Common Investment Trap: Borrowing to Invest
This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy.
The second financial advisor I actually invested money with was a pleasant woman who used to work at my bank branch handling my mortgage and had moved out on her own. I won’t use her real name; let’s call her Gina.
Initially, my wife and I each invested a small sum with Gina in some mutual funds. We were contemplating moving the rest of our investments over from our first financial advisor, but Gina had an idea for something even bigger.
The Pitch
Based on our income and lack of debt, Gina said that we should be borrowing a large sum of money and investing it. Interest rates were low, and when it came to taxes the interest could be deducted from the big gains we were sure to make on our investments. At the end of 5 years, we would have big profits with “no money down”.
Gina worked on us for quite a while with this pitch. Fortunately, the borrowing made us nervous, and we decided not to go for it. This all took place just before the high-tech bubble burst. We would have lost a lot of money and would have been left paying off a large debt for some time.
Although Gina was surely aware that she was recommending something that would make her a lot of money, I think she believed she was helping us. The training Gina received as a financial advisor with her firm told her that borrowing was the right thing for a couple in our situation. I don’t think she knew any better.
Common Tactic
My wife and I are not alone in getting this pitch. Members of my extended family as well as friends have been hit with higher pressure versions of this “borrow big to invest” strategy from financial advisors. This appears to be a common tactic that financial advisors (or the firms who train them) use to increase mutual fund sales.
Borrowing large amounts of money to invest is called using leverage and is an advanced and risky investing strategy. This does not mean that it is always the wrong thing to do, but if you need a financial advisor to show you how to invest, then it is likely that borrowing to invest is not for you.
The second financial advisor I actually invested money with was a pleasant woman who used to work at my bank branch handling my mortgage and had moved out on her own. I won’t use her real name; let’s call her Gina.
Initially, my wife and I each invested a small sum with Gina in some mutual funds. We were contemplating moving the rest of our investments over from our first financial advisor, but Gina had an idea for something even bigger.
The Pitch
Based on our income and lack of debt, Gina said that we should be borrowing a large sum of money and investing it. Interest rates were low, and when it came to taxes the interest could be deducted from the big gains we were sure to make on our investments. At the end of 5 years, we would have big profits with “no money down”.
Gina worked on us for quite a while with this pitch. Fortunately, the borrowing made us nervous, and we decided not to go for it. This all took place just before the high-tech bubble burst. We would have lost a lot of money and would have been left paying off a large debt for some time.
Although Gina was surely aware that she was recommending something that would make her a lot of money, I think she believed she was helping us. The training Gina received as a financial advisor with her firm told her that borrowing was the right thing for a couple in our situation. I don’t think she knew any better.
Common Tactic
My wife and I are not alone in getting this pitch. Members of my extended family as well as friends have been hit with higher pressure versions of this “borrow big to invest” strategy from financial advisors. This appears to be a common tactic that financial advisors (or the firms who train them) use to increase mutual fund sales.
Borrowing large amounts of money to invest is called using leverage and is an advanced and risky investing strategy. This does not mean that it is always the wrong thing to do, but if you need a financial advisor to show you how to invest, then it is likely that borrowing to invest is not for you.
People like Gina must be put out of business. Fired with no possibility of ever obtaining a license to advice people on finances again.
ReplyDeleteIf anyone ants to use leverage, there are other ways to do it, but borrowing money is insanity. And leverage is best avoided anyway.
Mark: I'm actually more unhappy with the company that trained Gina and provided her with colour slides to convince people to borrow to invest. Gina isn't competent to advise people, and for that reason I agree that she shouldn't have a license. But her company will continue to find salespeople (who know little about investing) and train them to peddle mutual funds.
ReplyDeleteLeverage through borrowing is not very risky... for the salesperson and their company. They'll get paid even if you lose it all.
ReplyDeleteI guess in the late 90s it felt like stocks were destined to go up 15-25% every year. As long as that happens, leverage works, and *seems* less risky.