Borrowing To Invest Is Safer Than Waiting?
A recent post at Million Dollar Journey explores the message of a new book on “Lifecycle Investing”. The idea is that it’s risky to build up a traditional portfolio which is expected to be at its biggest and get most of its returns in a short period of 5-10 years before you retire. If those years aren’t so good, everything you did up to that point doesn’t make much difference. And if you’re moving to bonds in that time it will further reduce your returns at a time when you could be making more than ever before. Instead of doing this you really want a larger equity portfolio when you are young and a slightly smaller equity allocation when you are old. This can be balanced by borrowing at the start and increasing bond holdings at the end.
The blog post compares a borrowing strategy (borrowing enough to double your initial investments) to a fixed allocation (75% stocks) that give you the same average amount invested in stocks over your lifetime. The results show that the borrowing strategy has similar returns with less risk based on 140 years of historical data. However, keeping higher stock allocations at older ages seems to increase your returns without a lot more risk.
I’m practicing a slightly different form of this. While we have many opportunities to improve our finances right now, I’m focusing a lot on increasing our investment portfolio. For example we could pay down our mortgage a lot faster and then invest when it’s gone, but I prefer to invest most of it now and only take slight increases in our mortgage payments.
For some people it may seem simpler to do one thing at a time and pay out the mortgage first then invest more. I’ve even thought of this at times. But this assumes that it’s safe to build a portfolio in 20 years instead of 40 because investment returns are steady and consistent. If you know financial history before 1985 it’s obvious that would increase the risks. It’s not impossible to have a 20-year period of high and rising prices when you’re buying, followed by 20 years of stagnating and falling prices when you’re living off the investments. It reminds me of when I really started learning about personal finance in early 2007 and everyone was talking about how you could select a few uncorrelated stocks and the total return would be as safe as bonds (oops).
One thing I’m doing wrong according to this idea is still carrying some bonds. The formula calls for maximum leverage and no bonds until you have a significant portion of your planned lifetime savings put into stocks. However I live by the idea that there will be bad years when we don’t expect it, and I currently carry just enough bonds to attempt to increase the returns a bit through re-balancing.
I don’t borrow to invest because my business income is uneven. That provides us with enough risk and also comes with the potential rewards of higher income or receiving a lump sum from selling a business in the future. If I manage things well I can get higher returns by focusing on my own businesses first. But by investing in our portfolio and my businesses while keeping a mortgage balance we are doing something similar to borrowing to invest. And the mortgage gets us a very low interest rate. Directly borrowing to invest can make sense if you have a very high probability of getting a certain income far into the future, but you would still need to get a low long-term interest rate to make it worthwhile.
One thing that’s not mentioned in the blog post (I’ll read the book soon) is that borrowing early on increases the length of time you are invested in the stock market since an investment made 20 years earlier has 20 more years to grow. Unless you’re buying at a peak, the length of time you’re invested is one of the most important factors in your portfolio growth so it’s natural this would increase returns.
It’s absolutely true that the right plan for when to invest, and how much, matters more than getting a slightly higher return. But borrowing comes with its own risks of poor planning that can be costly. Overall it’s not surprising that being invested longer and taking advantage of the difference between borrowing costs and investment returns can be profitable. The claim that this works almost 100% of the time is surprising but that depends on precise math and history that we can’t relive.
You don’t need to follow this exact strategy and borrow as much as you save. This is a useful reminder that it’s sometimes worth doing unusual things to increase the length of time you are invested in stocks. Even if you’re playing it safe, is there anything you can delay to give yourself more to invest now? Do this well and the investments might even pay for the expenses you delayed.