“Neither a borrower not a lender be,” is a long-established saying going back to Shakespearean times. However, as universal truths go, this one is only half appropriate for modern investors. Forced to choose between only one of two fates – being a borrower or a lender – I would unhesitatingly choose the latter.
The decision is, admittedly, coloured by an era of seemingly eternally low interest rates. Central banks in the United States and elsewhere have now declared this ultra-low-interest-rate era will extend at least until the year 2015.
But if you’re a borrower, particularly via the dubious route of high-interest credit cards, you will no doubt have noticed an annoying asymmetry between the rate of interest that credit card borrowers must pay – still close to a usurious 20 per cent — and what lenders receive on guaranteed investment certificates, bonds or money market funds: one per cent or two if one is lucky.
It’s true the interest paid on home mortgages is considerably less than what credit cards charge. The exception I’d concede on being a borrower is a home mortgage for young couples to get their feet on the first step of the housing ladder.
But I’d also urge them to pay off that mortgage as quickly as possible – I continue to believe that the foundation of financial independence is a paid-off home.
Tempting though it may be to get an investment loan at these rock-bottom rates, I’d counsel against it for all but the most aggressive investors. In theory, if the investment return generated by the resulting investments exceeds the interest paid on the loan – and the interest outlay is tax deductible – this is one route for building wealth.
However, remember a loan involves a fixed payout, which must be serviced in most cases by ongoing employment income. In case of job loss, that obligation continues, while the investment income generated may prove to be variable and less certain.
Far better, I think, is to be a lender – maximizing your savings in registered vehicles, like registered retirement savings plans and tax-free savings accounts, steadily compounding interest income or dividend income and growing wealth in this sure and secure manner.
Savers or investors should be able to construct balanced portfolios that generate roughly four per cent of income a year – ideally through some combination of midterm government or corporate bonds, preferred shares (tax optimized for taxable accounts), real estate investment trusts and dividend-paying stocks.
I’d far rather be on the receiving end of such investments than be on the hook for paying it out indefinitely in an economy that seems to be chronically uncertain.
This is another universal truth that I think most investors can live by.
Jonathan Chevreau is the editor of MoneySense magazine and author of Findependence Day, available at www.findependenceday.com