When you borrow to invest, you will benefit from leverage to increase your potential returns, and this is certainly a tempting idea. However, is it a good idea to invest with borrowed money? There is no right answer. It all depends on who you ask.
Economist Ian Ayres, a Yale Law School professor, argues “yes” in an investment book with coauthor Barry Balebuf called Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio. He believes that young people today don’t have the same investment capital as Baby Boomers and since they don’t have enough money to invest, the only way they can get leverage is to borrow the money. He argues that those in their 20s should consider leveraged investments. By making a 50 percent down payment on a stock, they will then be able to lower the lifetime risk in the stock market.
Meanwhile, investor Bruce Sellery, who is the author of Moolala, thinks it’s not a good idea. “I don’t think most people are equipped to borrow to invest. They get stars in their eyes about the upside potential, but don’t fully comprehend the consequences of the downside.”
3 Questions to Ask
If you do borrow to invest you have to ask questions about the interest rates, about your current level of debt, and about how you’re planning to pay back the loan. Here are 3 questions to ask to get clarity:
1. Can you get a loan at a good interest rate?
You will do well financially if your investment increases at a higher rate than the cost of the money you borrow.
2. What’s your current debt?
If you already have a high debt, then you will not be able to pay down the debt of the borrowed money quickly. When you begin to pile on more debt, it becomes increasing harder to manage your debt.
3. Can you pay back the loan if your investment doesn’t work out?
Still, there is the possibility of risk. You could lose the money you borrowed. However, if you have not borrowed heavily, you can rebound from unexpected losses. One way to do this is through a lender like Blue Trust Loans, which provides personal cash loans and installment loans in amounts up to $1250 as an alternative to payday lending. These loans are easy to acquire because they have minimal eligibility requirements, fast-funding and flexible repayment. It’s not difficult to qualify. All you need is a social security number, an active checking account, and a verifiable source of income.
Making a Decision
Things could go either way — you could lose the money you borrow and have to pay down the debt or could get enough leverage to make a small fortune. Consequently, your decision is based on a variety of factors.
Here are 7 things to consider:
1. Do you have enough education in the markets, as well as paper trading success, to believe that you can do well in the stock market? If you just have a lot of hope, but superficial knowledge and questionable paper trading results, it may not be a good idea to borrow to invest.
2. Have you done enough research into the stocks you are buying to be confident that they will do well or are you just working on a “hot tip?” Naturally, the more thorough your due diligence and better your research methodology, the more likely you are to accurately forecast your probability of success.
3. Do you have a high risk tolerance or will you be uncomfortable going into debt? Will you be overwhelmed by anxiety whenever your investment fluctuates in value? While you may be highly motivated to invest when you consider the upside, can you emotionally manage the downside?
4. Will a loss ruin you? If things don’t work out in your favor and you’ve borrowed on say, your home or other high-value form of collateral, a creditor can take your home to satisfy the loan. Alternatively, you may only have borrowed an amount that you can pay back from a cash reserve or out of a secure salary.
5. Is the loan fair and reasonable? What are the terms, the interest, and the fees?
6. If the investment pays off will it be profitable enough for the risk you are taking after deducting commissions and fees?
7. Will the tax consequences work out in your favor? You might be able to deduct the interest you’re paying on the loan based on your investment and receive a larger refund come tax season.
Borrow Only What You Can Afford To Pay Back
When you get a loan, you are paying back the money you borrowed with interest. This means that you can’t rely on the investment working out to decide whether or not you can pay back the loan. You should be able to pay back the loan even if your investment fails.
In other words, don’t factor in the success of your investment in your plans to repay back the loan. By borrowing more than you can repay comfortably, you are not behaving more like a gambler with an all or nothing attitude than a wise investor who carefully weighs all the probabilities. Even an apparently good, solid investment could go wrong for unexpected reasons. If it does, you will be forced to default on your loan and could lose your collateral, and if it’s an asset like your home or other investments, this could be financially devastating.