Risk of Borrowing to Invest
Borrowing to invest in Canada, often referred to as leveraging or margin investing, involves using borrowed funds to buy investments with the expectation of creating returns that are greater than the cost of borrowing. Make sure you understand how it works, including the interest rate, how interest is calculated, and any other risks and conditions associated with the arrangement.
The primary risk of taking out a loan to invest is the potential for significant loss. In the worst case, you can be forced to declare personal bankruptcy.
Here are some risks and factors that you should consider before borrowing to invest:
Is it right for you?
Borrowing money to invest is risky. You should only consider borrowing to invest if:
- You are comfortable with taking risk.
- You are comfortable taking on debt to buy investments that may go up or down in value.
- You are investing for the long-term.
- You have a stable income.
You should not borrow to invest if:
- You have a low tolerance for risk.
- You are investing for a short period of time.
- You intend to rely on income from the investments to pay living expenses.
- You intend to rely on income from the investments to repay the loan. If this income stops or decreases, you may not be able to pay back the loan.
You should also think about factors such as:
- How secure is my income?
- What is my cash flow like?
- What other debts or obligations do I already have, and can I afford to pay for them?
- Will I be able to repay the loan prior to my planned retirement date?
- Market Instability: Leveraged investments are more sensitive to market fluctuations, and losses can build up quickly.
You can end up losing money
- If the investments go down in value and you have borrowed money, your losses would be larger than had you invested using your own money.
- Whether your investments make money or not you will still have to pay back the loan plus interest. You may have to sell other assets or use money you had set aside for other purposes to pay back the loan.
- If you used your home as security for the loan, you may lose your home.
- If the investments go up in value, you may still not make enough money to cover the costs of borrowing.
The bottom line
Although it’s tempting to believe an investment will pay back the loan and even cover interest payments, in reality, there is no sure thing.
It’s very important to seek professional financial advice and develop a well-thought-out plan before considering this approach, as it’s not suitable for everyone and can lead to unfavorable financial consequences. If you are using, or intend to invest with borrowed funds, it’s crucial to let your financial advisor know. Whether a bank loan, a line of credit or another type of third-party investment loan, borrowing can affect your overall financial circumstances and your ability to meet your financial goals.