Borrowing money to invest, also known as ‘gearing’, can be a risky business. While it can increase your returns when markets rise, losses can be extreme when markets fall. It is important to understand the risks involved when deciding whether borrowing to invest is right for you.
The main benefits of borrowing to invest are:
- It gives you more money to invest.
- If you are on a high marginal tax rate then there may be tax benefits as you are usually allowed a tax deduction for interest payments on the loan.
Despite the benefits, borrowing to invest is only worthwhile if the investment return after tax will be greater than all the costs of the loan, such as interest and fees. If not, then you may be taking on significant risks for an overall low or negative return.
The more money that you borrow increases the chance of risk, as you will have to repay the loan regardless of the performance of the investment.
Some major risks of borrowing to invest are:
- The income that you receive from the investment may be lower than expected.
- Interest rates on the loan could rise.
- Income risk in circumstances where your income may stop, such as illness or redundancy.
- Capital risk can occur when the value of your investment falls and the proceeds from the sale may not cover the remaining loan balance.
It is vital to understand and have a plan in place to manage these risks. As borrowing to invest is a high-risk investment strategy best suited to experienced investors, you should seek further professional financial advice to make sure that this is a viable option for you.