With interest rates at historic lows, a rising market, and money starting to flow again, some investment advisors are encouraging investors to look at the merits of leveraged investing.

Is this a good idea? Maybe, but first look at your reasons for why you want to borrow to invest. Are you hoping to make up the money you lost in the stock market over the past year? Do you feel like you’re just not getting ahead fast enough and want to implement what can sound like a “sophisticated” investment strategy? Or perhaps you’re facing increasing pressure from your investment advisor to put more money into a hot market.

There are conscientious advisors out there who can be of great assistance in advising you about the pluses and minuses of leveraged investing, but you should also take responsibility yourself to make sure this strategy fits with your goals, your psychology and your risk tolerance. Here are a few pointers to help guide you along the way:

Pluses of Leveraged Investing:

1. You can magnify portfolio returns;
2. You can deduct interest rates at your marginal tax rate. (Note, however that your investment must have the capability of producing income – not just capital gains. You might need to consult a tax expert.)
3. The cost of borrowing has never been lower. Some firms are offering an interest rate of prime + 1% on investment loans – or about 3.25%;
4. Dividend yields on many corporate stocks and bonds are outpacing interest rates;
5. Investors who are best suited to leveraged investing are generally those with no mortgage and low debt, a stable cash flow and a thorough understanding of the risks of leverage.

The Down Side:

1. While leverage can magnify gains, it can also greatly magnify losses;
2. Leverage adds a whole new level of risk to investing. You could be putting the collateral of your loan at risk, such as your house or mutual funds;
3. Buying “on margin” through your investment dealer typically means you can borrow up to 50% of your investment on margin. The danger is that if the markets drop, you are liable for a margin call requiring you to put money into your account to cover any shortfalls;
4. Remember, there is never a good time for a margin call. Just ask anyone who has experienced one in the last year what they now think of buying on margin.
5. Debts of any kind can dramatically increase your stress load. Paying off debts on investments that have just tanked is no fun;

Leveraged investing can be an attractive way to accumulate dividend-paying stocks and bonds if you have a long term investment horizon of ten years or more. Unfortunately many ill-equipped, ill-advised and ill-prepared people are also lured by the prospect of borrowing easy money to speculate in the market. Not only is that just plain bad business – it is also a recipe for disaster! Be careful out there. – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.