The Seed of Possibility
Debt aversion has been a part of my psyche since a very young age. I learned that all debt was bad. The only debt that could possibly be a good debt was a mortgage (and that was only a “maybe”).
After racking up a $100,000 in debt during medical school, I set about to pay it down during residency. I loved watching that LOC number shrink with every paycheque.
It never occurred to me to dip back into the LoC.
In my mind, the LoC was my emergency fund. I had also heard, vaguely in passing, that during the transition-to-practice period, you might potentially not get paid for the first couple months of working but still have to live and have various costs to starting up your clinical practice as a physician. Sounded worthy of having emergency funds for.
Then, one of my friends casually mentioned that he had used his medical school line of credit to invest, the tax benefits of this approach, and my mental horizons burst open into a whole new plane.
If you have not yet had a chance to read of the background theory behind borrowing to invest, check it out here.
The Roundabout Journey
My journey into leveraged investing (leverage = borrowing to invest) looked a bit like this.
- Five years ago – learned that it was possible to borrow to invest and that there are tax advantages that could be had. Thought it was too risky, more focused on paying down LoC at the time. Then, forgot about the whole idea.
- March to April 2020 – watched portfolio value decrease by 18%. While this was uncomfortable, I also had the strong urge to panic-buy during the market downturn. Kept impulses in check, reasoning that this is a decision better made after learning more about leveraged investing. And since there was a pandemic in full swing, I did not prioritize learning about leveraged investing.
- September 2020
- FI Garage (one of my two favourite Canadian FI podcasts – the other one being Explore FI Canada) released an episode on Leverage. In it, they discussed lifecycle investing (among other things), and mentioned Ed Rempel’s article.
- I read through Ed Rempel’s article a few times
- Ran the concept by Mr. Sparks
- Ran the concept by my accountant
- October 2020 – took the plunge and opened a non-registered Questrade account for the purposes of using money leveraged from my fully paid off LoC to invest. I opened a margin account since that was only non-registered account type I could find on Questrade…and promptly made a few gaffes as I tried to figure out how this new account worked.
(I didn’t actually want to borrow on margin to invest but accidentally did so, and then overextended my chequing account trying to balance out the problem.)
(And then, because I keep very little cash in the chequing account, did not have enough cash in the chequing account to cover the first interest payment.)
(Overall, lost $10.64 to overdraft fees and had brief periods of 11/10 stress. Got started though!) - November 2020 – one of my personal finance idols, the Canadian physician finance blogger Loonie Doctor, gave a virtual talk to resident physicians through the CMA Joule Practice Management Curriculum (It was a fabulous talk, and packed with good pointers. I may have had stars in my eyes as I explained to Mr. Sparks that the person talking to us through my laptop speakers was the Loonie Doctor).
In his talk, there was brief mention of using the LoC to invest, and there was some interest from the listeners about the subject. That reminded me that I had done this very thing…and maybe I could write about it.
Specific Risks and Benefits Considered
I did not take out the entire value of my LoC. And this after discussing the fact that even taking out the entire LoC would not equate to proper Lifecycle investing, as – hopefully – $350,000 would not be the entirety of my retirement portfolio.
Why?
- I treat my LoC as a backup emergency fund. As I am moving into practice soon(-ish) I anticipate potentially having start up costs. My first line of defense for the start up costs is the HISA which I have been building up (initially meant for paying down the remaining student loans in one blow after residency is done, but now that I would like to keep my LoC clear-cut for accounting purposes, I will turn to the HISA first).
- I am not sure what my cashflow will look like in the first year to two years out of residency, and don’t want to be stuck making uncomfortably large payments on a debt (even though it’s more of a “good” debt).
However, once I get a sense of what the cash flow will look like (probably in the latter part of year 2, or year 3), I fully intend to leverage the entire LoC. And perhaps connect with a fee-only financial advisor about other sources of leverage.
Now, I’m definitely not saying you should do what I do. A more sanguine investor would look at the math, shrug their shoulders, and say “Imma go for it.”
And a more risk averse investor would say, “I’m just going to leave this entire LoC for a rainy. Can never be too careful with taking on debt.”
None of these is wrong. As the saying goes, “Personal finance is personal.”
Important Assumptions Made
- Gut fortitude: The investor assumes a certain degree of gut fortitude and cash flow to hold onto their investments during downturns and not sell. Given that I had to hold myself back from panic-buying this past spring (with no urge to panic-sell), and I’m hoping that it will be okay. We shall see.
- Interest rates stay low enough: The investor assumes that market returns will outstrip the money lost to interest. Looking at this table, I think it will be okay for a bit (but I am not an expert on interest rates). Of note, the bank rate not the same as prime interest rate, which is what the LoC and other interest rates that reach your average consumer are based on (e.g. prime minus xyz or prime plus xyz) but you can see the prime interest rate moves with the bank rate. As the interest rate changes, I will need to intermittently re-evaluate.
What Has Happened So Far
Well, as mentioned earlier, I lost some money to overdraft fees during my confusion in the set-up period.
And the markets have been plodding upward for some mysterious reason despite the fact that the pandemic is still raging on for most of the world (including here in our little corner of Canada).
The margin account gained $14,000 when I last checked at the start of December. Short term gains are nice, but not the point. My goal is to hold on for the long term.
