How much leverage is safe in investing?

[RMA]

Let's say if you're getting a loan at 2.8% p.a. (overdraft facility, i.e., interest will incur only if you use the loan) and you are low to moderate risk taker then would you use the loan or not? If you decide to use then where will you invest?

[Kanto]

Let's say if you're getting a loan at 2.8% p.a. (overdraft facility, i.e., interest will incur only if you use the loan) and you are low to moderate risk taker then would you use the loan or not? If you decide to use then where will you invest?

I would not expose myself to investment risk and loan risk at the same time.

If you have an appetite for risk, but do not want to expose yourself to debt, then you could purchase leveraged ETFs.

The other option is, of course, options. You could purchase puts and calls on the TSX or foreign markets via IBKR.

More upside risk.

I would not do any of this myself.

[mighty58]

It really depends... is this a margin account? Or some other sort of loan facility that will (for some reason) allow you use the money investing? With a margin account, you'll need to keep sufficient liquidity (cash) in order to meet a margin call in case your securities take a dive, or eat a big loss. If this is a traditional loan, you can of course be more patient in the event of a dive.

By saying that you are a "low to moderate risk taker", what exactly do you have planned? Are you planning to, say, put it into an all-country index fund? It's certainly feasible that you could return more than 2.8% with an index fund... but it's also feasible you won't. On the other side, with an index fund, it's highly unlikely you'll lose 30% in a year, but then again... you might.

So the next question then, is how big this loan would be vis-a-vis your entire portfolio? Is a 30% loss an amount you could cover? 30% of $100,000 vs. $1m vs. $10m are all very different scenarios.
It all comes down to your appetite for risk/reward, and investing with borrowed money will amplify both the gains and the losses.

(if this is a loan, I'd be interested in hearing where you got a loan for investing)

[RMA]

Let's say if you're getting a loan at 2.8% p.a. (overdraft facility, i.e., interest will incur only if you use the loan) and you are low to moderate risk taker then would you use the loan or not? If you decide to use then where will you invest?

I would not expose myself to investment risk and loan risk at the same time.

If you have an appetite for risk, but do not want to expose yourself to debt, then you could purchase leveraged ETFs.

The other option is, of course, options. You could purchase puts and calls on the TSX or foreign markets via IBKR.

More upside risk.

I would not do any of this myself.

I understand your point. What if there is no timelimit of repaying the loan and you can easily bear the interest costs for the next 10 years?

Let's say if you take out a loan of JPY 1,000,000 at 2.8% interest p.a. and you don't have to repay that loan until you wish to and you can easily bear the interest cost for next 10 years. Don't you think refusing such kind of a loan would mean we are not sure that equity index funds will yield more than 2.8% annually on a 10 year horizon? Aren't we taking a risk by not utilizing the loan amount and increase our wealth?

I am not trying to be argumentative, I just want to see what am I missing here?

And ofcourse this is a hypothetical situation. It is not common for lenders to give overdraft facility at 2.8% interest p.a. with no repayment schedule.

[RetireJapan]

There is always a post

https://www.retirejapan.com/blog/bad-id ... to-invest/

[Kanto]

I understand your point. What if there is no timelimit of repaying the loan and you can easily bear the interest costs for the next 10 years?

Let's say if you take out a loan of JPY 1,000,000 at 2.8% interest p.a. and you don't have to repay that loan until you wish to and you can easily bear the interest cost for next 10 years. Don't you think refusing such kind of a loan would mean we are not sure that equity index funds will yield more than 2.8% annually on a 10 year horizon? Aren't we taking a risk by not utilizing the loan amount and increase our wealth?

I am not trying to be argumentative, I just want to see what am I missing here?

And ofcourse this is a hypothetical situation. It is not common for lenders to give overdraft facility at 2.8% interest p.a. with no repayment schedule.

Typical loans cannot be used for investing.

Margin loans for investing can be riskier. If you face margin call, you have 24 hours or less to meet the margin requirement or your positions will be liquidated to cover.

If you are certain of continuous upside in the market set aside part of your portfolio for a 2x/3x index fund, or purchasing options.

Increased exposure without the loan risk.

[RMA]

It really depends... is this a margin account? Or some other sort of loan facility that will (for some reason) allow you use the money investing? With a margin account, you'll need to keep sufficient liquidity (cash) in order to meet a margin call in case your securities take a dive, or eat a big loss. If this is a traditional loan, you can of course be more patient in the event of a dive.

