and mine would be more like 1:10...

That’s why I can't talk about this with anyone I know. Now, Mrs. just get her eyes glazed over when I say words like: investment, taxes, rate of return, debt ratio etc (MMM ruining your marriage anyone?). She’s still recovering of an anti-Mustachian childhood, so I just try to stay on “the efficient frontier” with her because of the higher cause ;-)
Waiting for your comments fellow Mustachian !

Le Barbu

Now, I realise the title should have been "Crush mortgage fast then use HELOC to invest"




« Last Edit: September 30, 2014, 12:54:29 PM by Le Barbu »

trailrated

  • Handlebar Stache
  • *****
  • Posts: 1136
  • Age: 33
  • Location: Bay Area Ca
  • a smooth sea never made a skilled sailor
Re: Borrow to invest
« Reply #1 on: September 29, 2014, 10:29:00 AM »
@Beric I am not sure the rest of the handle pointed this out in one of the earlier threads last week I think. Essentially someone had a similar idea and pulled the trigger back in 2007 right before the financial shit hit the fan. It took me two days but I read every comment in the thread. It was fascinating to say the least. Just know there are some major risks involved.

http://www.bogleheads.org/forum/viewtopic.php?t=5934

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #2 on: September 29, 2014, 11:14:56 AM »
Hi trailrated, I read this thread myself as well but still don't get how come it's more risky to borrow 20K$ to buy an asset class that can return an average of 5% to 8% considering an actual P/E of 17.3 compared to buying a 25K$ brand new car with a 20K$ car loan. The car WILL for sure, depreciate 15%/year an cost some insurances, maintenance etc. It brings negative cash flow, the interest are not tax deductibles. Everyone still do it every 2-5 years !

Let say I do it and the market tank 50% the day after the transaction. I will have to pay 360$ of interest per year after tax (whoooo!!!). If it didn't recover after 1 year when I buy the second slice of 20K$, I get a 50% rebate so twice the number of share (Hourra!!!). At this point, I have 40K$ loan with 30K$ face value (10K$ capital loss on paper), 720$ after taxes interest to pay per year and dividend yield probably around 500-700$ (0 to 250$ negative cash flow on a yearly basis. By this time, the guy who bought his new car still owe 15 grant with a car that worth 15 grant and a negative cash flow of -5,000$ per year.

Remember that I got 375K$ NOW in the markets and I talk about 20K$ more...by the time I reach 100K$ leverage, all my debts are repaid and my total investment would be around 900K$

I "lost" like 100 grants in the crisis and did not sell/panic, why would I do so in the next one ?

its a perspective question I know...
« Last Edit: September 29, 2014, 11:27:01 AM by Le Barbu »

trailrated

  • Handlebar Stache
  • *****
  • Posts: 1136
  • Age: 33
  • Location: Bay Area Ca
  • a smooth sea never made a skilled sailor
Re: Borrow to invest
« Reply #3 on: September 29, 2014, 11:29:16 AM »
I never considered that, you just made this way more interesting to me. Valid points sir!

Beric01

  • Handlebar Stache
  • *****
  • Posts: 1156
  • Age: 30
  • Location: SF Bay Area
  • Law-abiding cyclist
Re: Borrow to invest
« Reply #4 on: September 29, 2014, 11:55:08 AM »
Hi trailrated, I read this thread myself as well but still don't get how come it's more risky to borrow 20K$ to buy an asset class that can return an average of 5% to 8% considering an actual P/E of 17.3 compared to buying a 25K$ brand new car with a 20K$ car loan. The car WILL for sure, depreciate 15%/year an cost some insurances, maintenance etc. It brings negative cash flow, the interest are not tax deductibles. Everyone still do it every 2-5 years !

Let say I do it and the market tank 50% the day after the transaction. I will have to pay 360$ of interest per year after tax (whoooo!!!). If it didn't recover after 1 year when I buy the second slice of 20K$, I get a 50% rebate so twice the number of share (Hourra!!!). At this point, I have 40K$ loan with 30K$ face value (10K$ capital loss on paper), 720$ after taxes interest to pay per year and dividend yield probably around 500-700$ (0 to 250$ negative cash flow on a yearly basis. By this time, the guy who bought his new car still owe 15 grant with a car that worth 15 grant and a negative cash flow of -5,000$ per year.