If I Could Go Back in Time…
…I would have used my LoC to invest from the get-go after my TFSA was filled, leave all of my RRSP room untouched. Then I would have used my stable, predictable resident salary to pay into the LoC bit by bit, and give myself more LoC breathing room again.
Ah well. Best time was earlier. Next best time is now. And better now than never.
Can You Do This Too?
Maybe! There are some factors to consider:
- What shape is your LoC in?
If you have a fully paid down or untapped LoC, then it’s much easier. The full amount of interest on the LoC is deductible from your taxable income, if the LoC is used purely for leveraged investing.
If you have an LoC with some debt on it already for other things, you’ll have to keep track of things very carefully. Please consult with your account first. (In fact, please consult with your accountant first before making any big financial decision). - Do you have other debt?
I would not consider doing this until all credit card debt has been paid down. A relatively quick solution is, given the difference in interest between the LoC and credit cards, one could consider using the LoC to pay down credit card debt first. Then this leads you back to Question 1.
If you have other debts that you’re balancing (e.g. mortgage, car payments, etc.), it’s worth taking a look at the overall financial picture and seeing if you want to pay down those debts first / faster (if possible) or take on more debt (a calculated risk). Either route might make sense, depending on your circumstances. - Can you avoid panic-selling in a market crash?
If you’ve never through a market crash, this is a hard question to answer. I’ve never been through a market crash either (at least, as an investor) – I’m hoping that my reactions to the spring 2020 downturn will hold for next, bigger/longer market downturns.
If you panic-sell leveraged investments, not only have you locked in your losses (turning paper losses into real losses), you’ve done so on borrowed money, which is worse than doing so on your own money, as you still have to pay that borrowed money back. Bad deal.
So overall…
Takeaway Message
Consider lifecycle investing (or its more general cousin, leveraged investing), in the context of your overall financial picture. It makes sense mathematically – you just need to decide if your own money psychology will get in the way or not.
Until next time!
-Dr. FIREfly
Love it!! Congrats on jumping into the big kid pool with some leveraged investing. Many thanks for mentioning the podcast and doing the deep dive with Ed’s articles. He’s the brains, we just pump the info. LOL As my leveraged investments have grown more complicated I am building out a tracking spreadsheet. I don’t use my HELOC for anything else, but should I use it for non-investment purposes this will make my accounting much easier. I’ve talked with ‘The Accountant’ about what needs to be tracked and it’s much easier that most think. Basically reference the date of the transfer from LOC to Margin and amount. Then the purchase amount, qty and date of the equity. At the end of the year you’ll just calculate all the interest from the date of each transfer. But like you said this may be beyond some peoples comfort level and willingness to do. DIY personal finance and investing should probably start with an Excel course!! Cheers, MM
Hehe, there was a bit of flopping around at the start in the big kid pool, but hopefully I’m swimming now. That’s a great idea about building out a tracking spreadsheet! I’m going to have to look back and get started on that. As always, a big thank you for putting out not one, but two great podcasts!
Hey Dr. FIREfly. Great to hear that you enjoyed the webinar. My blog has been a bit on pause due to the speaking load. Plus, we downsized (selling my dirty little 11000 sqft secret) and bought a fixer-upper that has required a lot of fixer-uppering.
I think it is great that you are sharing your experience with leveraged investing. It really is something that I would only consider when I could afford some mistakes and when I had a very disciplined plan of how I was going to use it. The idea of lifecycle investing (using leverage to spread out your temporal risk, like missing a great bull market early in life) is interesting. I think most people would find it too risky since the peak leverage is when you can least afford to pay it off (early life). The ability to behaviourally stick to an investment plan is huge. Personally, the emotions from volatility if I owed much more than my assets/income would be major. The irony is that the time when leverage is the most emotionally/behaviourally tolerable is also when you have so much money that it doesn’t bother you. Usually later in the life cycle, and when you probably don’t need it to achieve your goals. I use leverage even though I have reached FI and some have criticized me for taking risk when I don’t need to. However, my feeling is that if you are good at playing the game, then why take your ball and go home early? If I steward my money well and build a larger-than-needed nest-egg, then that is money that I can use to direct to causes that I feel are important. If I don’t, someone else will make the money and who knows where they would direct it.
Keep up the great blogging – I am a fan and your voice from the perspective of someone earlier in the professional career life-cycle adds a lot.
-LD
Glad to hear your blog has been on pause for fun reasons. Many speaking engagements means more awareness (in medicine, I’m guessing?) about the importance of personal finance – and that fixer-upper sounds like a great project!
Yes, the conundrum about the “best” time to leverage (math-wise) being early – and it also being the time when you can least afford to pay it off – is huge. I do wonder if the start of residency would be a good time to look into leveraging, however, especially if looking at a 5 year residency. There’s reasonable expectation of steady money in for the next few years, which can help offset the risk of leveraging. *IF* one can tolerate the volatility and not sell when markets go down.
Interesting point about leveraging after reaching FI. I hope the critics aren’t giving you too hard a time! Personal finance is different to each person. The goal doesn’t have to be “FI/RE and done”. I suspect that engaging with finance is an intrinsically motivating activity for you and all the other personal finance writers out there. Why stop if it’s fun and has the potential to do a lot of good?
Thanks for dropping by! Looking forward to your next posts 🙂