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Should you borrow money to invest?
It is a very common thing to do in property investments. Almost everyone borrow to invest in properties. Why not? When the interest rate of the loan from the bank is lower than the rental yield you would get from your properties? Not only would you get the difference in yield and interest rate, chances are, you can even get the capital appreciation of the property as a reward. In fact, if you have RM 1,000,000, instead of buying one property, you might choose to instead, use the cash to pay for the down payment of 10 properties and borrow the rest from bank. If all goes well, you can enjoy the capital appreciation of not 1, but 10 houses, possibly 10X the return you would have get if you have invested all RM1,000,000 in cash in one property. This is a no-brainer.
At this point you may think you have made a very smart decision.
How about in stocks?
Should you borrow money to invest in stocks?
If you're still unaware of, you can..actually borrow to invest in stocks..using this facility called buy on margin. That means to say that if you have RM1000, you can buy a stock worth of RM2,000 (or more depending on your brokerage.) Now the question is should you buy on margin? Again, if you have a stock that promises you a dividend yield of 8% and the interest rate is just 6%, then you should be able to get a 2% free cash. Very clever move,right?
(If you're unfamiliar with buy on margin, it is actually like you use your stocks of RM1000 as collateral to borrow another RM1,000.)
It depends..(Please don't hate me,just pointing out my concern)
Have you ever thought of what would happen if all of a sudden, your dividend yield might not be able to pay for your interest rate?
At this point you might think, "It won't happen,the company is stable"
Really? What if it decides to keep the dividend to fund new projects?
Well..you might have some saving to pump in right? Okay then..but what if you get a margin call? When your stock plummet in price and the brokerage calls you to top up more cash.
(Please don't say it will not happen, we are human not God,we can't predict the future. What if there is a black swam(911 Incident)).
Do you have that kind of cash prepared? Else, your share will be sold at a low price which is bad for you. Meaning to say, you lose your holding power thus incurring more risk. (More risk means more likely to lose money)
Then again, some property investor will say,
This will not happen to me, property rarely drop in price. I will be safe. Or really?
Is your interest rates from the bank loan fixed? or does it fluctuates? What if your rental yield become less than your interest rates? Even if your interest rates is fixed, you could be affected by the market condition. If there is an increase in interest rates and many people default in the loan, the properties will be sold at huge discount thus lowering market price. Your property might be revalued lower due to this and you might get your home loan margin call. (Yes,it exists). Do you then have the cash to top up?
So the point is never use debt to fund your investment?
No. What I want to illustrate here is debt is a very powerful tool. But like a double edged sword,it could help you or harm you. The key here is to buy at the right time, right after a crisis,when things are so cheap,you wish you could buy them all. This is the time of minimal risk,so you can use debt. Second thing is, predictability, only use debt to fund investments that is very predictable and stable. (Example: Buying companies like Nestle instead of Apple or Blackberry)
Final words, if you really want to supercharge your investment return using debt,make sure you know what you are doing and have factored in the risks before you make a decision.