Using Borrowed Money To Invest

While many have indeed taken up amazing opportunities with other people’s funds, there are certain rules that guide it especially when you are a sole individual

No matter how much somebody tries to explain the benefits that come with investing in the Nigerian stock exchange, the truth is that if you don’t have the money to invest, all the information you have would be futile.

Some of us have probably been in this situation before: A friend or colleague tells you about an amazing investment opportunity that apparently comes with impeccable gains and you’re just financially stuck.

The options presented are then to either completely disregard the information available to you and go on without investing or to seek out alternative sources of financing your interest in that investment like debt.

While many have indeed taken up amazing opportunities with other people’s funds (many of the big businesses do so), there are certain rules that guide it especially when you are a sole individual. Here are some of the most important things to be wary of:

The Kind of Investment It Is

In the first example where a friend or a colleague told you about an investment opportunity, many times, especially when the projected gains seem too good to be true, it is most probably a heavily speculative investment.

If you knew when the MMM saga hit, then you would have a very clear idea of the level of risk you are exposed to when you borrow to fund one. The simple advice here is that you do not borrow to fund speculative investments – especially one you do not know about very well and one with huge risks.

The Investment Risk and Its Potential Gains

Assuming you borrow to invest in certain stocks, then you need to assess the level of risk or volatility that comes with it and compare it to its potential gains. If the shares that you purchase with borrowed money fall, would you still be able to pay back the loan?

As a result of the risk of the stock market, especially when you want to tie it to the pressures of timing, it is also not advisable to take a loan that is based on the expected gains. However, investment companies and professional traders are known to use borrowed funds to invest successfully.

This is because of size (economies of scale), their level of experience, and so on. This might be a big risk for the individual investor. The only way to borrow to invest in something like stock is if you are not depending on the potential gains to pay back the loan.

That is, you could just need a raise until when your salary comes and you pay back. Borrowing to invest can increase your returns when markets rise, but losses can be devastating when markets fall when repayment is tied to the investment.

__The Interest on The Loan – If Any__

Borrowing to invest is a risky business as it is. However, when the borrowed fund comes with interests too, you are taking a deeper risk into ending up in a precarious financial situation. How do you ensure that you make enough profit to beat the interest rate of the loan?

Generally, you are only allowed to invest when the expected return on investment of the loan is high and the risk level of the investment is low. While this is an ideal situation theoretically, too many things could go against it.

For example, if interest rate on the loan rises by a marginal rate of say 2%, would you still be able to cover it? Also, if the investment would bring enough return to cover the loan, it means the risk of the investment is high. Are you prepared for the tradeoff?

How Much Idle Money You Have

One of the situations where you are allowed to borrow money to invest that we have cited is when you intend to pay back out of your personal purse and not out of the potential returns of the investment. You need to determine if you have enough money from other sources to cover the loan when you need to and where contingencies arise.

Borrowing to invest doesn’t necessarily mean borrowing to buy shares. It could mean borrowing to buy a house or a car. However, all of the same principles apply. More often than not, we are thinking of only short term gains when we try to borrow to invest and obtain gains.

Ideally, investments (especially in the stock market) thrive on waiting time for the long term. If you try to rush it, you would be caught unawares when it is time to pay back and might have to settle for a poor position, making little or no gains at the end of the day for yourself.

It is thus important that you seek professional assistance or advice so you can weigh your options and determine if borrowing to invest is good for you or not. If you will you lose sleep if your investment performs poorly, then borrowing for it is a terrible idea.

Written by Lawretta Egba.