Russian Roulette– some throw away comments from marketing brochures!

Some of the comments found in marketing brochures are incorrect and misleading and should be removed:

You are not using “somebody else’s money”. This is your debt, this is more than money, and while money gives you things, debt taketh away.  This comment should not be in these documents and incorrectly frames the risks of leverage.

Comments that suggest the returns on equities do not need to be large to justify the strategy ignore the fact that the narrower the potential differential between the return on the strategy and the costs of the strategy the greater the risks. The margin for return needs to be high to justify the extra risks of the strategy because of the instability of short term returns.  Using average long term returns to justify a leveraged strategy ignores the risks that impact such a strategy.

Comments like borrowing to invest is the same as borrowing for education or to buy a home are misguided and incorrectly frame the risks of leveraged investment in risky assets.   For one, buying a home replaces rental costs for mortgage, taxes and property capital costs.  But given that an average rent is usually higher than the sum of financing, tax and capital costs, borrowing to invest in property may reduce the cost of living over time, at the same time as building up capital.    

I have even seen comments that state that compound returns lead to investment growth that accelerates – in a positive return environment, the differential between a low growth and a higher growth investment widens, but the rate of growth of that differential actually declines over time (red line) to the high growth rate itself.

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What leveraged investors do not benefit from is the benefit of compound interest given that in most instances interest costs will eat up the dividend return. 

“By investing the tax savings generated from the deduction of interest on your investment loan, you can significantly reduce your overall risk of loss.”: unfortunately the gross interest paid is also cost and this cost is income and or capital that you may have otherwise used to invest in a risky asset anyway.   

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  1. Pingback: IIROC’s guidance for leveraged investment | Depth Dynamics

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