Remember that I got 375K$ NOW in the markets and I talk about 20K$ more...by the time I reach 100K$ leverage, all my debts are repaid and my total investment would be around 900K$

I "lost" like 100 grants in the crisis and did not sell/panic, why would I do so in the next one ?

its a perspective question I know...

The difference is, the car has insurance by law protecting it against total loss. The investment has no such protection.

Remember, borrowing money also hurts your returns due to interest on that money. If you have ~400K now and add 20K, you have increased your total portfolio by 5%. Subtract out the interest of the borrowed funds and you're talking about a miniscule amount of additional returns. Is it even worth it?

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #5 on: September 29, 2014, 12:52:38 PM »
Hi Beric01, good point about the +5% total portfolio, but I can’t really think this way coz my yearly contribution is in this 20-25K$ range, so worthless also. If I count both (cash + loan), it's more like a 10% contribution. I would also do it gradually over 5 years to get used with paperwork etc. It would also be my "reward" for paying my mortgage faster (12 years). In Canada, the interest on mortgages are not tax deductible but a loan for investment in my tax bracket is 40% less (actually 3% would be 1.9%) with dividend paying 2.3-2.5% taxed at 15% (2% net) so they cover the cost.

In the car/loan example, we must consider the depreciation and expenses a lot more than a total loss/insurances case. Even if I could buy an insurance in case of the Canadian stock market went to zero in a second, I wouldn't pay 1$ to do so. If there was an insurance available to protect a car from the 90% depreciation it suffer over 10 years, this one would probably cost the same as the depreciation itself + xx% profit margin.

I'm not ready right now to get a 175K$ loan neither to buy a rental house nor to commit myself in a private business but I definitely want to increase my total investment.

I even thought to decrease my domestic equity exposure in tax-sheltered accounts. This way, I can keep the same bond/equity ratio while I increase the total portfolio size (only by 5% I know!)

Whit conservative assumptions, this would bring 50K$ over 10 years with no cash down no tenant or repairs and few minutes of paperwork a year. Then someday, I could decrease the borrowing or keep it around 100K$ or sell everything and by a rental etc.
« Last Edit: September 29, 2014, 01:19:41 PM by Le Barbu »

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #6 on: September 29, 2014, 01:50:49 PM »
The Canadian stock ETF would be a low cost index (XIC or ZCN or VCN) purchased in a taxable account where dividends and capital gains are merely taxed. The MER of these ETF are 0.05% and they track 95%+ of the Canadian stock market. The interest on the HELOC would be tax deductible at marginal tax rate. Here are my assumptions and numbers I run my calculations with:
Loan rate over 10 years: 4% getting a 38% deduction considering my marginal tax rate, net 2.5% 
Dividend yield: 2.5% (taxed at 15% in my tax bracket). Net 2.1%
Capital appreciation: 5%
Borrow/invest 20K$ first year and 20K$ more every year up to 100k$
All this require no cash down, the cash flow would be pretty close to 0$ (especially if I “capitalize” the interest and keep all the dividends in the account). Worst case scenario? Paying 1,000$, maybe 2,000$ a year from my pocket any given year of that period, I don’t mind.
After 10 years: 20K$ interest paid, 19K$ dividend earned, 48K$ capital appreciation, net worth increase 47K$. I would sell only if I retire and step back in a low tax bracket with 50% of the capital gains taxable to keep the most of it.
A 30% drop of the market would mean losing a maximum of 23K$ on year 5 (the worst) and 1K$ on year 10 (the least) because everything ends as reverse to the mean on average.
Anything else I forget ?

beaster

  • 5 O'Clock Shadow
  • *
  • Posts: 45
Re: Borrow to invest
« Reply #7 on: September 30, 2014, 06:19:52 AM »
Wondering why you haven't maxed out your tfsa?


