When You Should Borrow Money To Invest

One of the most common question I get is this: is it a good idea to borrow money to invest in investment 'x' (the 'x' can be unit trusts, ASB, properties, business, Bank Rakyat shares, etc., etc.)?

Let me answer the question in real world terms.

Firstly, that is how folks build serious money – by using other people’s money. This strategy occurs regularly in business. Entrepreneurs borrow money from the bank to finance their expansion. They conquer the world, repay the loan and make tons of money. And that is always a good thing.

Now this concept of borrowing money to make more money works a treat for businesses as the margins are wide. The interest charged for the loan is often below 10 percent, but the business reaps 30, 50 or even 100 percent return on their investment.

Further, because of the wide margins, even when the returns drop, the businesses still make loads of money.

Now you can see why this concept is made-to-order for businesses.

However, the same does not apply when it comes to investments such as shares or unit trusts. Often time, the margin or spread between the interest and return is slim – less than 3 percent most of the time. For example, the interest charged is 9 percent but the return is only 11 percent.

Now, if the situation remains like that - interest 9 percent and return 11 percent - things are still hunky dory. You would do well taking the loan and making the investment. However, what usually happens is that the return starts to drop off. From 11 percent, they drop to 10 percent and then to 8 percent.(By the way, this is what happened to the once-fabulous ASB.)

The way things are going, the return could very well drop below the interest charged! This is not an unusual thing. When that happens, instead of making money, the investor is now forking out money. And that, needless to say, is not a very nice thing to happen. Not exactly fairy tales stuff. (By the way again, this is what usually happens when folks borrow money to invest in stocks.)

Now after painting the real world scenario, let me answer the question. Yes, you should borrow money to invest – if the spread is wide (more than 5 percent) and you are pretty sure that the situation will remain status quo for the loan period. For example, if the interest is 9 percent, the return should be at least 14 percent. Otherwise, let others be the test-pilot. You watch by the sidelines.

Now, I know a lot of people will jump and shake their heads. They will quote how their father, grandfather, uncle, auntie or neighbour made tons of money by borrowing money to invest even when the spread is ultra-thin. Of course it can happen. People also strike the lottery but has it happened to you?

If the spread is thin, you are taking an unnecessary risk. While you can make a little bit of money, but the chances of you losing a lot of money is significantly higher. Once the return starts to drop and/or the interest starts to rise, you lose both money and sleep and that is no way to make a fortune.

In case anyone thinks that this is a theory from the ivory tower, I personally will not borrow to invest if the spread is less than 5 percent. In fact, I will not borrow to invest in unit trusts or shares - period. I only borrow money to expand my business and for property investment.

PS. The questions have been coming in fast and furious lately. FYI, I get an average of 30 e-mails a day from folks who want the answer for something, some problem or some investment. While I am always happy to help, I am unable to give personal answers anymore. Otherwise, all I’ll be doing all day is replying e-mails!

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