Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.
Borrowing to invest is a high-risk strategy for experienced investors. If you're not sure if it's right for you, speak to a financial adviser.
How borrowing to invest works
Borrowing to invest is a medium to long term strategy (at least five to ten years). It's typically done through margin loans for shares or investment property loans. The investment is usually the security for the loan.
Margin loans
A margin loan lets you borrow money to invest in shares, exchange-traded-funds (ETFs) and managed funds.
Margin lenders require you to keep the loan to value ratio (LVR) below an agreed level, usually 70%.
Loan to value ratio = value of your loan / value of your investments
The LVR goes up if your investments fall in value or if your loan gets bigger. If your LVR goes above the agreed level, you'll get a margin call. You'll generally have 24 hours to lower the LVR back to the agreed level.
To lower your LVR you can:
- Deposit money to reduce your margin loan balance.
- Add more shares or managed funds to increase your portfolio value.
- Sell part of your portfolio and pay off part of your loan balance.
If you can't lower your LVR, your margin lender will sell some of your investments to lower your LVR.
Margin loans are a high risk investment. You can lose a lot more than you invest if things go sour. If you don't fully understand how margin loans work and the risks involved, don't take one out.
Investment property loans
Investment property loans can be used to invest in land, houses, apartments or commercial property. You earn income through rent, but you have to pay interest and the costs to own the property. These can include council rates, insurance and repairs.
See property investment for more information.
Borrowing to invest is high risk
Borrowing to invest gives you access to more money to invest. This can help increase your returns or allow you to buy bigger investments, such as property. There may also be tax benefits if you're on a high marginal tax rate, such as tax deductions on interest payments.
But, the more you borrow the more you can lose. The major risks of borrowing to invest are:
- Bigger losses — Borrowing to invest increases the amount you'll lose if your investments falls in value. You need to repay the loan and interest regardless of how your investment goes.
- Capital risk — The value of your investment can go down. If you have to sell the investment quickly it may not cover the loan balance.
- Investment income risk — The income from an investment may be lower than expected. For example, a renter may move out or a company may not pay a dividend. Make sure you can cover living costs and loan repayments if you don't get any investment income.
- Interest rate risk — If you have a variable rate loan, the interest rate and interest payments can increase. If interest rates went up by 2% or 4%, could you still afford the repayments?
Borrowing to invest only makes sense if the return (after tax) is greater than all the costs of the investment and the loan. If not, you're taking on a lot of risk for a low or negative return.
Some lenders let you borrow to invest and use your home as security. Do not do this. If the investment turns bad and you can't keep up with repayments you could lose your home.
Managing the risk of an investment loan
If you borrow to invest, follow our tips to get the right investment loan and protect yourself from large losses.
Shop around for the best investment loan
Don't just look into the loan your lender or trading platform offers. By shopping around, you could save a lot in interest and fees or find a loan with better features.
Don't get the maximum loan amount
Borrow less than the maximum amount the lender offers. The more you borrow, the bigger your interest repayments and potential losses.
Pay the interest
Making interest repayments will prevent your loan and interest payments getting bigger each month.
Have cash set aside
Have an emergency fund or cash you can quickly access. You don't want to have to sell your investments if you need cash quickly.
Diversify your investments
Diversification will help to protect you if a single company or investment falls in value.
Gearing and tax
Borrowing to invest is also known as 'gearing'. Before you borrow to invest, check:
- if you will be positively or negatively geared, and
- how this will impact your cash flow and tax
See investing and tax for more information about positive and negative gearing.
Kyle gets a margin call
Kyle has $10,000 invested in shares. He decides to borrow $15,000 to invest in more shares through a margin loan. The total value of his shares is now $25,000.
Kyle's LVR is 60% ($15,000 / $25,000). The maximum LVR his margin lender allows is 70%.
Kyle has invested in five mining companies. He's taking on a lot of risk as he's not diversified. After a fall in the price of commodities, Kyle's shares fell by $5,000. The total value of his investments is now $20,000. The value of his investment loan is still $15,000.
Kyle received a margin call from his lender as his LVR had increased to 75% ($15,000 / $20,000). He had 24 hours to lower his LVR.