Thank you for your reply.

No I don't mean margin account. It is some sort of a loan facility where you have to pay interest on only that amount which you use and there is no repayment schedule. You can repay tomorrow or you can repay after 10 years whenever you want to.

By saying that you are a "low to moderate risk taker", what exactly do you have planned? Are you planning to, say, put it into an all-country index fund? It's certainly feasible that you could return more than 2.8% with an index fund... but it's also feasible you won't. On the other side, with an index fund, it's highly unlikely you'll lose 30% in a year, but then again... you might.

I have not planned anything and not sure whether I will use the loan facility or not but I wanted to know what is the harm in using it? If I decide to use it then of course I will put it into an S&P or similar index fund or some other safe and sound option. As there is no repayment deadline so even if I don't make 2.8% or lose 30% in a year, I just have to hold on and bear the interest cost for that year.

So the next question then, is how big this loan would be vis-a-vis your entire portfolio? Is a 30% loss an amount you could cover? 30% of $100,000 vs. $1m vs. $10m are all very different scenarios.
It all comes down to your appetite for risk/reward, and investing with borrowed money will amplify both the gains and the losses.

It is upto me how much I want to use the amount of that loan. The interest will incur only on the amount I utilize and not on the whole loan facility amount. If I do choose to utilize the loan amount then I will calculate how much interest costs I can comfortably bear for the next 10 years.

(if this is a loan, I'd be interested in hearing where you got a loan for investing)

It is not from a traditional institution but let's assume it is from family/friend.

I know this is a peculiar case but if you were in this situation, would you go for it or refuse it?

[mighty58]

I understand your point. What if there is no timelimit of repaying the loan and you can easily bear the interest costs for the next 10 years?

Let's say if you take out a loan of JPY 1,000,000 at 2.8% interest p.a. and you don't have to repay that loan until you wish to and you can easily bear the interest cost for next 10 years. Don't you think refusing such kind of a loan would mean we are not sure that equity index funds will yield more than 2.8% annually on a 10 year horizon? Aren't we taking a risk by not utilizing the loan amount and increase our wealth?

I am not trying to be argumentative, I just want to see what am I missing here?

And ofcourse this is a hypothetical situation. It is not common for lenders to give overdraft facility at 2.8% interest p.a. with no repayment schedule.

Given the conditions of your hypothetical, I for one would be interested in taking that bet. Let's be clear though, it would be a bet, as there have been plenty of 10year periods where equities didn't grow. I wouldn't bother at the 1m yen level, though, 1m dollars would make it more interesting. But as Kanto said, nobody will give you such a loan for investing, much less such a loan with an open-ended term, so the point is likely moot. But with an open-ended term, you could sell only when it's expedient for you to do so, so you would have a major advantage.

If you are certain of continuous upside in the market set aside part of your portfolio for a 2x/3x index fund, or purchasing options.

While I agree that these 2x/3x leveraged bull funds are a better way to get exposure to leverage-like performance without actually leveraging, it's important to note that these products are not conducive to long-term holding, as they constantly "reset" to the previous day's level. Because the reality of the markets is that they go up and down everyday, the performance of these leveraged products is all over the place long-term (not to mention risky as hell).

[RMA]

There is always a post

https://www.retirejapan.com/blog/bad-id ... to-invest/

I just read that post but the case I am saying is different. It is not a term loan so there is no principal repayment schedule and I can repay the principal whenever I want to (no rush and no pressure).

[RMA]

Typical loans cannot be used for investing.

This won't be a typical loan. You can say it will be some kind of a special arrangement where my only liability will be to pay interest on time.

Margin loans for investing can be riskier. If you face margin call, you have 24 hours or less to meet the margin requirement or your positions will be liquidated to cover.

I would never touch margin loan with a ten foot pole.

If you are certain of continuous upside in the market set aside part of your portfolio for a 2x/3x index fund, or purchasing options.

Increased exposure without the loan risk.

I am not certain of anything but it is highly probable that equity index funds should yield more than 2.8% annually over a long period of time. If so then what is the harm in taking such a loan?

Or let's say you have 10 million extra cash lying around at which you can earn 2.8% interest p.a. in bank deposit. Would you keep that money in bank deposit at 2.8% interest p.a. or you will invest in equity funds?