Sent from my iPhone using Tapatalk

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #8 on: September 30, 2014, 07:11:11 AM »
I did when the account was issued in 2009 but when we reached 40K$, I transfered 35K$ to lower the mortgage capital. Since then, every penny is put on mortgage after RRSP and RESP. Now, I feel confortable with 100K$ debt and my HELOC is 0.5% lower than the fixed mortgage. I would just continue to crush that one, borrowing the same amount on HELOC and the interest will be 2% net (tax déductible)

beaster

  • 5 O'Clock Shadow
  • *
  • Posts: 45
Re: Borrow to invest
« Reply #9 on: September 30, 2014, 07:51:53 AM »
A lot of the decision will have to do with your ability to sleep at night :)
I'm a little bit younger and don't plan to need to use my invested assets for some time, but when we bought our house a few years ago we could have paid outright (we are lucky to live somewhere with reasonably priced housing) but the fixed rate we could get on our mortgage was very low so we just made the minimum down payment to avoid cmhc insurance and decided to take advantage of the low rates and invest the rest. So in a backwards kind if way we are sort of doing similar to what you propose.
I would never recommend anyone borrow to invest as is a very individual decision but for our risk tolerance we are comfortable doing this. I see managing your personal finances similar to running a business- you take advantage of leverage when makes sense to grow your company (personal wealth!)


Ps- I am a fan of maxing the tfsa (after maxing rrsp, and resp for max grant). In future I plan to live off withdrawals of funds from
Tfsa when I "retire early".


Sent from my iPhone using Tapatalk

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #10 on: September 30, 2014, 11:20:57 AM »
What do you invest your TFSA in ? The only asset class I know that can return over 3.5% on the long run is stock market...that´s why I figured It´s my tradeoff.

I use to max everything but Mrs. Works 4 days/week now (a family decision to improve life quality) and we put asside 45k$/90k$ net. If I push further, it wont be fun anymore !
« Last Edit: September 30, 2014, 12:44:53 PM by Le Barbu »

beaster

  • 5 O'Clock Shadow
  • *
  • Posts: 45
Re: Borrow to invest
« Reply #11 on: October 01, 2014, 07:15:54 AM »
I have usd stocks and options (and cash related to options trading) in my tfsa. Reason for the usd is that I had some us cash and did not want to convert back to cad. I live in canada but majority of my investments are usd.
The options part of my portfolio is my "mad money"- purely speculative but the most fun to manage ;)
One cad denominated etf I do allocate retirement funds to in other accounts when I don't have time to research and get lazy is CUD.TO.


Sent from my iPhone using Tapatalk

beltim

  • Magnum Stache
  • ******
  • Posts: 2961
Re: Borrow to invest
« Reply #12 on: October 01, 2014, 07:47:45 AM »
Before using leverage to increase stock exposure, why wouldn't you go to a 100% equity allocation?  The risk/reward of selling bonds to buy stocks is better than to use leverage to invest in stocks.

Put another way, money doesn't know where it came from.  So if you use HELOC funds to buy stocks, but still have bonds, then you're effectively using HELOC funds to buy bonds.  And, depending on interest rates, that could be close to a guaranteed loser over time.

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #13 on: October 01, 2014, 09:58:20 AM »
Pretty interesting beltim, maybe I just begin to feel uncomfortable about letting all the equity of my house sitting still. On the other side, I would like to crush the remaining capital as soon as possible. Now, my previous investing plans (private shares, land lording) are neither interesting nor suitable for the next 5 years at least, I’m looking for something else.

Why does I’m more inclined to keep about the same assets split/strategy and just increase the overall portfolio size instead of increasing stock % ? The 5 years strike of the markets…

In the meantime, if I decide to give a try, I’ll do it with 10k just to experiment the hassle of the paperwork (tracking and taxes). Maybe it will just convince me to let go.

