10 Comments

1. Hey guys,

   Really enjoyed this episode.

   I’m looking to use leverage to jumpstart my investment portfolio. My RRSP contribution room is fairly small due to my DB pension, but I do have significant TFSA contribution room.

   I’m wondering if in this scenario it makes sense to use leverage in a registered account, or to use it exclusively for non registered.

   Thanks

2. Hi Mark,
   Thanks for commenting on the show. One of our listeners used leverage to fill up his TFSA last March when the market dropped due to Covid. He timed the market and got lucky with a strong recovery. He also had a plan to pay off that leverage very quickly. But in general I don’t think it’s a good idea to use leverage for registered or TFSA accounts. Using leverage to invest in non-reg will get you a consistent yearly tax deduction, which you could top up your TFSA with. As always it’s a personal decision depending on the plan you have. Regardless of what you choose, I think leverage has to be a long term play. The market is too volatile short term, and our investor psychology plays a big part when we’ve got borrowed money in use.
   Cheers,
   MM

3. Hi,
   Regarding lifecycle investing and Megans experience (32:00), I’m really curious on how to best apply the leveraged approach practically. Megan says that she goes 2x and when markets drop she goes 3x sometimes… But is she using leveraged ETFs? It sounds like it.

   Are broad, diversified leveraged ETFs (2x) good vehicles to obtain lifecycle investing and that front-loading as early as possible? It’s the application I use myself since it is the most practical and cheap option out there (compared to e.g. increasing your mortgage loan in the bank and invest this free’d up capital in 1x ETFs).

   Looking forward to hearing your thoughts on the practical application of lifecycle investing.

   Best
   Mads (Denmark)

4. Hi Mads,

   That’s a great questions. I’ll ask Megan to reply to this comment, as I’m not sure what ETFs she uses.

   IMO I wouldn’t use leveraged ETFs due to the MER and the fact that you are exposed to a lot more downside risk (along with the upside benefit). I’d have to dig through some research, but I believe the performance of leveraged ETFs doesn’t keep up with the index either. It’s a math problem, if you lose 5% or 15% leveraged. Then you need to gain ~17.5% to get back to even. If you are using leverage from a mortgage loan, you accurately track the market and pay the ‘higher’ fees on the borrowing side. I think you could make a case for either depending on the situation and how much money you are investing. For us in Canada, the HELOC is a tax advantaged way to borrow money to invest. We don’t get any tax advantage with a leveraged ETF.

   I personally haven’t read the book on lifecycle investing, but it seems to be sound in principle, it’s just the application that is the hard part!!

   Cheers,MM

5. Hi Mads, great question! Personally, I don’t use leveraged ETF’s – I go to 3x leverage buying regular ETFs or sometimes stand-alone stocks, depending on what the market is doing at the time. For me, using 3x leverage in addition to leveraged ETF’s is a bit too much for my risk appetite (plus the MERs). Of course, it all depends on your own personal comfort level!

6. Hi Megan and MM,
   thank you for your responses. Regarding leveraged ETFs, I think a 0,35% MER for e.g. a Amundi MSCI USA 2x leveraged is fairly cheap. On an other note, I’ve been wondering a bit about the math behind the calculation of your total investments over time, that you sort of front-load as much as possible as early as possible using leverage. In “the ultimate strategy for millennials” that you refer to, it says that “The actual formula would involve calculating your “dollar years” every year as the sum of your investments today plus all the amounts you plan to invest in the future.”. Does this mean that you take the current amount of savings + all future contributions (and NO future return included) enabling you to reach your retirement goal in say 20 years when adding it all up with average market returns after inflation, compounding etc.? Because it’s two different figures: the ‘current savings + future 20y contributions only’ is much lower than ‘total wealth after 20 years’ with same contributions but return included, and thus much more reachable. I just want too make sure that I chase the right figure and set the right expectations.

7. Hi Mads,

   The figure is the same, just depends on what assumption you are making for returns. You calculate your current savings + future contributions. Then you figure whatever compounded return you want to assume. I’d play around with a compound interest calculator like this https://www.getsmarteraboutmoney.ca/calculators/compound-interest-calculator/ That way you can figure out what your contributions need to be in order to get the final result with your rate of return assumption. You’ll have to get much more detailed of course if you consider taxes and the cost of borrowing if you have any.

