The worst single-day decline since 1987. The worst week since the financial crisis. After 132 months, COVID-19 has ended the longest bull market run in history.
Does this mean the good times are over? History would say no. Rather, in every market correction since the 1950s, the S&Ps following 5-year average annualized return is +15%. For example, in the 12-months after the 2008 Financial Crisis, the markets posted a +35% return. The investors hurt by the Financial Crisis were those who liquidated their positions.
Do we know if the same story will play out with COVID-19? It’s too early to say and it is out of our control. What we can do, however, is put ourselves in the best position to capitalize on the recent market sell-off. Here’s what we are advising our clients.
Be Greedy in Today’s Market
“Be fearful when others are greedy. Be greedy when others are fearful” -Warren Buffett
Although this quote is a bit of a cliché, it does a good job of capturing how we should be thinking about the market. So how do you be greedy in today’s market? One strategy is to double down on recent market sell-offs with dollar-cost averaging.
Dollar-cost averaging is a process where you continue to invest throughout market declines. By doing this, you can reduce the average cost of your investments. This is especially important at the end of a long bull market (today) when high asset prices are reset. For example, prices are already -24% lower than February 2020. The time to capitalize is when prices are low, making it an excellent opportunity to double down.
Doubling Down with Low-Interest Rates
The market correction occurring right after the RRSP deadline isn’t optimal. As 2020 investments won’t receive RRSP related tax-benefits for another year. But what if another tax-efficient strategy was available to you?
One strategy is to use leverage to take advantage of the current market condition and low-interest rates. Leverage is using borrowed money such as a Line of Credit (LOC) to increase the amount you are able to invest.
This is how it works (the below figures are approximate values):
- You borrow $100,000 through a secured LOC. Current low-interest rates (our rate is prime + 0.75%) reduces your borrowing costs to ~$300/month.
- In your non-registered account, interest-only loans are 100% tax-deductible (similar to the tax deduction that an RRSP contribution would create). For example, if you are in a 40% marginal tax rate, your net borrowing cost (after interest tax deductions) is approximately $180/month or 2.16%. This helps you because when your investment makes more than 2.16%, you are now generating returns with other people’s money*. Best of all, you deploy a large amount of capital (that you did not have) to acquire investments at a lower price in this market.
- Since it is a secured line of credit, there is no ‘margin call’ (demand for you to repay the line of credit) if your investments go down. This allows you to hold investments for the long-term (even if we are not at the bottom of the correction).
*Note: While leverage may maximize your returns, it can also maximize your losses. Leverage may also impact your ability to borrow in the future. Consult with us before implementing any strategy discussed in this article.
Where Should We Invest?
With the power of leverage, returns are enhanced in a diversified portfolio. Unlike in recent years, investors had to chase returns in high-risk or foreign markets micro-cap investments. Leverage should supplement your portfolio strategy, not change it.
How do I know if this strategy is for me?
Review the strategy with us here.
Article written by:
The Investment Team at Elementus Wealth Management