Investing with borrowed money can be risky, but it’s all about timing.
Using borrowed money to boost your investment strategy isn’t something that you should consider lightly, but that’s not to say it doesn’t work.
Wealth Within chief analyst Dale Gillham told nestegg said that borrowing money to invest shares can be an excellent way to increase your returns, “with smart investors able to more than double returns when compared to investing with cash alone”.
However, he was quick to emphasise that timing is one of the most important details here.
Mr Gillham said that there’s a right and wrong time to go about investing in the sharemarket with borrowed money.
“Most people tend to borrow at the wrong time and that is in the last stages of a bull market,” he said.
In the lead-up to the GFC in 2008, Mr Gillham said that people invested using borrowed money in record numbers. For anyone considering borrowing money to buy shares, there’s an important lesson to be learnt in analysing what happened next.
“The higher the market rose, the greater the demand from investors which saw borrowing expand at an exponential rate,” he added.
This cyclical dynamic saw those who had overleveraged suffer enormous losses when the GFC ultimately landed.
“There were many cases of people losing more money than they initially had, investors losing life savings and the list goes on,” Mr Gillham continued.
With that cautionary tale in mind, he said that the right time to borrow for stocks is after a market correction. Doing so reduces risk while maximising your potential for profit.
“You can also invest in the early stages of a market recovery and once the bull market is underway, but caution needs to be exercised if you see everyone wanting stocks and borrowing to buy, as this is your signal to pull back,” Mr Gillham said.
While timing is a big part of making this particular approach to the sharemarket work for you, Mr Gillham noted that there are several other common mistakes that investors can make. These include borrowing too much or relying on financial products they do not fully understand.
Even then, he admitted that borrowing to invest isn’t going to be the right fit for everyone.
“For some, particularly those close to retirement or those without other sources of income, borrowing to invest should be avoided,” he said.
Article courtesy of Nestegg
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