When You Should Borrow Money to Invest

One of the most common question I get is this: is it a good
idea to borrow money to invest in investment x (the x can be
unit trusts, ASB, properties, business, Bank Rakyat shares,
etc., etc.)?

Let me answer the question in real world terms.

Firstly, that is how folks build serious money - by using
other people's money. This strategy is a regular occurrence
in business. Entrepreneurs borrow money from the bank to
finance their expansion. They conquer the world, repay the
loan and make tons of money. And that is always a good thing.

Now this concept of borrowing money to make more money works
a treat for businesses as the margins are wide. The interest
charged for the loan is often below 10 percent, but the
business reaps 30, 50 or even 100 percent return on their
investment.

Further, because of the wide margins, even when the returns
drop, the businesses still make loads of money.

Now you can see why this concept is made-to-order for
businesses.

However, the same does not apply when it comes to
investments such as shares or unit trusts. Often time, the
margin or spread between the interest and return is slim -
less than 3% most of the time. For example, the interest
charged is 9% but the return is only 12%.

Now if the situation remains like that - with the interest at
9% and return at 12% - things are still hunky dory. You would
do well taking the loan and making the investment. However, what
usually happens is that the return starts to drop off. From
12%, they drop to 10% and then to 9%. (By the way, this is
what happened to the fabulous ASB.)

The way things are going, the return could very well drop
below the interest charged! And this is not an unusual
thing. When that happens, instead of making money, the
investor is now forking out money. And that, needless to
say, is not a very nice thing to happen. Not exactly the stuff
of fairy tales. (By the way again, this is what usually happens
when folks borrow money to invest in stocks.)

Now after painting the real world scenario let me answer
the question. Yes, you should borrow money to invest - if
the spread is wide (more than 5%) and you are pretty sure
that the situation will remain status quo for the loan
period. For example, if the interest is 9%, the return
should be at least 14%. Otherwise, let others be the
test-pilot. You watch by the sidelines.

Now, I know a lot of people will jump and shake their heads.
They will reminisce of how their father, grandfather, uncle,
auntie or neighbor made tons of money by borrowing money
to invest even when the spread was ultra-thin. Of course it
can happen. People also strike the lottery but has it
happened to you?

If the spread is thin, you are taking an unnecessary risk.
While you can make a little bit of money, the chances
of you losing a lot of money are significantly higher. Once
the return starts to drop and/or the interest start to rise,
you lose both money and sleep. And that is no way to make a
fortune.

In case anyone thinks that this is a theory from the ivory
tower, I personally will not borrow to invest if the spread
is less than 5%. In fact, I will not borrow to invest in
unit trusts or shares - period. I only borrow money to
expand my business and for property investment.

Source : MILLIONAIRESPLANET EZINE-
September 2006 (issue #49), By Azizi Ali