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Using leverage is less risky when it comes to common investment 9 · Thursday, July 19, 2012 OAKVILLE BEAVER · www.insideHALTON.com B orrowing money to invest can be risky, but it's often less risky than the way in which some investors are currently managing their portfolios. The use of leverage magnifies your investment results in both directions. If your investments appreciate in value, you will have more profit because you invested borrowed funds as well as your own funds. On the down side the opposite is true. If you suffer investment losses then those losses will also be greater. So, we will consider both investment risk and the risk of using borrowed funds. This discussion will include the science of investing with the myth of investing. The myth is that we can beat the market. Most investors believe in that myth of hope for an investment return that is above the stock market average. One popular way to try to maximize investment returns is trying to time the market with buy-and-sell decisions. The second is to attempt to select a manager who will have higher returns than the market. Attempts by investors to beat the market is a natural part of the human instinct to win. You might have heard that investing is driven by fear and Dollars & Sense By Peter Watson greed. The greed factor motivates us to maximize investment returns. This leads many to make common investment decisions that prove to be detrimental. Contrast that to the science of investing. Investment studies support the idea stock markets are efficient enough that no excess return should be expected through attempts to capture any inefficiencies through market timing or stock selection. If you accept that theory, then timing investment decisions or attempting to select a manager who can beat the market is a very poor strategy. Academic research shows that one out of three managers beat the market in any given year, on average. Two out of three years managers fail to beat the market. Is the lucky one-third likely to beat the market next year? No. Research also shows that the average gain is smaller than the average loss to market averages. This research is validated when manager results are compared to index average returns on a one-year and five-year basis. People differ in their opinions of what was just stated and that is to be expected. However, the science of investing is remarkably clear. In my opinion, all investors who are trying to outperform the stock market through market timing and manager selection are attempting to do something that is very risky. A less risky approach would be to enter the stock market but with investments having a lowmanagement cost. If you invest in a portfolio that reflects the broad market and uses a reasonable number of borrowed funds, then over time I think that is a less risky strategy. I'm not suggesting that everyone invest with borrowed funds. That must be a carefully made decision considering many factors. The discussion on the risk of investing leverage is used to illustrate that most investors are taking a risk far greater than leverage by investing with outdated and unproven investment strategies. To summarize, is the use of leverage risky? Yes. A greater risk may be managing your investments using outdated ways of thinking without considering the scientific research and historical manager performance results. -- Submitted by Peter Watson, MBA, CFP, R.F.P., CIM, FCSI. Midnight Madness Open 'til 12am Friday, July 20th Come take a look High End Engagement Rings Diamond Stud Earrings Tennis Bracelets One Of A Kind Diamond and Precious Gemstone Jewellery Unbelievable Deals! 50 - 80% OFF 905.339.7604 (East of Trafalgar Road), Oakville 309 Lakeshore Road East Toronto · Mississauga · Brampton · Ajax · Concord · Markham · Oshawa www.omnijewelcrafters.com Burlington MID-SUMMER SALE HAPPENING NOW! DESIGN SERVICES *THOMASVILLE BURLINGTON 2269 Fairview Street, Burlington Ph. 905-631-6000 SPECIAL FINANCING AVAILABLE Please see store for full details } Available at both locations