Pros & Cons to Take On a Debt to Invest

Taking a debt to invest is something that many Singaporeans who want fast cash consider. After all, borrowing a small sum now can boost your return on investment faster than if you were to invest your savings.

This technique is called leveraging.

Leveraging entails using, obviously, leverage. And that leverage is your debt’s small cost compared to the high returns you’re foreseeing.

And that’s the first problem:

How do you know if you’re going to get a more significant profit compared to the cost of your loan? And what if you ultimately can’t repay your debt?

To find out the answer to those questions, along with some practical alternatives, continue reading below!

The PROS of Taking a Debt for Investment

Let’s get straight into it with the advantages of taking a loan to invest:

Better Investment Returns

Higher return on investment is the main reason why traders and investors consider taking loans in the first place. And it’s true: injecting that extra cash in an already good investment can make your returns skyrocket.

At this point, you’ve already spotted the first issue:

You need to be 1000% sure of your investments. So:

  • You want a diversified portfolio to reduce risk as much as possible.
  • You have to compare the monthly loan instalment to the expected revenue/ month from your investments. For example, suppose you’re taking a loan to purchase a private property that you’re looking to rent. In that case, you want to consider the rent/ instalment ratio and additional expenses like insurance, accidents, rent fraud etc.

Warning: Watch out for too-good-to-be-true deals. Those exponential returns may be just a mirage hiding a potential loan scam.

But here’s the thing:

Better Opportunities

Better opportunities do exist. Of course, you’ll have to do due diligence first and triple-check all the details. One example is March 23rd 2020.

This fantastic day for investments brought with it the lowest point in the market, which means you could have bought very low and sold very high. You first needed to know about this opportunity, and secondly, you needed to have had the cash.

But that’s just one example.

The story always goes the same way, with frequent market dips and discounted stocks. If you don’t have enough liquidity to jump on the investment boat, you can consider a debt.

However, you have to move fast.

In this scenario, you’d need to quickly choose the right financial partner to obtain a fair loan. Afterwards, you’d need the confidence and determination to make your moves single-mindedly to penetrate the market.

Otherwise, you can lose the boat again.

The CONS of Taking a Debt for Investment

Now that you know the wonders waiting for you just around the corner, let’s objectively look at the dangers of taking debt to invest:

Increased Losses

You know how the saying goes: you win big, you lose big.

The problem with using a loan to invest is that you need to act fast, following your instinct and the research you’ve done. Hesitating can be fatal.

However, the market is volatile too.

So, sure, the probability of an expert trader/ investor maximising their gains is pretty high. But there’s also a significant risk that your investments don’t work out the way you’ve envisioned.

That’s why the great Warren Buffet himself argues against this practice.

Lack of Expertise

Expertise is crucial in investments. Sure, beginners’ luck may be a thing, but are you ready to base your investments on this?

Conversely, if you’re sure about your plan, go for it. You’ll need sound setup goals, strategies, and the know-how to tackle iffy situations, though.

You also need a comfy blanket to fall back on.

Because that’s the other thing:

The investors/ traders who take on debts to improve their ROI rarely go bankrupt. Even if those particular investments don’t go through as expected, those investors won’t go bankrupt.

So make sure you can always pick yourself up and dust yourself off. To do this, consider:

  • How much funds you have in your emergency/ savings account
  • If your job is stable
  • The cash you have tied up in other commodities, like stocks/ bonds/ properties etc.

The Risk

Taking a debt for investments can be a risky endeavour.

Let’s look at the best-case scenario. You’re taking a loan with a licensed moneylender at a 4%/ month interest rate. At the same time, your stock investments bring you an 8% profit monthly.

That’s a definite win.

But what if the company where you bought stocks doesn’t perform as expected? If those stocks bring you any less than 5%/ month, you could say that the debt you’ve taken was an unnecessary risk.

In this case, a savings account would have been better.

However:

  • You never honestly know anything until you’ve tried it, and secondly:
  • Some stocks can plummet in the short term, but they will perform well in the long run. That’s why it’s best to analyse the market objectively instead of selling your stocks in a moment of panic.

The Extra Costs

When you’re judging the debt cost vs investment ratio, consider all the extra fees that come along with your investments and your loan:

  • Processing charges
  • Transaction charges
  • Early/ late repayment charges

So even though the potential returns are significant compared to the monthly loan cost, in theory, remember that in practice, these extra charges snowball and can therefore make a significant dent in those profits.

The Alternatives to Debt for Investment

As you’ve seen from the two sections above, taking on debt to invest has a considerable appeal. However, if you’re unsure of your expertise, you should consider these strategies too:

Compounding

Compounding entails investing early on so that your interest has more time to add up. As such:

  • You can avoid market volatility.
  • You spend more time analysing the market from a practical standpoint.
  • Your wealth is growing faster than if you were to put your extra cash in a savings account.

For instance, $100/ month bringing a 5% return/ month get you to $15,692.93 at the end of those ten years.

Increase Your Earnings

Instead of taking debt to invest, consider increasing your available capital. You can do that in two ways:

  • Spend less money. Look at your budget and see where you can tighten the belt. For example, you can limit eating out to once or twice per month. Remember that $15,692.93 extra you can get just with $100/month.
  • Earn more money. Consider a side-hustle like a cooking blog, freelancing or tutoring. Pick something you enjoy doing, and that doesn’t take up much of your time. Remember that you don’t need a massive starting amount for successful investments.

Taking a Debt to Invest Conclusion

Taking a loan to start investing isn’t everyone’s cup of tea. You need to understand the market very well and act decisively at all times. Even so, you have to be prepared for some losses.

On the other hand, that loan can accelerate your ROI faster than you’ve ever hoped for. If you’re taking the time to research and minimise your risk as much as possible without disregarding your profits, you can pull this off.

For instance, an aggressive ETF like Invesco QQQ Trust would more than makeup for your monthly instalment. So, in this case, a quick loan now would be well worth it later.