Borrowing To Invest Vs. Saving To Invest

How Come You're Rich?

This is a follow up to my post about bums not being richer than you. I want to give an example of how a leveraged investment not only make you more money, but is no more risky or cost any more than the standard “save and invest” method.

The Money Saver

The saver is someone we’re all familiar with. He likes to save a certain amount of money every month into investments so he will have a nice nest egg when he retires. He likes to avoid debt at all cost because that is what everyone who don’t know squat about finances tells him.

Let’s assume our saver socks away $500 per month, every month for 20 years, into long term investments (stocks, bonds, mutual funds, etc). Let’s also assume our saver average a return of 10% per year. Some years will be up, some will be down but over the long term, 10% is about what the stock market has returned to investors.

At the end of the 20 year period, and after socking away $120,000, our saver has a nice retirement nest egg of $378,015. Not too bad!

The Leveraged Investor

In this scenario, our investor wants to be like the saver and put $500 per month into long term investments. However, instead of putting the $500 directly into investments, he goes to his bank and sets up a home equity line of credit for $120,000. He takes the $120,000 and uses it to buy the long term investments. So, instead of spreading the $120,000 out over 20 years like the saver did, the leveraged investor borrowed $120,000 to invest everything right now.

Every month, our investor needs to make a payment to the line of credit. Payments can be as low as interest only to as high as the entire outstanding amount. Interest on a line of credit is generally done at Prime. Let’s assume it’s 5%. Prime is a lot lower than that right now but over 20 years, it will average out. If our investor pays interest only on the line of credit, he would need to pay $500 every month to maintain the line.

Because the $120,000 was used to buy investments, the $500 interest payment is tax deductible so our investor can look forward to a $6,000 tax write off every year. That will result in a $3,000 tax refund if our investor is in the 50% tax bracket. If our investor was smart, he’ll put this refund back into investments. But let’s assume he’s just blows it on women instead.

Comparing The Numbers

If we assume our leveraged investor makes the same 10% return as our saver, that $120,000 will turn into $807,299.99 in 20 years. At this point the investor can take out $120,000 to pay off the line of credit and will be left with a net of $687,299.99.

By taking average of good debt, our leveraged investor manged to build a nest egg nearly twice the size of the saver, with the same $500 per month. In addition, the $500 per month the investor paid was tax deductible, while the saver got no tax benefits. Had our investor put the $3,000 yearly tax refund back into investments instead of blowing it on women, he would have made $996,307.49 at the end of 20 years. Women are expensive!

Most financial planners won’t tell you about leveraged investments because they are prevented from doing so. Unless you’re an Accredited Investor (net worth over $1 million or income over $200,000 per year for the past two years) a financial planner cannot legally show you some of the more sophisticated investments available to people with money. This access to higher yielding investments vehicles is one more reason why the rich get richer. It was never a level playing field.


100 thoughts on “Borrowing To Invest Vs. Saving To Invest”

  1. No doubt John about the upside to using leverage, but what about the downside? Leverage cuts both ways. I’m a proponent of leverage, but you need to use it with your eyes wide open to the downside as well.

    Matt

    1. jtGraphic says:

      That’s totally right. One of the biggest risks is that the market may not return more than the interest rate on the loan – like right now. If someone took out $100,000 six months ago and invested it, depending what they invested in may be worth $50,000 now. That’s not a good place to be in with the bank when you don’t have the money to pay.

      1. Tushar says:

        Investing 6 months ago, when it was made clear that we were in the midst of a recession, would have been a real stupid idea anyways.

        1. John Chow says:

          The best time to invest is in a recession. Everything is on sale. It’s buy low and sell high, not buy high and sell low that most people do.

          I love the mainstream media. They got everyone so scare that everyone is unloading their investments at a lost. Then, when times are good and prices are high, they tell everyone the bull is here, you should buy! Buy high, sell low. I see it all the time.

          1. jtGraphic says:

            Good point. $500 is worth more now than 2 years ago.

          2. Tushar says:

            $500 is worth less now than 2 years ago. We’re not in a depreciative economy, and inflation still exists.

          3. jtGraphic says:

            I meant in terms of investing in shares. Generally speaking, $500 buys twice as many shares now as it did a year ago.

