January 24, 2001    For Immediate Release

Leveraging a risky strategy to increase investment returns

WINNIPEG - As Canadians ponder how much money to sock away in their RRSPs, some investors might be tempted by leveraging.

But Canada's securities regulators warn that leveraging -- borrowing money to invest -- can be a risky strategy not suited for all investors.

"The idea of borrowing money to purchase a car or a home is not unusual. However, the idea of borrowing money to invest is quite foreign to the average person," says Doug Hyndman, chair of the Canadian Securities Administrators, an umbrella organization of Canada's 13 provincial and territorial securities regulators.

Leveraging your investments involves paying a portion of your own money and borrowing the rest. Borrowing money allows you to make a larger investment. The more you invest, the greater the potential returns. However, leveraging can also result in increased losses.

For example, if you purchase 100 shares of a company at $25 per share, the initial investment would come to $2,500. If the shares go up by 10 per cent, you make $250.

If you invest your $2,500 and borrow a further $2,500 you can buy 200 shares. With a 10 per cent return, you make $500. While the share value has increased by 10 per cent, you made a 20 per cent return on your original $2,500 investment (less the cost of borrowing).

But if the investment decreases, your losses are magnified. If the shares fall by 10 per cent, you lose $500 of your original $2,500 and still have to pay the cost of borrowing the additional $2,500.

"If your financial advisor suggests leveraging, make sure they explain all of the risks involved. Don’t be persuaded into leveraging if you don’t fully understand the idea or you're not comfortable with it," Hyndman said.

As long as an investment increases at a rate higher than the cost of borrowing, leveraging can be an effective way to magnify returns. Interest and inflation rates must be carefully monitored because increased interest rates will increase the cost of borrowing, diminishing any gains.

Because of the very real possibility that investments could decrease and losses magnified, it is important to determine whether or not borrowing to invest is appropriate for you.

Consider the following points:

• Understand the risks of borrowing to invest (in particular the risks of using collateral as security for the loan).

• Ensure that leveraged investments are at your risk tolerance level. The fact that leveraging can magnify your losses makes investing even riskier.

• Borrow only an amount that you can comfortably pay back. You should be able to make the loan payments out of your regular cash flow.

• Understand exactly how the interest and repayment terms of your loan work.

• Understand exactly how much money you will lose in a worst-case scenario.

• Ensure that the interest on the borrowed money is tax deductible.

For more information, please contact:

Nancy Stow Ontario Securities Commission (416) 593-8297	Dean Pelkey B.C. Securities Commission (604) 899-6880
Denis Dubé Commission des valeurs mobilières du Québec (514) 940-2163	Bonnie Beswick Alberta Securities Commission (403) 297-2664
Ainsley Cunningham Manitoba Securities Commission (204)-945-4733	Suzanne Ball New Brunswick Securities Administration Branch (506) 658-3117