Kyle used $2,000 of his savings to reduce his loan balance to $13,000. This lowered his LVR to 65% ($13,000 / $20,000).
Kyle has money in a savings account ready in case he gets another margin call.
FAQs
You can't afford a failed investment
If you need the investment to deliver on its suggested returns to afford your personal loan, this route is a bad idea. No investment can offer a 100 percent guarantee on returns, and you'll need to start repaying your personal loan immediately — with interest.
What are the disadvantages of borrowing to invest? ›
Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.
Is it illegal to borrow money to invest? ›
If you're thinking about taking out a personal loan for investing, you might wonder about the specifics. Again, there are no limits on what is allowable. It comes down to what makes sense for you. There are a variety of investments you can make.
Do rich people borrow money to invest? ›
Use debt as a tool
For example, very rich people might borrow money to acquire a company if they think they can improve its profitability. They might also borrow to fund a startup business, or use margin in their brokerage account to invest in more assets that will help them build wealth.
What stock broker does Warren Buffett use? ›
Sokol's remark in January that he had come to know Lubrizol by owning the stock." So he acted. So who is John Freund? For someone that's Warren Buffett's broker, he's got a pretty low online presence -- spare video interviews on being: Buffett's broker.
What is it called when you borrow money to buy stock? ›
Buying on margin is borrowing money from a broker in order to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you'd be able to normally.
How do the rich use debt to get richer? ›
Wealthy individuals create passive income through arbitrage by finding assets that generate income (such as businesses, real estate, or bonds) and then borrowing money against those assets to get leverage to purchase even more assets.
What type of borrowing should you avoid? ›
We recommend avoiding cash advance apps, credit card advances, payday loans, pawnshops and title loans. These types of personal loans have multiple disadvantages, including high-interest rates and other fees.
What are 3 disadvantages of borrowing money? ›
The disadvantages include a higher interest rate, terms which can change on a whim, surprise fees being levied for missing/late payments, and in the case of unscrupulous, illegal money lenders people coming around to beat you up if you do not pay.
Why should you never invest using borrowed money? ›
The primary risk of taking out a loan to invest is the potential for magnified losses. If the investment performs poorly, you are still obligated to repay the borrowed funds, including interest, which could lead to significant financial losses.
They don't need to sell stocks, which would trigger capital gains taxes. Instead, they can take loans against their shares. Securities based lending, securities based lines of credit, home equity lines of credit and structured lending are options for leveraging assets without selling them.
How to borrow money to buy stocks? ›
The most common way to borrow money and invest is with margin. Margin is money you borrow from your stock broker. To do this, you need to open a margin account. A cash account, on the other hand, only lets you invest your own money.
How do billionaires avoid taxes? ›
Billionaires (usually) don't sell valuable stock. So how do they afford the daily expenses of life, whether it's a new pleasure boat or a social media company? They borrow against their stock. This revolving door of credit allows them to buy what they want without incurring a capital gains tax.
Where do most billionaires invest their money? ›
How the Ultra-Wealthy Invest
| Rank | Asset | Average Proportion of Total Wealth |
|---|
| 1 | Primary and Secondary Homes | 32% |
| 2 | Equities | 18% |
| 3 | Commercial Property | 14% |
| 4 | Bonds | 12% |
7 more rowsOct 30, 2023
If a wealthy American must make a large purchase like a new car or a piece of expensive equipment, they may use their credit card to pay for it and then pay off the balance over time, rather than having to pay for it all upfront. This allows them to have more cash to finance investments or other opportunities.
Can I borrow money to make an investment? ›
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.
Is it a good idea to borrow against your own money? ›
Clients who have built up their net worth—whether in their homes or investment portfolios—could have broader borrowing options by using their own assets as collateral. But doing so exposes those assets to increased risk, so you've got to have the fortitude and investment knowledge to manage such debt effectively.
Is it good to invest $100? ›
On average, the stock market yields between an 8% to 12% annual return. Investing $100 per month, with an average return rate of 10%, will yield $200,000 after 30 years. Due to compound interest, your investment will yield $535,000 after 40 years. These numbers can grow exponentially with an extra $100.
Is it worth investing if you have debt? ›
If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
