The myth
Borrowing money to invest is called investing with leverage. Some people may do this if they want to buy a certain asset or put more money into existing investments, especially when they don’t have enough liquid capital to do so.
They hope to take advantage of market conditions or simply make returns that are higher than what they’ll pay in interest and fees. This way, they might turn a profit even if they didn’t initially have enough capital.
The reality
There are different ways to invest with borrowed money, and each can come with its own set of risks. Here are some examples:
Examples of leveraged investing
- Real estate investing
Many people take out loans to buy real property like a house since they can’t pay the whole amount in cash all at once.
They may aim to resell the house at a higher price or turn it into a rental property to have a source of regular income.
- Buying securities with borrowed capital
Borrowed money may also be used to buy securities like stocks and bonds. This can give people the ability to invest a larger amount of money than they could with their available cash.
Some brokerage platforms allow the use of leverage in trading so that qualified traders can borrow money from their broker to buy assets. This is called margin trading.
Risks of borrowing money to invest
If you invest with borrowed money, you must pay your debt regardless of how your investment performs. This could worsen investment losses when things don’t go as expected.
For example, if you borrow P10,000 to invest but the asset value drops P1,000, you’ll still have to pay the full borrowed amount plus interest and applicable fees.
Interest payments can also eat into your returns. If you invest your borrowed P10,000 and earn P1,000 after investing, some of the earnings will be used to cover loan interest and fees.
Your actual returns will be lower than what you would’ve gotten if you used savings to invest.
If you lose a lot of money and become unable to pay your debt, you might end up defaulting on your obligation.
This can lead to negative consequences like a bad credit rating and foreclosure of property (for housing loans).
Verdict: It depends.
Borrowing can give you access to fresh or additional capital and increase your buying power. You can then use the money to possibly build wealth.
However, borrowing to invest can be risky if you lose money because you’ll still need to repay what you owe. That’s why this approach is best left to those who understand and can accept the heightened risk.
If you’re considering this strategy, you should be financially healthy enough to be able to repay the debt no matter what happens to your investments.
It’s also wise to keep cash in your portfolio so you can take advantage of investing opportunities without getting in unnecessary debt.