          4. Tushar says:

            You’re right.

            That just goes to reinforce my point that saving money is better than ripping out loans in the long run, because you’ll never know when all that capital can come in handy.

          5. jtGraphic says:

            Maybe it’s best to have a healthy combination of both?

          6. Tushar says:

            That’s always the best idea….to diversify.

          7. Tushar says:

            This has nothing to do with the mainstream media.

            6 months ago was very close to the height of the stock market. That would be considered buying high selling low.

            Buying right now is a very good deal. That’s the true meaning of buying low and selling high.

          8. John Chow says:

            Ya, six months ago the market was at its high and what was the mainstream media saying? BUY! πŸ™‚

          9. Jovan says:

            so true, thats why stupid people stay poor

          10. Ben Pei says:

            Not really… I feel in this current society, the rich gets richer and the poor will just get poorer. Vicious cycle..

          11. JOhn is exactly right!! I’m loading up on both high risk and low risk/high dividend investments – check out my blog for my current stock pics – I’m doing A ok so far!! πŸ™‚

          12. your right chow….if you have the money and can handle the risk then it is a good time to buy. If someone has 20k in cash image what deals they can get for a home and still have a morgage of about 800-900.00. I don’t think anyone would say that was a bad deal. The question is….if all hell breaks loose can you still handle the risk. If you can’t then don’t. There is no sense to buy a home that you still can’t afford during a recession.

        2. Investing in a recession is the smartest thing to do. The prices can only go one way – UP

    2. John Chow says:

      Good question but over the long term, it’s really a moot point. Given a 20 year time line, you have to really really suck to lose money! The other thing most people forget is that, even if the investment goes down, as long as you can service the debt, the bank don’t care. Keep is mind that if it goes down, it also goes down for the saver as well.

      1. jtGraphic says:

        I thought about that after the comment too, but the biggest difference is that the debtor has an obligation to the bank and the saver has an obligation to himself. The saver can always skip a payment and be OK if times are hard. Overall the strategy is sound though – especially over the long term.

      2. Tushar says:

        Well, it doesn’t matter where you were in between.

        If your investments end on a recession, you’re screwed.

        Ex:

        Investor X puts in $120,000. Earns $180,000 back over 15 years. So he now has $300,000 in the market. Oops…A recession just struck. Now his $300,000 is worth $150,000. Even though he has made money overall, he hasn’t made more than the other person or maybe not even enough to pay interest.

        1. John Chow says:

          If you use a 20 year time line, you’ll find that there is not a start or end point where you didn’t came out ahead. That even includes the great depression.

          1. Tushar says:

            Like I mentioned, even if you come out ahead, you might not come out ahead enough to make money off your loan, or to make more money than you could have with that money.

          2. John Chow says:

            What are you talking about? If you come out ahead, it means the value of the investment is greater than the line of credit. The only way you lose is if after 20 years, the investment is worth less than $120K. And even if that happened, you still enjoyed $120,000 of tax write offs over the 20 years. So the investment would need to go to ZERO for you to break even. Anything above that is a gain when you look at it from an after tax view (which how all investments should be looked at).

          3. Tushar says:

            You only “earned” (though ‘penny saved = penny earned’ principle) $60,000 through the write-offs.

            Also, you would be able to write off the contributions Person A has been making as RRSP contributions, as we are discussing a retirement nest egg here.

            So we’re on a equal footing between the two.

            Secondly, if you only have investments worth $150,000 after the entire ordeal, you’ve broken even, because you’ll pay the $120,000 back, and then you’ve paid $30,000 in interest. Technically you’ve lost money because you could have earned interest on that $30,000.

          4. John Chow says:

            While I can see that happening on a five year time lime, you have to be the worst investor in the world to break even or lose money after 20 years. πŸ™‚

            And BTW – if the leveraged investor lost money, imagine how much the saver lost.

          5. Tushar says:

            Well, the worst of investors can lose money at any time, screw 20 years.

            Also, even the best of investors can easily get screwed over. It’s all part of the market.

          6. Over 20 years you will have made more, partly due to inflation. Your arguement is incorrect and over a 20 year timeline you will make more then your initial investment – this may not be the case for the short term.

