Leverage Ratio | Debt to Equity Ratio
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Leverage Ratio | Debt to Equity Ratio |
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Video From Rob Tetrault |
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This Video Uploaded At 08-10-2019 12:00:01 |
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1) Leverage Ratio | Debt to Equity Ratio
-Leveraging is borrowing to invest. The traditional form of leveraging is the form that most people do at one point in their young adult lives. The first time they buy a house, they end up borrowing to invest in their home.
2) Margin Account
-Let’s talk about a margin account. A margin account is a non-registered investment account. It's not an RRSP or a TFSA. You can borrow on the margin that is available on your securities.
-Most if not every investment firm will allow you to do this. Interest rates will vary, but you could be as low as prime plus a bit. You could be as high as prime plus a lot depending on the institution and depending on the amount of leverage that you have.
-Let's assume you got a list of securities. The Securities Commission gives us rules and there are compliance rules with respect to how much we can lend off of each security. Depending on the price of the security, some securities are as high as 70%. Let’s pretend you have $100 worth of security. You could lend up to $70 on that $100 every day.
-These shares are marked to market and if the value of the loan is higher than 70% you get what's called a margin call.
-What ends up happening is you start to get wiped out in a declining market every day. Your shares are worth less, therefore your loan is worth less, but your actual loan amount hasn't moved.
-You need to either put cash into the account or you need to sell securities. If people don't have the cash, they start selling securities the next day the market's down. This spreads more selling. More selling means lower prices. The stock market is falling, people are getting margin calls which leads to selling securities and eventually there's nothing left in the portfolio.
-Say the market is falling, we would suggest to you that when the market falls during a correction by 5%, you would increase your leverage.
-Hypothetically, the markets are falling, you are adding to your investment portfolio a little bit at a time. I suggest that you set some limits. You should talk to your advisor and make sure you have limits in your mind as to the maximum amount that you'll ever be leveraged. I would strongly advise that you not go close to the 70% mark unless you have a ton of cashflow that you can fund your account with if you do get a margin call.
3) Home Equity Line
-Now, if you're of the view that you want to borrow off an asset, one way you could do it would be through a HELOC, a home equity line of credit.
-A HELOC is an investment. Basically, it's an account that's tied to the value of your home that you can draw on. Every time money goes into the account, you now have available margin room. You can take that money out and you can put it in your investment account if you'd like.
-Every time money goes in, you now have available margin room. Note that your paycheck goes into the same account. Your expenses come out of the same account as well. If you would do it that way, most people would be leveraged at the same number for a while, with the goal of funding an investment account on the side.
-You're paying 3% or 4% on your home equity line and you should ask yourself if you are going to make that number with your investments?
4) There’s also another strategy for leveraging. Let's say you get a windfall either through an inheritance, through the sale of a business or through some sort of cash windfall like a lottery. One way to effectively reduce your costs of borrowing and increase your leverage while increasing your return would be you take that windfall, pay down your mortgage, so it goes to zero. Then you borrow either through a conventional mortgage or through a HELOC and then you could place that into the market.
-That becomes tax deductible because you are borrowing to invest and that would be another form of being leveraged. You could do the HELOC, you could do the traditional mortgage or pay the mortgage down like I just taught, which is a kind of modified Smith maneuver. This would allow you to write off the interest. Additionally, you could do it through your margin accounts or if you're gutsy, you can do it in all of them.
"📽 Watch our other video on Short-Term Equity Consolidation: https://youtu.be/66OwHYn4W1o
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