I tried some quick calculations. To make it simple, I made it without considering new money:

Option #1: 500K at 6.8% (25/75 split) worth 965K after 10 years
Option #2: 600K at 6.3%* (25/75 split *with 100K leverage) = 1105K$
Option #3: 500K at 7.1% (20/80 split) worth 993K after 10 years
Option #4: 500K at 7.5% (10/90 split) worth 1031K after 10 years
Option #5: 500K at 7.9% (0/100 split) worth 1070K after 10 years

Conclusion, 1105K$ vs 1070K$ over a 10 years period are probably too close to call ;-)



« Last Edit: October 01, 2014, 11:08:26 AM by Le Barbu »

beltim

  • Magnum Stache
  • ******
  • Posts: 2961
Re: Borrow to invest
« Reply #14 on: October 02, 2014, 08:58:25 AM »
So it looks like you're assuming 4% bond returns against a after-tax cost of 2.5% on your loan.  I'm not sure what your taxes are on bond interest and capital gains, but that looks too close to me to be worth the risk.  The numbers for equities are much more favorable, as you showed in
Here are my assumptions and numbers I run my calculations with:
Loan rate over 10 years: 4% getting a 38% deduction considering my marginal tax rate, net 2.5% 
Dividend yield: 2.5% (taxed at 15% in my tax bracket). Net 2.1%
Capital appreciation: 5%
Borrow/invest 20K$ first year and 20K$ more every year up to 100k$
All this require no cash down, the cash flow would be pretty close to 0$ (especially if I “capitalize” the interest and keep all the dividends in the account). Worst case scenario? Paying 1,000$, maybe 2,000$ a year from my pocket any given year of that period, I don’t mind.
After 10 years: 20K$ interest paid, 19K$ dividend earned, 48K$ capital appreciation, net worth increase 47K$. I would sell only if I retire and step back in a low tax bracket with 50% of the capital gains taxable to keep the most of it.

clifp

  • Pencil Stache
  • ****
  • Posts: 547
Re: Borrow to invest
« Reply #15 on: October 02, 2014, 03:10:21 PM »
Before using leverage to increase stock exposure, why wouldn't you go to a 100% equity allocation?  The risk/reward of selling bonds to buy stocks is better than to use leverage to invest in stocks.

Put another way, money doesn't know where it came from.  So if you use HELOC funds to buy stocks, but still have bonds, then you're effectively using HELOC funds to buy bonds.  And, depending on interest rates, that could be close to a guaranteed loser over time.

+1 that was exactly my thought also. Now I know very little about the Canadian market or how taxes work there..  What you are doing is borrowing short and lending long with respect to your bond portfolio. Now that is a great strategy if interest are falling, the value of your bond portfolio increase, and you can arbitrage the difference between short and long-term rates. Of course not a good strategy if interest rates are rising.

I'll tell you my experience in Jan 2008 I borrowed 100K via a 4% (fixed) HELO. I invested some of the money in index funds, but the bulk was invested in individual bank stock.  The bank dividend were around 5%. My interest was deducted at ordinary income (28% rate) the dividends were taxed at 15% and they were been raised 5-8%/year.  The dividends complete covered the interest expense. Maybe not fool proof but low risk which it was until the summer of 2008.  Now my bank stock picking skills (Wells Fargo, BB&T, US Bank) were fine all of the banks came through the great recession in very good shape.  But my timing? well that sucked...

The interest rate is low enough and your leverage small enough, that doubt it will make much of difference.  It is not something I'd do in the US market at current levels.

sirdoug007

  • Pencil Stache
  • ****
  • Posts: 585
  • Age: 40
  • Location: Houston, TX
Re: Borrow to invest
« Reply #16 on: October 02, 2014, 03:53:06 PM »
I think in order for this to have any significant chance of success you would have to be willing to ride it out on a pretty long time horizon.

This chart from a Random Walk Guide to Investing shows the range of annual returns over various time periods.



This only goes through 2002 so the last 13 years has not been included.  Note that 2000 to 2014 had an annual return of 3.55%.

So you would be looking at a 15 year plan for this to have a good chance of working out.  Otherwise it's just rolling dice.

Beric01

  • Handlebar Stache
  • *****
  • Posts: 1156
  • Age: 30
  • Location: SF Bay Area
  • Law-abiding cyclist
Re: Borrow to invest
« Reply #17 on: October 02, 2014, 04:04:03 PM »
I think in order for this to have any significant chance of success you would have to be willing to ride it out on a pretty long time horizon.