8. Hi MM, what is your pespective on the amount of leverage with respect to one’s various “buckets” of savings? As Megan mentions on the podcast, she’s pretty high risk (200-300% leveraged) due to the fact there is pension savings as well being factored in. In my situation, there is likewise a pension retirement bucket alongside my main savings invested bucket. Two different tax environments as well as with regards to how readily disposable they are, respectively. The pension bucked is almost ‘locked up’ for at least 40years from now in my particular case. And for me – and I suppose for many others as well – what you can do with the pension bucket investment wise is more restricted with regards to leverage options compared to the normal savings. 100% equity is the most aggressive you can go. So I do that. But if your total savings is split 50/50 between pension bucket and regular savings bucket, then applying a 300% leverage to the latter is only merely getting you up to the recommended 200% when looking at the total picture. And applying the recommended 200% to the latter bucket ends up being only a “conservative” 150% leverage when again taking the whole current savings picture into account. So my question is: If there are pension retirement savings in the picture, should you be more than 200% leveraged on the bucket of savings where you can actually do something to lever up and compensate for the part of savings that cannot be leveraged more than 100% in order to be close to 200% leveraged all in all? Or is this too aggressive to be advisable when it is only one savings bucket that is being leveraged up to that 300% extend?
   Kind regards
   Mads

9. Hi Mads,

   Tough question. I think the only way you’re going to get to 300% leverage would be including 3x funds into your portfolio, and that may or may not be appropriate for the long term. I’m pretty sure there is some research out there that has studied funds with leverage multiples under perform over the long run. As for your pension, you state 40 years out, which may change, and locked up isn’t as locked up as you think. It could be commuted into a LIRA, and that LIRA converted to a LIF, so you could access that money almost anytime. Granted there are ‘terms and conditions’ attached to those decisions. There’s also the consideration of what assets you are levering up. Megan is heavily invested in Real Estate, and this is where leverage is a huge advantage. If you managed to lever up an equity portfolio to 300%, how susceptible to margin call are you? How able are you to cover the cost of borrowing? Do you earn enough to make the cost of borrowing vs. tax deduction arbitrage make sense? Can you emotionally and psychologically sustain a highly levered portfolio over a long period of time?

   Personally I choose to use a moderate amount of leverage. I know I could cover the cost of borrowing even if the assets depreciated, or stopped cash flowing. I know the theory of Lifecycle investing, but I don’t think I could have done it. Maybe if I knew what I know now in my 20s?? I think one of the interesting quotes in the book (which I haven’t read) is that the authors admit that mathematically it works, but the likelihood of most people succeeding psychologically is low.

   I guess that’s a long way round for me to not answer your question. The only thing you can do is assume you pension is the bond portion of your portfolio, which it sounds like you do. Go 100% equities in the other bucket, and then gradually lever up and see how you feel about it. Nothing says it has to be all in right away, well apart from the book, lol. The one problem I see, is that if you go all in and lever as much as you can, then find out it’s not working for you. You may be in a bad market swing and take a big haircut in your portfolio.

   One more thing, figure out how brokerages calculate your excess liquidity and buying power. I use leverage at Interactive Brokers, and I am careful to leave enough excess liquidity when trading options that I won’t get margin called. I would use a similar approach to your whole portfolio if you’re using leverage. Always calculate, consider and maintain and excess of liquidity.

   Cheers,
   MM

10. Hi MM, Thanx for your thorough reply. I highly appreciate it.
    The choices I have with regards to leverage are 2x S&P500 ETFs (no risk of margin call) and HELOC (borrowing fairly cheap with a mortgage on the home). Investing 100$ from the HELOC leverage into a 2x ETF equals 3x leverage all in all on those 100$ (with the type of leverage being sort of ‘diversified’ between the two mentioned available cheap borrowing options). I think your advice to “gradually lever up and see how you feel about it” is good and that’s what I’ve been ‘forced’ to do since the beginning of 2021 where I started to shift all of my monthly contributions over to 2x leveraged S&P500 ETFs because I knew I wanted more risk. And since then I’ve not been scared away from leverage and the amplified moves up and down along with market movements – rather the opposite; thrill, excitement, FOMO. And now HELOC is an additional leverage opportunity for me and there are basically 3 options with some different pros/cons, respectively: 1) Investing all HELOC in 1x ETF = 200% leverage. 2) Or some of the HELOC invested in 2x ETF = 200-300% leverage. 3) Or invest all HELOC in 2x ETF = 300% leverage or more.
    Option 1 is the least risky with regards to whipe-out risk but more costly on the cost-of-leverage side because you need to be 200% leveraged for some time until reaching the target lifetime equity exposure. Option 3 is most risky in terms of whipe-out risk and bad market conditions short term, but on the other hand, one would hit the target lifetime equity exposure way faster and thus be able to enter the ‘de-levering phase’ faster and start paying off the most expensive part of the leverage sooner and more aggressively (i.e. the HELOC at a certain low but still variable interest rate). When it comes down to it, I will probably go with the in-between option 2. But just to think things through with likeminded’s, what should keep one from going with option 3, which – from a financial planning perspective at least – seems fairly rational because you pay off the most expensive dept faster and decrease the negative compounding interest effect more compared to option 1 and 2? For all options/scenarios, margin call risk is low, the psychic/emotional side is capable and ability to cover the cost of borrowing is almost constant (because the MtM costs on the HELOC is the same throughout all three options, albeit faster payed off on option/scenario 3).
    Happy holidays and kind regards,
    Mads