Investing in shares through borrowing is a relatively fresh concept compared to the widely known lending practice for property investments.
However, it's essential to recognise that this approach carries risks like any other investment, particularly when obtaining funds from a bank or broker.
This blog will explore the advantages and disadvantages of borrowing money to invest in shares. We'll guide you through the process of doing it and help you determine if it's a worthwhile consideration. Stay tuned to learn more about this intriguing opportunity!
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1. Why Would You Borrow To Invest?
Borrowing money to invest is called gearing or leverage, which allows you to invest more than you have already saved. It is beneficial if the value of your borrowed cash rises more than the interest you pay on that money.
Here are two main reasons why people would consider borrowing to invest:
You can benefit from the rise in the investment value without making an upfront payment, i.e., in the case of buying a house.
To access tax benefits for interest payments on the borrowed sum when the interest exceeds any income earned.
2. What Is A Margin Loan?
Margin lenders who offer this loan require you to maintain the loan-to-value ratio less than a pre-decided level, i.e., mostly 70%.
3. What Are The Downsides Of Borrowing To Invest In Shares?
Many people ask if it is illegal to borrow money to invest. No. It is not, but it involves various types of risks:
The most significant disadvantage of borrowing to invest is that even if the return on investment is negative, you still have to pay the loan balance and interest repayments. It may amplify any losses to the extent that you may even owe more than you own.
Another drawback of this strategy is that leverage can give you massive gains but can also lead to significant losses over the short run. Therefore, it is wise to borrow only the amount you are comfortable investing for the long term. Otherwise, it may cause your savings to wipe out entirely.
Furthermore, the income you generate from investment could be lower than expected. For example, if you took a loan to buy shares in a private company and it didn't pay a dividend. Ensure you can cover living expenses and loan repayments without earning investment income.
If the return (after tax) is greater than the investment and loan costs, you are taking a higher risk for a negative or low return.
4. What Are The Benefits Of Borrowing To Purchase Stocks?
Here are some good reasons why taking on some debt can help enhance your stock portfolio and investment returns.
Build a more extensive portfolio at a faster rate than when you use your funds
Use leverage to maximize profits and earn higher returns.
Access additional stocks to diversify your portfolio without selling any shares.
Some lenders lend you money based on your current share portfolio as collateral. So, you can increase your investment size without depositing extra funds.
You can borrow and invest in stocks of other sectors using the equity in your existing portfolio. This way, you can manage concentration risk in your portfolio.
Benefit from potential tax deductions linked to borrowing. You can avail of tax benefits through negative gearing if the income you earn from your stocks is below interest costs.
5. Can You Borrow Money And Put It In Stocks?
Yes. Here are two potential ways you can use debt to buy stocks:
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The below are just some general options for educational purposes. All these options come with risk. This is not financial advice.
Use Margin Loan
Approach a lender to get a "margin loan ." Here the lender will grant you a loan against your stock portfolio.
The problem with this method is that if the stock price falls, the bank may call you to put in extra money to bring the loan-to-valuation ratio to the desired level. On failing to do so, the lender may sell your stocks.
Use The Accumulated Equity In Your Home
Compared to the earlier method, you pay a lower interest rate which keeps your repayments down. You can direct more funds to additional investments or repay your outstanding non-deductible home loan.
Another benefit is that you have much more control, with a negligible chance of a margin call. Also, you can get started without an existing stock portfolio.
However, the Australian Securities & Investments Commission Moneysmart platform warns first-home buyers and occupiers against this option. If the investment turns terrible and you can't keep up with debt repayments, you may also lose your home.
6. How Can You Qualify For A Loan To Invest In Stocks?
Investment loans involve a higher risk than standard home loans. It implies that you must be financially stable to qualify for the loan.
Here are the essential lending criteria that almost all lenders follow:
You should have stable employment.
You should have between 5% and 10% in genuine savings.
If borrowing is over 90%, lenders will require equity in other properties as collateral.
You must have a good credit history and above average credit score.
7. How To Find An Investment Loan For Borrowing Against Shares?
An investment loan is a higher risk to the bank. Both bank and non-bank lenders offer up to 95% of investment loans in Australia. However, the qualifying criteria for the loan can vary between lenders.
The principal doesn't go down, so you always accrue interest on the original loan amount. Otherwise, you can consider principal and interest repayments that reduce the loan amount with time.
These loans only last for a while. After a specified period, you must also begin paying the principal.
Here are some investment loan examples:
Westpac Online Investment Loan
Lends you to invest in an array of approved securities that includes ASX 200 shares, Managed Funds, and ETFs
No application, transaction, or establishment charges
Get preferentially fixed and variable interest rates.
Like the above loan, you enjoy 24/7 portfolio access, no application, transaction fees, establishment, and flexible repayments.
Westpac Protected Equity Loan
As the name suggests, the loan lets you invest in an array of ASX-listed securities, including ETFs.
You can use the loan amount to build your portfolio with complete capital protection at maturity and no margin calls.