This chart from a Random Walk Guide to Investing shows the range of annual returns over various time periods.



This only goes through 2002 so the last 13 years has not been included.  Note that 2000 to 2014 had an annual return of 3.55%.

So you would be looking at a 15 year plan for this to have a good chance of working out.  Otherwise it's just rolling dice.

And remember, past performance is not indicative of future returns. Returns could be better... or worse in the future (see Japan).

sirdoug007

  • Pencil Stache
  • ****
  • Posts: 585
  • Age: 40
  • Location: Houston, TX
Re: Borrow to invest
« Reply #18 on: October 02, 2014, 04:12:21 PM »
Also doesn't include the Great Depression.  1/1/1929 to 12/31/1944 had an annualized return of 1.82%...although one more year to 1945 and it goes to 3.72%

Self-employed-swami

  • Handlebar Stache
  • *****
  • Posts: 1094
  • Location: Canada
Re: Borrow to invest
« Reply #19 on: October 02, 2014, 07:11:41 PM »
I'm a Canadian, and 2 years ago, I borrowed $65,000 from our HELOC and bought some no-load mutual funds that are now worth ~$83,000.  The interest is pretty small, we just pay it every month from our cash flow, and write it off as an expense against income earned at tax time.  It has worked out for us, but we aren't at the maximum we could take out of the HELOC, so we have emergency room as well.

A few months ago, I also shifted my extra mortgage payment money to the mutual fund (along with my RRSP funds, as I've maxed that out already for the year), so an extra $250/week is going into that pool.
« Last Edit: October 02, 2014, 07:13:20 PM by Self-employed-swami »

tracylayton

  • Guest
Re: Borrow to invest
« Reply #20 on: October 02, 2014, 07:25:16 PM »
I would never borrow to invest, with the exception of a mortgage on a rental home that had a low interest mortgage and automatic equity because I put 20% down and also bought way below market value.

Overseas Stache

  • Stubble
  • **
  • Posts: 130
  • Age: 36
  • Location: Democratic Republic of Congo
Re: Borrow to invest
« Reply #21 on: October 03, 2014, 06:41:55 AM »
The numbers make sense IF your HELOC stayed at 3%. But it is based on the prime rate, so what happens if the market takes a dive and the interests rates go up? This unknown variable of the interest rate really makes it hard to say if it will be a winner or a looser in the long run. Because you are planing on buying and holding for the long run, but the longer you hold the stock the more you risk that the interest rates will go up.

Le Barbu

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Age: 49
  • Location: Québec
  • I really didn’t say everything I said - Y. B.
Re: Borrow to invest
« Reply #22 on: October 03, 2014, 09:39:49 AM »
Makes sense guys, there's a lot of unknown in this process even if my conservative assumptions made it look as a win on the long run.

Before using leverage to increase stock exposure, why wouldn't you go to a 100% equity allocation?  The risk/reward of selling bonds to buy stocks is better than to use leverage to invest in stocks.

Put another way, money doesn't know where it came from.  So if you use HELOC funds to buy stocks, but still have bonds, then you're effectively using HELOC funds to buy bonds.  And, depending on interest rates, that could be close to a guaranteed loser over time.

Considering this, I just decided to decrease my bonds allocation from 25% to 20% NOWWW on the overall accounts. Some of them just can't go lower than xx% for xx reasons. I'll probably shift toward 10% over time but will keep some bonds for rebalancing purpose. Anyway, the performance increase from a 10/90 to a 0/100 split is thin, especially on a risk/inflation adjusted basis. BTW, my bonds are short gov., the least equity correlated, not very sensible to interest rates and they keep up with inflation.

All cash available will be applied on the mortgage capital, increasing the available HELOC that will remain unused unless there's a no-brainer opportunity. The future cash flow will be better this way and no more debt risk involved.

To be honest, I could give a try with 10,000$ next year just to experiment a bit of hassle ;-)
« Last Edit: October 03, 2014, 09:53:48 AM by Le Barbu »