Over the years I have had a number of clients ask me about the multiplier effect of borrowing to invest. Often a friend or relative has bragged about the improved returns and tax benefits and our clients want be to see if it applies to their situation. There are many good uses of leverage and in principle it can be good strategy to consider. However leverage should not be used to offset a high cost investment approach.  The first step is to make sure you have built a low cost, efficient portfolio  that captures the returns to the markets in which you are investing.

Think of your investments as a private company . If you are a high cost producer your margins are lower than your competitors and your bottom line will not look as good. You can improve the numbers by borrowing and adding more capital and volumes to the business and turn say an 8% return into a 12% return. The problem here is not all 12% are created equally, there is much more risk to the downside for the leveraged company and in a downturn your leveraged company is the first to go under. It is far better to get your costs and efficiencies in place and then add leverage. The lowest cost producer in a market plus leverage can be a very good thing indeed.

Portfolios with high cost mutual funds and or aggressive trading strategies are expected to underperform the markets in which they invest. Adding leverage may mask the problem in good markets but mostly you have simply added much more risk to the approach.