Borrowing is viewed by many investors as a last resort, for emergencies only. Debt comes at a price, since creditors demand to be compensated, and there can be significant risks if you're not able to repay on time. In addition, taking on debt can be seen as a sign of living beyond one's means.
But while it might seem counterintuitive, borrowing can be a useful tool for wealthy individuals. Although borrowing doesn't directly generate returns, it can facilitate gains and enable investors to avoid locking in temporary losses. Our new report "Why borrow if you're already wealthy?" details how investors can use borrowing as a means of achieving their financial goals. The report details how loans can help investors meet their financial goals under a variety of circumstances.
- Averting the need to sell high-return assets and mitigating taxes: You need funds temporarily, and don't want to sell assets that offer the potential for strong returns. Borrowing can also help avoid realizing taxable capital gains and transaction costs, fund business ventures, or improve portfolio returns as long as expected returns outweigh borrowing cost.
- Increasing diversification: Your net worth is overly concentrated, perhaps even in a single asset. This is often the case for entrepreneurs or top executives, whose wealth can be highly focused prior to selling a business or tied up in restricted company stock. If this is your case, borrowing can help fund a diversified portfolio, with investments that are less correlated to the bulk of your net worth. Using leverage in this way can help improve risk-adjusted returns when done carefully.
- Improving returns: You are considering borrowing as a way to boost the growth rate of your net worth. For a long-term investor, returns on risk assets can often exceed the cost of borrowing. Such strategies do, however, involve the risk that investment returns undershoot expectations, or that the investor faces liquidity needs that reduce their ability to ride out bear markets.We focus on three guiding principles: Using debt to diversify and build resilience, avoiding a mismatch between the duration of your liabilities and the duration of your assets, and managing your liabilities proactively. See our new report “Why borrow if you're already wealthy?” for details on how borrowing can form part of a plan to achieve your financial goals.
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