STRATEGY SHEET
January 2000
Do You Use Power Tools?
© Talbot Stevens
One of my goals as a financial educator is to help investors and advisors understand one of the most controversial strategies in financial planning.
Leveraging, or borrowing to invest, is a wealth-building strategy used by the rich for centuries that has started to become more popular in the 1990s as interest rates have fallen significantly.
My experience is that the strategy of borrowing to invest, either to increase RRSP investments or non-registered savings, is very poorly understood by investors and even financial advisors.
A lack of good information detailing the pros and cons of leveraging results in many people becoming greedy or scared of retiring poor, and consequently leveraging much more than they should. Even more often, investors are unaware of the strategy or dismiss it due to the same lack of understanding.
Even industry watchdog and Ontario Securities Commission consumer advocate, Glorianne Stromberg, in her latest review of the mutual fund industry, acknowledges that if leveraging is both understood and implemented responsibly, the classic win-win results where all parties involved benefit, most importantly the investor.
This is why I have always referred to the approach of using conservative leverage. If it does benefit the investor, then why don't we implement leverage responsibly, as opposed to leveraging too much or not at all.
In my educational seminars, I give a simplified example of how leveraging over a 1-year period can magnify a 10% before-tax return to a 25% after-tax return. Then I demonstrate how leverage is a double-edged sword by showing how a 0% return can be leveraged into a 100% loss!
The best analogy or metaphor for leverage is a power tool. How many people use power tools? Almost all of us do, but why? We want to magnify or speed up our efforts.
We know that if we use a power saw carefully and responsibly, we can perhaps cut 10 times as fast as with a hand saw. We also know, or better know, that if we use the same power saw carelessly or irresponsibly, we can hurt ourselves very badly, perhaps even losing a few fingers.
But even the person who has lost fingers will choose the power saw over the hand saw because we all want the positively magnified results. So the critical issue is how are we going to use the tool.
If we use the power tool responsibly, we can expect to get the positively magnified results. However, if we don't fully understand the tool and don't use it properly — with all of the guards in place — we can be worse off than if we didn't use the tool.
If you are responsible enough to use power tools, consider learning how to use the power of leverage responsibly — conservatively, long term, and with a trusted advisor — to magnify your savings and achieve your financial goals faster.