Make Leverage Work For Your Investments - dummies

By David Stevenson

Using leverage in your investment portfolio in the UK is probably suitable only for professional investors (such as hedge funds) or affluent, sophisticated investors. Here’s what you need:

  • A high tolerance for risk.

  • A long investment horizon.

  • An excellent credit rating and low interest on the loan (these two factors tend to be in tandem with each other).

  • A healthy personal cash flow and the ability to absorb any potential losses.

Even if you meet all these demanding criteria, it is also suggested that you adhere to the following simple rules when using leverage within an investment strategy:

  • Invest for the long term: The amount of risk involved in leveraging decreases as your investment horizon increases.

  • Commit to the strategy: Even for long-term investors, short-term market volatility carries the risk of emotional decision making – that is, selling at the first sign of trouble – which can derail an investment strategy before it has time to work. Make sure that you’re committed to a particular leveraged-based strategy for the long term.

  • Borrow less than you can afford: The last thing you want to worry about is being forced to cash out early because of an unforeseen change in your ability to make interest payments.

  • Consider a ‘no margin-call’ loan: Many investment loans now offer a ‘no margin-call’ feature (sometimes at a slightly higher interest rate). Unless you can easily come up with cash to cover a margin call, choose a loan with a no margin-call feature.

  • Diversify your investments: Don’t increase your risk by investing in a single investment or by investing in high-risk investments.

  • Make the repayments on the principal: Reduce the risk by repaying the loan gradually over time.