Borrowing money is taking funds that are not yours on an arrangement that the amount borrowed (principal) will be fully paid back at a specific time, at a predetermined interest rate, according to a payment schedule. Having that money placed into an investment is based on the premise that as the value of the loan reduces (as payments are made), the value of the investment increases.
At the end of the loan term when the loan is fully paid off, you have an investment fully owned. This type of arrangement is very popular with investment properties and stocks.
But what do these statements really mean? While it can appear on paper that if our borrowing interest rate is lower than our investment returns, then it’s a no-brainer. You could borrow as much as you want and then invest the rest, pocketing the difference, especially with interest rates today being as low as they ever have been for quite some time.
But what’s the catch?
The problem is the uncertainty of time. Things change.
For example, interest rates could change, right? Currently, the interest rates being charged are at extremely low rates, but what if things change, and they start increasing? You could minimise the impact of rising rates by locking in a fixed rate for a specified number of years, but what if the rates are higher again at the end of the fixed rate period?
Notice how time causes problems. If the investments returns or value isn’t realised within a certain time then you have to look outside the investment to meet the obligations of the loan.
Borrowing to invest places stress upon the investment.
Do you have the capacity to pay off the loan at any time, exclusive of the investment? In other words, if your loan got called in by the lender, could you afford to pay the principal without having to liquidate the investment?
If so, then why not just pay cash for the investment?
What if I use up a portion or all of the emergency funds? Then you’d need to save up more before making the investment. The emergency fund is not for converting into a different asset. Sure, you could use it in a short-term deposit account, provided you can quickly draw down on it within 24 hours, or use the amount to offset against your home loan, but it’s not an amount of money that is waiting for an opportunity.
Borrowing adds risk
The reason why it’s often stated most traders don’t make money in the stock or forex market is because they play with leveraged instruments. One of the ways financial institutions made money was by offering financial instruments that were leveraged.
So instead of owning just stock, you could own 10 stocks through a leveraged instrument like Contracts-For-Difference (CFD). Or instead of owning just 1 stock, I’ll give you the option to purchase 100 stocks 3 months from now.
When you look closely at most instruments offered in the financial markets today, such as options, futures, warrants, CFD’s (etc) they are all based on leverage. Even some ETF’s are starting to get on the bandwagon.
Remember, playing with somebody else’s money exposes you to risk, and places stress upon the performance of your investing choice. Investing can be difficult enough with trying to figure out what to buy, when to buy it, how much to buy, and when to get out, and by placing additional pressures on our decisions it can cause you to make further rushed decisions.
By borrowing money you are forcing yourself to repay the principal back along with interest (and any other fees), and these repayments need to be returned according to a payment schedule. If the payments are not met from what is required in the loan agreement then the lender, according to the terms of the contract, could start proceedings to recover those payments.
Hardly anybody at the beginning of 2020 when setting their New Year’s resolutions thought: This year is going to be a pandemic year. It’s the same with each and every year – what may have been working well in the past, may not necessarily work again from this time forward, you can’t be too presumptuous about the future.
Borrowing panders to greed
If I really boil down the reason why I want to borrow money to invest it’s because I’m getting too greedy.
I want more and I want it now.
Why do I want more?
So that I don’t have to work as hard tomorrow, or so that I can give more to others. I always hope for the latter reason, but deep down I know it’s probably the former for why I want to leverage my investments. Unfortunately, impatience, laziness and greed aren’t good ingredients with any decision, especially an investment one.
The Bible asserts that Godliness with contentment is great gain (1 Timothy 6:6 KJV) and continues on by also making the obvious observation, For we brought nothing into this world, and it is certain we can carry nothing out (1 Timothy 6:7).
By really stopping and thinking about the decisions you’re making you can check if they are aligning with what you want.
If your financial goal is to be financially free, then why have debt any place within your finances. If you want to have peace and not worry about your finances why borrow money and invest if all you’ll be doing is eyeing your investment values every day?
See how by deciding to borrow for an investment can actually be inconsistent with what you actually want?
Compare your leveraged investment to how it would have been if instead of obtaining a loan you actually paid using cash. There would be:
- No repayment schedule to meet
- No additional expenses such as interest and fees to pay
- If the investment value fell, you could just continue to hold and ride out the storm
Less worry, less stress, no need to dodge the creditor, all because you employed patience and waited for the next opportunity to come around.
In the end, borrowing money to invest in a property is not a good strategy. It adds undue risk and issues that you would have otherwise avoided.
Rather than using debt as an investment vehicle, it’s best to save up for your investments.