Should you borrow to invest?

If you’re thinking about making an investment, it’s a good sign that you know the importance of your money working hard for you. Ambitious financial goals need to be backed with smart money strategies to get you where you want to go.

If you don’t have savings behind you, borrowing money to invest (known as ‘gearing’), is seen as a high-risk strategy. Making it work requires:

  • a solid understanding of the types of investment
  • a well thought out investment plan
  • risk minimisation strategies.

For most people this means seeking professional financial advice.

Questions to ask about borrowing to invest

Asking these questions can help give you clarity on whether borrowing to invest is a good way forward. They’ll also be the type of questions a financial advisor will ask, so you will be well prepared when you get professional advice.

  1. What is your current financial situation: what do you own, what do you owe, and what is your income and expenses?
  2. What are your investment goals?
  3. What is your investment timeframe? Short, medium or long-term?
  4. What level of risk are you comfortable with? If you have a partner, do they have the same appetite for risk?
  5. How secure is your income? How much flexibility is built into your strategy?

Benefits of borrowing to invest

Borrowing to invest means capacity to increase your investment amount, and potentially increase your investment returns. It also gives you access to investment opportunities with a higher minimum buy in.

If you’re on a high marginal tax rate, your interest payments may be able to be claimed as tax deductions.

Risks versus rewards

Borrowing to invest is inherently risky. Potential risks include:

  • income investment risk – the income from your investment ends up lower than expected, such as a defaulting tenant in an investment property or shares losing value
  • interest rate risk – rising interest rates increase your loan payments, perhaps beyond your capacity to pay
  • income risk – a change in your family’s income, through job loss, illness or birth of a child, means you have trouble meeting repayments
  • capital risk – your investment decreases in value.

Some risks are mitigated over a medium or long timeframe, so borrowing to invest is usually considered for longer-term investments. Risk is part of any investment and need to be factored into your investment strategy, so you’re not caught unprepared if things go wrong.

Tip: As part of your financial planning, think about best and worst case scenarios for your investment. If it doesn’t pan out, will it mean hardship for your family or put other assets at risk?

Don’t forget your tax

Any investment opportunity is likely to affect your taxable income. If your investment runs at a loss, you can use negative gearing to reduce your tax bill. On the other hand, if your investment makes a profit, positive gearing comes into play, which means you earn more money but pay more tax.

Understanding types of investment

Understanding diversification and the role it plays in lowering risk can be useful in deciding how and where to invest your money. There are five classes of investment assets:

  • cash
  • fixed interest
  • bonds
  • property
  • shares.

An ideal investment portfolio includes a mixture of higher and lower risk investments spread across the asset classes. Diversification helps spread your risk, so you’re less vulnerable to threat to a specific financial sector. For example, if you already own or are paying off a house, you may get financial advice to consider investing in bonds or shares rather than another piece of real estate.

Tip: If you’re not ready to buy where you’re living, you could become a ‘rentvestor’ and buy in an affordable area.

Building a financial future

Whether you consider yourself financially progressive or conservative, investment is a smart strategy to build your wealth. But before you borrow to make an investment, get some quality financial advice from people you trust with your money. Talk to QBANK or call 13 77 28.

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