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At a glance

Central banks have responded to COVID-19 by easing monetary policy further, bringing rates near to zero or below throughout developed markets. In the context of a broader financial plan, investors can make use of these relatively low rates to consider borrowing strategies. These can be used to ensure sufficient cash flow while reducing the drag of holding excess cash or selling assets with high expected returns, or to magnify portfolio returns for more risk-seeking investors. Nevertheless, as the sharp sell-off has shown, it is important to maintain a prudent collateral buffer to avoid margin calls.

The crisis has underlined the importance of maintaining adequate liquidity and avoiding over-leverage.

Interest rates are now at or below zero throughout the developed world, as the Federal Reserve and Bank of England have eased further in response to the COVID-19 crisis. With rates likely to remain at low levels for years to come, wealth planning strategies that involve borrowing offer greater potential, especially when the alternative is selling assets with a high potential return. More risk-tolerant investors can consider strategies to leverage up returns. Added to this, as governments emerge with higher debt levels, central banks may be prepared to tolerate a rate of inflation somewhat above the 2% target rate for a year or two. This could also increase the appeal of borrowing and leverage by reducing the real cost of debt.

But the crisis has also underlined the importance of maintaining adequate liquidity and avoiding over-leverage. Doing so not only allows investors to meet their obligations without being forced to sell in falling markets it also gives them additional confidence to pick up oversold stocks and sectors. Both objectives are crucial aspects of long-term wealth creation, and borrowing can play an important role.

Why borrow?

To increase leverage and boost portfolio return, to avert the need to sell assets that offer high upside and to increase diversification.

Avoid cash flow shortfalls

The Liquidity. Longevity. Legacy. (3L) framework starts with a Liquidity strategy to ensure sufficient resources to meet cash flow needs for the next three to five years. This allows investors to confidently invest the capital earmarked to long-term objectives such as retirement (the Longevity strategy) and inheritance or philanthropy (the Legacy strategy). Setting aside resources for spending needs provides an ample buffer to help ensure that investors aren't compelled to sell assets at the wrong time—a comfort that's particularly helpful during periods of market panic. Investors that we advised to structure a strong Liquidity strategy—which includes cash and short-term bonds, but also the ability— had no reason to sell out of the market during the recent sell-off. T, and their investment discipline has already paid off, as they have been able to participate in the strong rebound without having to compromise their long-term financial goals by locking in losses to meet short-term obligations.

Borrowing can contribute to long-term wealth creation.

Access to borrowing can avert the need to sell assets with a high expected return, or the need to hold excessive cash reserves. Rates are now extremely low. At the same time, stocks' forward-looking returns are higher, since their when valuations are depressed by fear, as they are today. Together, these factors tilt the arithmetic in favor of prudent borrowing strategies.

Conservative capital buffers are important to avoid disruptive margin calls.

Risk profiles differ between investors. Borrowing can also be used by more risk-tolerant investors to boost returns, especially at times of low yield, or to increase diversification. For more risk-averse investors, borrowing capacity is considered an alternative to selling assets at bear market prices. In both situations, it is important for investors to ensure a capital cushion to guard against margin calls.

*Liquidity. Longevity. Legacy. Disclaimer:
Time -frames may vary. Strategies are subject to individual client goals, objectives and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.

So borrowing can be an important tool, when managed prudently, for meeting cash flow needs safely and also for contributing to long-term wealth creation.

Key takeaways

  • Central bank policy rates are now near or below zero throughout developed markets, and we see no tightening of policy on the immediate horizon.
  • That increases the potential appeal of wealth planning strategies involving borrowing, especially where the alternative is selling assets with a high expected return.
  • Rising government debt levels could also lead central banks to allow moderately higher levels of inflation, which would also favor the use of debt.
  • But the crisis has also underlined the need to use debt cautiously, and to maintain adequate liquidity, avoiding the need for forced selling and allowing investors to take advantage of over-sold stocks and longer term opportunities.

Timeframes may vary. Strategies are subject to individual client goals, objectives and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.

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