Author: Ivy Finley
Undeniably, taking a loan or borrowing to invest is common. As a matter of fact, it is termed gearing or leverage.
You need to know that it is most common for experienced investors since it is known as a higher-risk strategy. After all, there is always the possibility of huge losses when the market falls. Besides the losses, there are the obligations to pay back the investment loan together with interest.
How borrowing money to invest in stocks work
Borrowing money to invest in stocks is typically a medium to long-term strategy.
Most times, it can be at least five to ten years loan. The most common ways to borrow money are through investment property loans or margin loans.
Investment property loans are best used for investing in houses, lands, commercial properties, and apartments. With this kind of investment, you can earn revenue through rent.
However, you need to contemplate deeply in investing here because you also need to invest money to pay the interest and the cost of owning your chosen property. Additional costs also include insurance, repairs, and council rates.
On the other hand, margin loans let you take out some money to invest in shares, managed funds, or exchange-traded funds (ETFs). On average, margin loan lenders require borrowers to keep the loan-to-value ratio below an agreed level, typically at 70%.
Major risks of borrowing money to invest
Without a doubt, borrowing money for investment is an opportunity to access more money. Nevertheless, you should consider the risk.
- Interest rate: Interest rate varies depending on the loan types and conditions. Most companies charges for late payments and the interest rate may not be suitable.
- Capital risk: The market value can always go down. If it happens consistently, you might end up selling your investment at a price that doesn’t even cover your loan.
- Bigger losses: As mentioned above, it is hard to take out a loan to buy stock since the market is volatile. The guarantee of return is not 100%. Aside from that, you still need to repay your loan and interest, regardless of the outcome of your investment.
Tips for managing the risk of investment loans
Here are some tips you can follow to avoid suffering from big losses:
- Have cash set aside: This is the best safety measure you need to remember if you don’t want to sell your investments quickly just for cash. Ensure you have a stable revenue source to service your loan.
- Borrow less than the maximum: If you keep your loan less, you don’t have to feel anxious about the interest repayments and potential losses.
- Regularly pay the interest: Don’t wait until the interest increases each month. Make this your mindset so you can enjoy the income you might earn through your investment, not just use it as repayment.
Should I take out a loan to buy stocks? That’s the question you might now have in your mind. Since you already know the risks that you might encounter and other relevant information, the decision is in your hands. Also, you can decide by contemplating important factors, including investment returns, borrowing costs, and risk tolerance.