Most people would love to invest to increase their net worth, protect their finances or safeguard their future when they will be less productive.
But there's one major impediment that prevents people from achieving this goal is the most crucial tool of all – money.
A lot of people have been forced to put their investment plans on pause because they don’t have the needed capital to invest. Others have seen an opportunity to buy assets at bargain prices but had to pass due to a lack of finances.
Others wish that they had more firepower to profit from a fast-moving stock or asset appreciation.
When faced with such situations, the question that comes to mind is if it's safe to borrow money to invest. Of course, this goes contrary to the principle behind wealth building because he who goes a borrowing goes a sorrowing.
At the mention of debt, most people have a negative perception of it. However, when used wisely, debt could also be a fulcrum upon which you can pivot your finances to bountiful returns.
Borrowing can increase your returns, especially when used as leverage. But it can also amplify your losses when the market goes south. So, is it safe to borrow to invest? Let us look at certain factors to consider before you take out a loan to invest.
Before you make plans to borrow money, you have to first consider how you intend to pay it back.
When taking out a loan to invest you have to ascertain if returns from the investment would be enough to offset the loan.
If this is not achievable, you would be digging yourself deeper into a debt hole because you would have to source funds from elsewhere to repay the loan – funds which could have been channeled to other investment purposes.
Another factor to consider when borrowing to invest is interest rates.
If you borrow money during periods when interest rates are high, this means you would be paying more money to offset your loans. Even though returns from the investment may be enough to offset the loan and interests, the fact is that you would save more money during periods of low interest.
As such, you have to consider prevailing interest rates before you borrow money to invest. The best time to obtain a loan is during periods of low-interest rates.
The higher the risk, the higher reward, right? Not in all cases, as there are situations where caution is necessary.
Borrowing to invest in high-risk investments is akin to shooting oneself in the chest. You are battling with repaying the loan and also with the probability that your investment may go down south.
It is never a good practice to borrow and invest in high-risk investments such as junk bonds, futures, or options.
Your investing behavior goes a long way to determine the nature of the risk you are exposed to and how well you can withstand the pressure that comes from volatility.
A careless approach to investing without due diligence increases the chance of losing your capital and borrowed funds. A more conservative approach towards investing would seek the safety of capital, loans inclusive.
When you are taking on the added risk of borrowing funds, you should understand that you have an obligation to pay back the loan. As such, it is expedient that you use a conservative, less risky approach.
Borrowing to invest can be a way to increase your finances and net worth.
Legendary investor Warren Buffett is known to have borrowed to invest, so why shouldn’t you? The key is doing it properly and having a long-term outlook.
One strategy which can work for borrowers is spreading the costs between the investment returns and the cost of obtaining the loan. If you choose a longer time frame to repay the loan, this means that you pay less in monthly deductions and remittances.
This reduces the pressure on your finances and makes repayments more manageable.
Another strategy is investing in instruments that have cash flow. As such, if you invest in an asset that generates substantial income, this lowers the cost of borrowing and also enables you to offset the loan within a shorter period.
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Borrowing to invest is a double-edged sword.
It can work for or against you. You have to have a detailed plan on how you intend to repay your loan and stick to it. If you are considering borrowing to invest, this means that you are taking on additional risk.
As such, you have to try and control the risk in your investment as much as possible, which implies having a conservative and long-term approach to your investing.
August 13, 2022
August 10, 2022