            Which is why when investing in the stock market you should always look long-term (10years +)

          7. Matthew Lynch says:

            Hello John,
            I am having a lot of problems at the workplace right now. Not enough hours, not enough pay, etc. Can you give me some advice on how to make more of myself while also taking care of a wife and kids. This would help me out so much and I would thank you forever.
            By the way I love the advice and your blogs that you provided with borrowing to invest save to invest. It just seems to be that you would buy your stocks or invest on a recession and sell them when the recession is over.
            If you could please send me this advice as soon as possible. Love your work man.
            Good luck,
            MATT LYNCH

  2. jtGraphic says:

    I totally agree with this. This was a case study we did back in college in one of my final classes. It’s amazing how it works, but you really need the credit and/or the disposable funds to really make it work. The interesting thing is that it will also work on a much smaller scale. Even if you could do $1200 (for the smaller investors out there), the math will come out essentially the same less fees. What really affects the smaller scale is broker fees. You can usually handle that by using a fee free firm, but you may not get the best advice that way either. It’s a lot to think about.

  3. J.D. Meier says:

    I’ve heard the story before and it’s a good one.

    It’s a powerful use of the principle of contrast to show the results of one path over the other.

    The interesting thing is, I got my best advice from accountants and my worst from financial advisors. Obviously I didn’t have good advisors, but the real lesson was about being accountable for your own results and asking the right people the right questions. It makes perfect sense to ask an accountant who’s really making money and how, since they see all the numbers. Once I realized this is was a great “ah ha” and it’s served me well ever since.

    1. jtGraphic says:

      I find that a lot of times good investment advice comes from economists. I have a drinking buddy with a Phd in Economics and has made a ton of money over the last 50 years and isn’t worried at all about the recession. He moved his money around about ten months ago and has been flying high ever since. That being said, he also disclaims himself all the time by saying he can’t predict the future πŸ™‚

      1. Dan Udey says:

        I read about a study a while ago that concluded the best place to go for financial advice is a credit union. They don’t have to make a profit or sell you on services – the person you talk to gets paid the same whether they invest your money or you take it to Switzerland – so they’re more interested in giving you good market advice, not advising you into their best service.

        1. Tushar says:

          There is the issue that most of the people who do end up working at the credit unions are not that great anyways, so you’ll probably not get awesome advice.

      2. Recessions are the best time to buy. Prices are low, you’ll maximise your return in the longer term by doing so.

        Even if you buy now to sell when the economy is back into a recovery – you’ll still make a profit.

  4. Tushar says:

    If making money was this easy, everyone would be doing it.

    1) How is a 40 year old (assuming 20 years before retirement) supposed to have enough money to have paid off his mortgage?

    2) What does the 2nd person do when the economy tanks like now? Take out another loan?

    3) The interest on a $120,000 loan will usually be more than $6000 a year, especially in a year when the stock market is giving you a return of 10%.

    1. jtGraphic says:

      I think the overall sentiment is that the market would return an average of 10% over 20 years, not 10% each year. That means you’ll have some ups and downs, but ultimately you’ll get an average of 10%. I’m not sure that that completely addresses those points, but it’s a start.

      1. Tushar says:

        Nope, it doesn’t seem so. I’ve calculated the compound interest and everything and 10% per annum at montly compound is around what John is talking about.

        10% over 20 years is really low, and you’d probably end up making more in a money market fund.

      2. jtGraphic says:

        I meant an average of 10% per year. Sorry for not being clear.

        1. Tushar says:

          Okay, I understand.

          What I meant by point 2 was that what will you do when the economy tanks, and you do not have enough money to pay interest.

  5. Tushar says:

    PS:

    I don’t know if this is possible or not for you, but could you enable AJAX comments or something? It takes like 45 seconds for me to submit a comment on the blog.

    1. jtGraphic says:

      I was noticing the same thing. I thought it was my internet, but it’s just this site.

