Introduction

The best predictors of the amount of money that you'll manage to set aside for your retirement are the amount of your savings, your investment expenses and the number of years that you're invested in the market; see Savings and returns on our site. You will note that earning a market-beating return is not one of the predictors. Yet, a very different message is repeated constantly in the media- stay in cash because the market looks bad, followed by buy quickly because the market is about to rise, then sell because the market is about to go down, and why not borrow while you're at it to boost your return. This is of course the opposite of long-term investing.

Fortunately there are dissenting voices that promote a long term approach. An example? The Aspen Institute , which campaigns against what it calls the disease of short-termism, whether by corporations or by investors:

Short-termism: concentration on obtaining immediate profit at the expense of long term security Source: AllWords

The Aspen Institute  published in September 2009 an interesting text or as a PDF doc.1595  that features a series of measures to fight against this disease, and in particular to discourage repeat transactions and short-term investing. In general, see the CFA Institute and Tonello Confrence Board doc.1603. For our part we wanted to present some of our own suggestions to guide the self-investor who takes a long-term approach to investing. They relate to when if ever to borrow, stay in cash or to trade.

Rule no. 1: minimize borrowing

Here are a few rules to guide you on the best time to borrow:

Start by never borrowing

There are many arguments for never borrowing.

Your lender is not your friend. A loan is a source of income for a lender, but an expense for the borrower. Borrowing is risky- you must repay a loan even if the return turns out to be negative, and even if the repayment date does not suit you. In general, see Borrowing to invest: financial risks and tax issues  and Borrowing to invest: a checklist for investors .

The profile of the ideal borrower

We can think of at least one major exception: if you borrow to buy a home, since you have to live somewhere in any event. But don’t think of it as an investment; see The family residence on our site. 

The best investor profile for investment borrowing is the following:

• Considerable investment experience (and have experienced one or more complete stock market cycles)
• A high tolerance to risk
• A stable source(s) of income; and
• A sizeable cash flow.

Now be honest with yourself. Do you have this profile? If not, you are not probably a good candidate for borrowing to invest. And if you do, do you really need to borrow?

5 tips if you do borrow

Read the documentation to be certain to understand what you're getting into; see Your Broker’s Margin Account Form

Limit yourself to borrowings whose proceeds are used to acquire assets that will continue to benefit you after final repayment of the loan. Don’t borrow to buy the family groceries.

Limit yourself to borrowings whose proceeds are used to earn income, because the interest is normally deductible; see Borrowing to invest and taxation: income tax rules governing interest deductibility  

Avoid borrowing short-term to invest long term, such as a margin loan from your broker to purchase common shares. It is always safer to synchronize the two, otherwise you are taking the risk that you may need to repay a loan at a time when disposing of the asset purchased with the loan proceeds is not ideal.

Here is a more general red flag: borrowing to invest is a risky business.This becomes obvious if you recalculate your Asset Allocation after borrowing to invest. A financial liability is a kind of negative asset in your portfolio and should be taken into account in calculating your asset allocation, with the result that the actual percentage of portfolio in equities is higher than it appears; see Asset allocation- four other factors to consider on our site. Be careful not to end up with an overly aggressive asset allocation. Let’s say you have $ 100,000 in assets invested $ 60,000 in shares and $ 40,000 in bonds; you have a 60/40asset allocation, which is typically considered a neutral allocation. But if you had borrowed $ 20,000 to create this portfolio, your allocation is actually a much more aggressive 75/25% allocation ($60,000 divided by $100,000 less $20,000).