27 July 2011

Should you borrow to invest?

Borrowing money to invest is a risky trade. Though some people are hesitant to borrow to invest, this can be a powerful wealth-building strategy. If you are an experienced investor, and you have a good credit history and you are looking for an alternative strategy to grow your wealth, Leveraging or investing with borrowed money may be a good option. While borrowing to invest magnifies both positive and negative returns, you can reduce risk by adopting a strategy that reflects your personal risk tolerance and financial circumstances.

Borrowing to invest is also called 'gearing'. Before executing your plan of leveraging, weigh the pros and cons. Whether this will help you build on your income.

Risk Factor

Borrowing to invest magnifies the highs and lows. The result can be ruinous when the market falls. There are chances of you losing your investment and end up owing money to the lender. The more you borrow, the greater the risk.

It is very risky when you are investing in a diversified portfolio or managed funds and you are borrowing more than 50 percent. The less diversified your investment, the greater the risk. If you plan of investing in just one company or one industry then it's recommended you don't borrow.

Make sure you do not borrow against your home and use the money for the purpose of investment. It is very treacherous. Have you given a thought of what would be the outcome when the investment turns bad and you can't keep up your loan repayments? You would lose your home.

If earlier you had availed a personal loan calculate and see if you can afford the loan repayments if rates go up. If the rates go up by 2 or 4 percent, the repayments get too expensive. You would have no other option than to sell your investment in a hurry at a low price.

Loan is a legal contract which you got to repay regardless of how the investments perform. If their value goes down, you may be subject to a margin call, depending on the type of investment loan used.

The tax rules regarding the tax deductibility of interest are subject to amendment. It's important to keep abreast of changes.

Key Benefits

On borrowing money to invest is quite similiar to availing home loan where the mortgage provided by the bank allows you to purchase the house with the bank's money.

With the help of these additional funds borrowed, you can invest in diversified portfolio. With this you get into a monthly loan payment, for which you need a savings plan. This helps you deal with your monthly saving plans.

Borrowing money to invest may create a deduction for interest costs incurred. Leverage can magnify effective after-tax returns.

Borrowing to invest though has exciting benefits; it has a down side to it. It is your choice as an investor whether borrowing to invest is suitable option to meet your demands? The value of your investment will vary and is not guaranteed, however, you must meet your loan and income tax obligations and repay your loan in full.