Investing is a great idea if you want to grow your wealth, but you can't invest money if you don't have any money to begin with. Normally when you need money you don't have, you can get it from a financial institution in the form of a loan. As it turns out, you can do the very same thing for the purpose of investing.
Many savvy investors have made good money by borrowing the funds for their investments and it’s a well-established and common strategy. However, it takes careful planning to make sure the strategy is viable and it won't be for everyone.
You may be interested in this strategy because of the great potential it can offer you, but you also need to be aware of the potential risks involved. In this article, we will explore the topic of borrowing money to invest to help you better understand how you can use this option to grow your wealth.
The basic premise behind borrowing money to invest is pretty simple to understand. As an investor, your potential returns are limited by how much you put in. In addition, there are some investments that require a certain amount of money or you can’t invest at all. When you recognize a good investment opportunity, you probably want to make the most of it, but you won't always have the money to make it viable. This is where your lenders come in. It’s possible as an investor to borrow money from a lender that you can then invest where you like. This investment can come in many forms including starting a business, buying an investment property, funding an education, or simply building a portfolio in stocks, bonds, and investment funds. This style of investing is also known as leveraged investing because these loans are often leveraged off the value of an existing asset that the bank will use to secure your loan.
A lot of people think it doesn't make sense to borrow money to invest, after all, the point is to grow what you own, not to put yourself in more debt. The truth is that debt is a powerful tool that allows you to defer costs and control what you owe and when in order to maximize your dollar's potential. This characteristic of debt is the key to borrowing to invest.
When you borrow money, your lender is naturally going to expect that money back at some point. In almost all cases, they don't want just their money back – you’ll need to pay interest in addition. The key to borrowing to invest is simply to focus on investments that return at a greater rate than you owe interest. By paying a bit extra in the long run, you can access funds now and begin to collect a return on investment. When this return is greater than your interest, the resulting leftover funds represent your profit and every payment towards principal represents a greater ownership share. In some cases, if the investment generates enough cash flow, the returns may even help to pay off the principal as well as the interest.
Naturally, any loan or investment comes with risk and borrowing to invest is no different.
The first and most obvious risk is that no investment is guaranteed. In a best-case scenario, your invested money grows just like you planned and you get to take home the profits. Unfortunately, this is not always the case.
Losing money on an investment is not uncommon and it's not ideal even when it's your own money. But, what about when it's someone else's money that has been invested? You still owe them what they expect in payments, so every loss with borrowed money hits a little harder. The only real way around this problem comes down to making sure your investment is sound enough to bet on. You should also have a backup plan in place if things don’t work out.
The other problem is that even when your investment makes money, you won't be making as much as it seems. For every dollar that you make, some portion of that will have to go towards servicing your debt. Naturally, the more your investment succeeds, the less the cut is. But, until you have paid off your loan, you will always be making less than you could with your own money.
The key is to make sure the benefit of a larger investment with borrowed money outweighs the cost of borrowing and to aim for long-term investments that will continue to pay out after you have paid back your loan, so you can start to reap the full returns.
There are a number of different products that allow you to borrow money for investment:
One common option is to borrow against an asset you already own and your home may be a great option. Two common borrowing options to leverage your home’s value are Home Equity Loans and Home Equity Lines of Credit (HELOC). You can borrow from your home equity to invest as you see fit and pay back the borrowed amount and interest over time. These loans offer good interest rates as they are secured by a property and are often easy to qualify for if you have an existing mortgage and home equity.
You can also borrow against other assets like a large portfolio in the stock market. If you don't necessarily want to sell but you want to take advantage of this value for even more growth, this is a good option for you. This can also help if you want to borrow against a less liquid asset when you want to invest a lump sum all at once.
Some lenders will offer specific RRSP loans so you can make the most of your tax savings. These loans can help you to max out your RRSP contributions and take advantage of the tax benefits.
Finally, some lenders will offer general investment loans. These don't necessarily need to be secured against anything in particular other than your income and savings being enough to cover payments. An investment loan may only be available in smaller amounts and with higher interest rates.
Because of the wide range of options when it comes to leveraged investing, it’s hard to say exactly how much this sort of loan will cost you. Your interest rates will depend on factors like how much you want to borrow, what you are leveraging against, what you plan to invest in, and more. Things like a HELOC will generally have a lower interest as they are secured to a valuable asset while something like borrowing against stocks can be riskier as they fluctuate more drastically in value.
There are a number of places you may choose to invest money you borrow.
For example, you might borrow money to invest in a home. With great appreciation as well as potential additional income (like through renting), you can easily make a profit from this strategy.
In fact, this is essentially the fundamental concept behind mortgages, though it’s possible to borrow money to invest in real estate through sources other than a mortgage loan.
Another popular use is to start a business. Businesses can be highly profitable, but they need a large amount of capital to get started. In addition, many businesses do not make money in their first year or more, meaning these extra funds can help to tide you over until your business is profitable. By borrowing, you can start a business to begin making money. without borrowing, you may not be able to start your business at all and you won’t make any money.
Other uses of borrowing to invest include leveraging an existing portfolio in order to diversify into other asset types and borrowing to fill out a registered retirement savings plan or a tax-free savings account. This can help you get ahead on your retirement savings and, thanks to tax-deductible investments, you can get money back on a tax deduction that can even help pay your loan back.
Borrowing money to invest is a very useful option for those looking to accelerate the growth of their investment portfolios. However, this option won't be for everyone due to the risks involved.
One of the biggest factors that you should consider when deciding if you should borrow to invest is your risk tolerance. When you invest borrowed money, you expose yourself to more risk than if you invest your own cash. If you aren't able to handle the risk, this strategy is not for you.
Connecting to that, you should ideally be investing with a long-term goal. Not only does this help you get the most out of your borrowed money, but it can also help to lower the impact of short-term losses.
You also need to carefully consider the relationship between how much you want to borrow and what you stand to gain. Fundamentally, your investment needs to grow more than your interest payments, but you also need to be making enough income that it makes the whole process worth it. Borrowing to invest only a small amount of money will only add complexity to your investment for little benefit.
Finally, if you are planning to borrow to invest in something like an RRSP for its tax benefits, consider your own tax bracket. Tax savings will be most beneficial to investors with a high marginal tax rate, while those in lower tiers will not see the same benefits.
You need to carefully consider these factors before you decide to borrow to invest. Also, seriously consider consulting professional advice from a financial advisor to ensure you don't make any mistakes that can end up costing you.
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