  6. liciece says:

    I agree with John.But I think we need to insert something called risk into our considerations too.
    Investment is keen to gain some return,however not all investments are the cases.We know ‘Lehman’ nowadays because it was turned into bankruptcy.There are lots of long term inverstors plunging into the mire.Thus,sometimes investments could bring a real negative result.If assumed that people borrowed money to invest in the product of Lehman,they now lose the principal as well as the interest from borrowing.If the fund is from savings,it is only about the principal(also dying inside).Which one is considered better?
    So whether using savings or borrowings to invest,we should figure out whether we are risk-taker or risk-conservative.Am I correct?

    1. Tushar says:

      You’re absolutely correct,and that’s whole point of risk in the first place.

      RISK basically means taking a chance of losing. So it’s not always that the risk takers come out on top. Some of them obviously lose.

      1. jtGraphic says:

        Risk also depends a great deal on the medium in which you’re investing. Mutal funds have a lower return than single stocks, but are less risky. Something like an index fund would be your safest bet other than bonds and moneymarkets. Venture capital is at a totally different end of the spectrum, but should return quite well.

  7. BusinessX says:

    Can you even get an interest only loan nowadays? Much less one for 20 years?

    This strategy seems to work for those who were Money Savers to build up $120,000 in equity or capital. Then they can become Leveraged Investors. Sadly that is what everyone just did. Took their conservative savings built over decades into investments they didn’t understand. Now they can’t retire and have to wait another 10-20 years for 1). the economy to rebound, then 2). their investments to reacquire their value (if their investments survive until the economy rebounds).

    If anyone has capital or equity left, this would be the time to be a Leveraged Investors.

    1. jtGraphic says:

      That was my big point in the beginning. Given the credit market, one may not actually be able to pull this off simply because a bank wouldn’t fund it. The saver would be in a better situation, given the state of the current credit market.

      1. John Chow says:

        It would depend greatly on when you set up the LOC. Right now, banks may not give it out but if you had it all set up a year ago, you’re set to pick up some great bargains because everything is cheap!

        This is also the reason why Ford didn’t need any government bailout money. They set up over $20 billion of loans and credit lines a few years ago and have access to them. GM and the other guy didn’t do so and had to go begging to Uncle Sam.

        1. jtGraphic says:

          There is also foreign and equity lending too. I’m working on an equity project right now where a group of people are pooling equity to purchase some foreclosed buildings in our downtown area and revitalize them.

        2. BusinessX says:

          Amazing some of the business basics are missed even by the huge corporations. When times are good, get you business credit in order for when times are bad. No one will lend it to you when you need it.

    2. John Chow says:

      Not sure about the US, but here in Canada, you can still make interest only payment on a line of credit.

    3. Tushar says:

      Once again, everyone has the same idea.

      It’s just that even the people with capital can not get a loan these days because banks are being greedy.

      1. John Chow says:

        Banks are making loans. They’re not just making loans to people who shouldn’t be getting loans. If you’re credit is good and you have a good history with your bank, you shouldn’t have any problems getting a loan even now. I borrowed $225K last month without any problems and I’m maybe looking at borrowing another $500K in the next few months.

        1. Tushar says:

          That’s because you have the assets and the income to back up those loans.

          What about the people who don’t make $500,000+ a year and need some money? I agree that they don’t deserve $225,000 like you, but a measly $50,000 would be helpful.

          Unfortunately, the banks are using the federal aid to fatten their bottom lines and therefore hurting our economy further.

          1. John Chow says:

            The banks go into their current mess because they loan money to people who couldn’t pay them. I doubt they’re going to start doing that again anytime soon.

          2. Tushar says:

            There are many people who do have the ability to repay loans but now cannot get any, period.

          3. banks did a poor job in holding the line and protecting themselves from those that would not be able to pay back their loans. Banks were thus on the far left side just giving everything away. Now they are moving towards the more conservative side. Although it is going to be harder to get loans banks are still going to loan money to those who can afford it. Therefore, if the bank doesn’t think that someone has the “ability” to pay then most likely they aren’t in a place to have the money to repay. What do you think?

  8. I think I’ll stick to simplicity. Borrowing may have potentially better returns, but just saving is so much easier and less worrisome.

    1. jtGraphic says:

      Well stated πŸ™‚

  9. Chester says:

    Okay, stop arguing people..
    Let me find a way to get $120k now. I will let u guys know the result in 20 years’ time πŸ˜€

    1. John Chow says:

      Ya, that will shut them up! πŸ˜€

      1. jtGraphic says:

        I’m accepting donations!

