I was passed a link on a blog item by Larry Mcdonald of Canadian Business on “Why you shouldn’t borrow to invest right now”. I thought “yet another blog on the bloody obvious”, but that was until I got to the following…
“With five-year rates on fixed mortgages as low as 2.99%, it’s not surprising financial advisors such as Ted Rechtshaffen are now recommending borrowing to invest. After tax, a lending rate of 2.99% drops to as low as 1.6%, a very low hurdle for a portfolio of stocks to clear. Alas, the basic problem with this advice is that it comes late in the stock-market cycle.”
And so I turned to the article in question: “Borrowing to invest? There are times when it makes sense, like now”, by Ted Rechtshaffen.
Based on the facts above – I am going to say it straight. Borrowing at 1.6% after tax and investing in a diversified portfolio for five years, is a smart thing to do, and one that growth investors (who understand the risks) should be considering today.
Based on the facts…but are all the facts in plain view? We have no mention of transaction, management and other service costs for one and the probability analysis ignores the greater historical certainty of lower returns and higher risk at high market valuations.
Personally I believe that given the global economic risks we currently face and high market valuations, such a public recommendation is not only a huge risk for people to follow but could possibly be a career defining declaration. I would not be so brazen about the future path of returns, but to wrap such a gesture in leverage is akin to placing your head in the guillotine while school children play absent mindedly with the release handle.
I believe, and I have always held this belief, that we need to pay attention to the risk and return profile of asset classes as valuations and economic cycles mature, as well as specifically to significant economic risks impacting valuations. I do regret that more of the financial services’ profession do not place greater emphasis on risks to returns in their recommendations and their modelling.
But recommending leverage purely because the costs are low is far too one sided an analysis and to declare this as a smart strategy is reckless.
Please note my blog posts on leverage in the leverage section:
I would also recommend readers review some of Hussman’s Sisyphean posts on the matter: