The leverage loan: a calculated risk when used conservativelyBy Alain Thériault | April 22 2007 08:08PM
|For many hesitant advisors, a leveraged loan is simply one more risk that increases their liability insurance premiums for errors and omissions (E&O). However, specialists believe that a conservative approach will keep lawsuits at bay.|
Talbot Stevens , a leading expert in the field, uses the term conservative leverage when he talks about leveraged investment loans.
“Most of the complaints and lawsuits on compliance issues against financial planning firms and dealerships are linked to leverage,” he observes. Mr. Stevens understands the hesitation of advisors and wants to help them and their clients use leverage in a responsible way.
“Driving a car is not dangerous in itself. But if you drive drunk and fast in a snowstorm, you can seriously hurt yourself, if not get yourself killed,” he says.
“Leverage, even conservative leverage, magnifies both positive and negative results,” he explains. “There are no guarantees. Using leverage can hurt you even more than not using it.”
To limit the damage, Mr. Stevens proposes five kinds of behaviour that are at the heart of conservative leverage: stay conservative on cash flow, on collateral and on your emotions; eliminate the risk of a margin call; invest over the long term for a minimum of 8 to 10 years; diversify in several (global equity) funds; use a trusted advisor to help you understand all the pros and cons, and then implement and stick to your initial plan.
Mr. Stevens also advises not going too fast. If the bank agrees to loan you $100,000, you should start with $20,000 or $30,000 and then increase your stake in the following years once you master the approach.
For his part, Scott Bergen, product director at Manulife Bank, believes that the risk of leverage is above all a question of emotions. He urges advisors and their borrowing clients to prepare for volatility. “When investments are on a roller coaster, keep your long-term goals in mind.”