  10. Shannon says:

    Wow. I put away about $1000 a month in INGdirect and I also tuck away an additional 4.8%. Now Bad right…

    1. John Chow says:

      I love ING. Great place to park your money while you’re waiting for the right investment to come along.

        1. Tushar says:

          I don’t like ICICI customer service though, it’s on the bad side.

          While we’re on the topic of good banks, HSBC seems to be a mainstream solution that gives pretty good rates. Don’t know about fees though.

    2. Tushar says:

      INGdirect is an awesome place for high interest and good service.

      Only thing is that it’s making less sense to store your money in the bank due to the constant reduction in interest rates by central banks everywhere (which is exactly what they want).

  11. robert klein says:

    Actually any fool can get investment loans. Last year, there was a way to use agf trust to get access up to 200,000 in investment loans with no net worth and you didn’t have to prove income. You did not have to be an accredit investor. All you had to have was a beacon above 600…and this was debatable. They no longer do this, as all of their investors have lost 30% to 40% over the last 6 months, and now people are asking their advisors why they put them into these leveraged investments. So….everybody, don’t sell those leveraged loans!, they have no marginal calls, but if you close your accounts, you will be on the hook for leveraged losses.

    Also, there is a way to get your tax deductions back immediately, instead of waiting for next year. πŸ™‚

  12. Great article John!! I have always been the leveraged investor, and it has certainly paid off!! Although in recent months I’ve taken a hit, I’m still better off in the long run!!

  13. James says:

    But if everyone takes out a loan, doesn’t that cause the banks to run out of money and result in a huge economic crash like what’s happening now?

    1. Marita says:

      Here’s a great video explanation of why leveraging (debt) helps grow the economy as opposed to de-leveraging (paying off debt) :

      http://marketplace.publicradio.org/videos/whiteboard/deleveraging.shtml

      The other videos explaining financial issues are excellent as well.

  14. The best time to invest is in a recession. Everything is on sale, I love to invest in this time

    1. Tushar says:

      Yep, this is the time when the new rich are born and old rich stumble.

  15. James Wilcox says:

    Both of these posts are based on information found in Robert Kiyosaki’s Rich Dad, Poor Dad series. I recommend everyone read them. I also recommend getting the game “Cashflow 202” which teaches these concepts as well as how to create cash flow properties that produce income month after month.

  16. Fantastic post John. I guess its best to take some risk some times. Its said fortune favors the brave. How true.

  17. Investing truly will pay off in the future, but also depends how much you have to invest πŸ™

    -Mike

    1. Tushar says:

      Look at it from a percentage gained perspective, that’s the way all investments should be.

  18. jtGraphic says:

    I just want to step out and say that it’s pretty impressive that John was that active in the comments back and forth. I headed back to this post like 2-3 times a day since it went up to check out what’s new. Usually you don’t get something like that from these big guys – Shoe? Props John. The real test – will he respond to this?

    1. Tushar says:

      Yea, I agree.

      I’m still heading back to this post so I can debate with John a day later.

      1. Like to look the bull in the face? Good job πŸ™‚

  19. Awesome post! This is being bookmarked for future reference.

  20. Mike Lau says:

    Home Equity Line of Credit are ONLY tax deductible if you use the money for home improvement for personal use. If it a rental property, then the expense can only used as depreciation expense.

    If you use Home Equity Line of Credit for investments for tax deductions, you are sorta breaking the law. Anyways.. that is only if they catch you.

  21. Great post John, convincing. I was with the other way round, now I’ve to rethink my strategy.

  22. Very informative post, John. I’ll admit that there were some things I wasn’t sure about.

  23. StoreEbay says:

    You’re right…

  24. Harry Tran says:

    The thing about the investor and the saver in the bad situation is that even if the investor can still produce labor to pay off the loss, he’ll be living a life of debt servitude til he dies for being too rash, and for all intent purposes a lot of people in the US would be living in debt servitude if the govt wasn’t always talking about a bailout for them. There are so many people who are underwater with their homes that if they were required to pay that back than they’ll be working until they’re dead.