Also, you are entitled to receive ordinary distributions during the loan term.
8. What To Consider Before Borrowing To Invest?
Below are some essential points to consider before borrowing money to invest.
Time Horizon: Don't select a stock based on its past performance. It may deliver other returns in the future. In other words, the best-performing investment for a year could perform poorly in the next year. That's the reason investing with a long-term perspective is essential.
Reliable Income: It is always a good practice to have a plan B to cover the interest expenses on the loan in case of job loss.
Additional Savings:When borrowing for stock investment, you may get a 'margin call' if your investment's value declines. In that scenario, you need to infuse more capital to keep the overall gearing within a certain level.
Tax: Though negative gearing can offer you tax benefits, investing in negatively geared investments isn't wise. You may benefit from the rising investment value, but increasing interest rates could reduce your overall gains.
Emotions: Stock investment is a risky business. You must control your emotions while seeing your equity shrinking before your eyes during market downturns. Only borrow if you can stick with your investment plan and stay invested even if the market falls.
Interest Rate Considerations: Remember that investment loan rates will not remain low forever. Investing with the loaned amount may make you less comfortable with each rate increase. That's when it is vital to have an investment strategy to avoid making higher repayments.
9. Is It Okay To Borrow Money For Investment?
Yes and No. While a stock investment loan can accelerate the growth of your investment portfolio, it can even amplify losses if the stock price moves against you. This way, you can lose more than your invested capital.
Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk, especially when you borrow money.
10. Should You Borrow Money To Buy Shares In Australia?
No. Borrowing for investment to gain short-term returns is terrible, as stock markets are very unpredictable.
It increases the amount you will lose if your assets fall in value. You will need to repay the loan and interest even if you incur negative returns.
Other risks include:
If the interest rate rises, you may not cover the loan payments. It can, in turn, force you to sell the investment.
In case of job loss, you may be unable to repay the loan's interest.
Interest costs linked with the loan may lessen your profits. As Interest rates keep changing, it can increase the cost of servicing the loan.
11. What Are Some Ways To Borrow To Invest Without A Job?
If you are unemployed and don't have any income source, you can take advantage of an emergency cash loan using the below options.
However, investing using leverage is a bad idea, especially if you don't have a job. Only borrow money if you can pay it back.
Below are some options for educational purposes which one could consider (not reccommended):
No Interest Loan Scheme
It is another type of loan that borrowers access without job verifications. NILS providers are not-for-profit organizations that approve loan loans to pay for necessary goods or services without charging interest or fees.
However, borrowers must have a healthcare card or Centrelink pension to avail of the loan under this scheme.
No Documentation Or Payday Loans
Though you don't need to provide income proof and pass the credit checks, you have to pay higher interest rates and fees. Generally, lenders do it to safeguard themselves against high risks.
Providing proof of Centrelink payments in place of employment payslips speeds up the loan sanctioning process.
Find A Loan Guarantor Or Co-Borrower
People without an income source can secure a loan if they apply for it with their co-borrower/guarantor, who has a good credit rating.
However, if the borrower fails to repay the debt, the lender has the right to legally go after the guarantor's assets to recover the loaned amount.
Instead of asking for employment/income proof and performing credit checks, the lender lends you money against a moveable or immovable asset you own.
Due to the sizable underlying security, this loan has a slightly more acceptable set of interest rates and fees (still more than usual personal loans).
13. Why Do People Borrow Money To Invest?
Borrowing to invest has the potential to amplify your investment and achieve higher gains. Nevertheless, it's crucial to acknowledge that this approach can also magnify your losses.
As a result, only individuals with a strong understanding of investment strategies should consider borrowing money for investing purposes.
Before borrowing to invest, you should ask these questions:
How much risk can you bear?
How safe is the investment platform?
Do you have a diversified portfolio?
In how much time are you likely to see an investment return?
Though borrowing to invest can help accelerate your wealth creation, it also implies taking on more risk where your losses can exceed your invested capital. Whether you repay the debt depends on your investments and timeframe.
Before taking out a stock investment loan, you must consider the loan servicing costs. Seeking professional financial and tax advice concerning the risks and advantages of geared investing is beneficial.
Borrowing to invest is a high-risk business that can lead to more significant returns when markets go up and hefty losses when markets fall.
The strategy could be worth considering if you are an experienced investor seeking to take calculated risks to achieve your financial goals. However, if you are still uncertain, consulting with a financial adviser before making any investments is crucial.
|The advice and information on OzStudies.com is in general nature and should not be seen as a replacement for independent financial advice. We strongly encourage readers to consult with financial experts regarding their own financial decisions and investments.
Please note that the information presented on OzStudies.com is solely for educational purposes. Every individual's financial situation is unique, and the products and services we mention may not suit everyone. We do not provide financial advice, advisory, or brokerage services nor endorse buying or selling specific stocks or securities. It's essential to know that information might have changed since publication and past performance does not guarantee future results.
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