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What a Quarter Point Really Means

Although the overnight rate increased by only a quarter point this past week, the current higher level of interest rates may actually be a breaking point for investors and consumers alike. Although borrowing to invest carries higher risks that most investors are comfortable with, for those who have undertaken this proposition, in many cases, they are currently reconsidering.

About a year ago, an unsecured line of credit was widely available to investors who had an average credit rating for no more than 6%. Today, that same line of credit is approaching 7%, which has a significant impact on the outlook of many investors wishing to borrow money for investment purposes. For those in the 35% marginal rate who are “on margin,” the return needed on a post-tax basis to justify the scenario is no less than 9.23%, calculated as 6%/0.65 where the 0.65 is obtained by calculating 1 minus the marginal rate of tax.

With now increased rates, the same calculation using a 7% rate of interest is no less than 10.77%. Investors need to achieve results that clear a higher hurdle rate in order to justify borrowing funds. As this is no longer a no-brainer decision for many investors, the markets may experience more selling pressure in the weeks to come, as the act of deleveraging is only just beginning.

Although most investors do not consider the net returns on a post-tax basis, there is still something to be said about a required rate of return of 6% vs. 7%. When considering a 3% to 4% dividend yield in addition to a little capital appreciation, it becomes much easier to clear a 6% return (or 9.23% on a post-tax basis) compared to a 7% return (or 10.77% on a post-tax basis).

With a much more daunting task at hand, investors who are willing to hold their securities for a long period have many options.  The first name on the list is none other than Manulife Financial Corp. (TSX:MFC)(NYSE:MFC), which at its current price of $27.50 per share has grown at a compounded annual growth rate (CAGR) of almost 14% over the past five years. For those wishing to employ additional leverage despite higher interest rates, this may be one of the best names on the market.

As an insurance company, Manulife Financial Corp., which has large premiums that are currently held and invested in short- term, fixed-income instruments, is primed to offset the higher interest rates by receiving higher interest payments from their own deposits. Shareholders will eventually see these higher rates returned to them.

With a number of fantastic options available to investors, including those willing to borrow money to invest in addition to those who are not, there remain many ways to profit from the current market. The only thing investors need to ask themselves is whether they’re willing to remain patient — and for how long.

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Fool contributor Ryan Goldsman has no position in any of the stocks mentioned.

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