    A key difference with Donald Trump though is that if he gets others to fork up their investments for his projects he isn’t going into debt at all. Which leads to the best money is someone elses money going into your idea for a slice of the cake. There you put no money down but your idea. And to that, many individuals have gotten rich and successful without having to go into debt at all.

  25. A lot of people are holding back because they expect prices to go even lower but anyway if you are a value investor, now is as good a time as any to start buying in bulk.

  26. Roger says:

    Saving to invest is not a wise decision because risk taker always take the lead.

  27. Steven Appiah says:

    People.
    Two points to make:
    Yes, leveraging can be dangerous if not done properly. Better to use a LOC than margin account. Margin is even more dangerous as you will get a “funny phone call” if your account is even 1 penny negative for one day.
    And as far as the last 6 months: You could have made a pile of money playing the downside. Without shorting! How? Contra ETF’s. You take a long position as the ETF does the shorting for you. No margin needed as you are not physically shorting a stock. They are eligible to be used in your RRSP/IRA’s.
    QID – peaked 100%+ from Sept-oct. (short NASDAQ)
    DUG – Peaked 100%+ form Sept. Oct.(short oil and gas)
    SKF – peaked 250% from Sept.-Oct. (SHort Real Estate)

    If you are unsure of the concept of the contra ETF’s…A house will fall faster than the time it takes to build. That being said, being in the right vehicle, when a sector or stock falls, you can make a pile of cash real fast. But watch you support/resistance lebvels, and have an exit strategy. If you get to about 40-50% profit…don’t get to greedy and have a profit mgmt plan in place!

    Check it out and see for yourself.

    Good luck to all…do your homework, do today what others won’t, so tomorrw you will have what others don’t.

  28. If debt is good, then I’m probably the richest person on earth!!!

  29. kyle says:

    i think this site is becoming way to commercialized every video u do now is like an infomercial every time you come here u get a pop up to subscribed which is really annoying dude calm down with all the crap concentrate on your content

  30. Unless you have money to start off with stay away from borrowing. Like with credit cards you will only find trouble follows this supposed free lunch.

  31. max says:

    Great post John,

    I think to make money, you have to invest, even if that means using credit cards.

    Let’s just say “smart” gambling, the more money you invest, the more chances of you making money.

    I can attest to this as I maxed out all my credit cards earlier this year to keep my blogging business going.

    But look at me now, my blogging business has grew almost 500% in the course of only one year.

    If I didn’t take those risks, I’d still be working like a slave for a corporation.

  32. andre says:

    I dont believe in buy and hold anymore after many personal losses in the internet bubble. I think the best strategy is understand the market and where its going to make money when its going up and when its going down. That has help me to book heavy gains even in 2008. Most of the time I dont even hold a stock for more than one month. I dont fall in love. I just seek a conservative gain from a stock of 50% or cut my losses early if they fall 20-30%. For example, if I use my tools and I know the market is going up (Long), I will select the best 10 stocks on based on their strong fundamentals across various sectors. When I gain 50% on each stock, I sell and move on. If any of stocks lose 20-30 percent, I sell. I use the inverse strategy most of 2008 because the market the was weak most of the time (short) and made money shorting when my tools said it was going down. If I dont know and I am unsure, I stay out. With the above, I made 80% gain while others lost their shirt include Warren Buffet. I dont believe in buy and hold and I will not use it ever except in my 401K because I have no choice but do that.

  33. Buy and hold just means you don’t have an exit strategy or plan. Most sophisticated institutional investors who do buy and hold, have special agreements for preferred stock dividend payments guaranteeing that capital return. For most people the only way out is to OWN something. Either you are an owner, or your are OWNED.

    Ephren Taylor
    The Social Capitalist

  34. As with anything, there’s risk involved and you have to be able to make informed decisions when it comes to taking those risks no matter where the money is coming from.

    There’s valid points here on both sides of the coin and I think we can all agree that the most important thing we can do is invest in our future, whichever method we use.

  35. Atniz says:

    It is easy to do the maths here. But, the most important thing is to have that sort of income to take this kind of loans, or credit of line. If I could make $30-$40k a month, things would be a lot easier.. I don’t think you will have problem in getting 500k loan too.

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