With RRSP season in full swing, the New Brunswick Securities Commission is warning investors about the risks of leveraged investing.
Echoing a similar warning from the Ontario Securities Commission, issued last month, the NBSC is warning investors about the potential for serious long-term financial hardship when borrowing money to invest. It notes that while leveraging is a legitimate investment strategy, it is not suitable for everyone and may not work out as planned.
“There are substantial risks and investors need to know all the facts before deciding if borrowing money to invest is right for them,” said Rick Hancox, executive director of the NBSC. “Ultimately, investors should know who they are dealing with and fully understand what they are investing in.”
In its investor alert, the NBSC notes that the expectation is that the returns on a leveraged investment will be more than sufficient to pay the interest on the loan; and as the money borrowed is being used to invest, the interest paid on the loan is tax deductible, providing additional cash at tax return time.
The biggest drawback to a leveraging strategy, the alert stresses, is what happens if the investment drops in value. Then, the returns won’t be enough to pay the interest, additional collateral will be required to secure the loan, and the investor is left with a loan to pay off. The alert sets out a series of questions that investors should ask themselves before deciding to borrow to invest.
“There are suitability criteria set out by the industry that your financial adviser should carefully review with you before attempting this type of strategy,” said Hancox. “Investors should fully understand the risks and be extremely cautious if considering borrowing beyond their financial means.”