Should You Borrow Money to Invest?
Investments take money, but you don’t always have the liquid capital available to participate. When an investment opportunity arises and you aren’t ready with the cash, should you ever borrow money to invest? There are arguments for both sides. You’ll have to decide based on your own circumstances, the investment itself and your loan details.
The Downsides of Borrowing Money to Invest
Investments inherently carry risk. No matter how much of a sure thing the investment might seem, you can’t be 100% positive you’ll get your money back. You can’t be 100% sure you’ll get your promised return, and you can’t be 100% sure you’ll get everything back on the date promised. So there are three risks of investing right there. That’s not even counting the risk of who you’re investing with. Is it a reputable company that you actually wantto be in business with? Is the representative an individual that you can trust, or is it someone that your connection is going to cause problems for you later on down the road?
When you borrow money to invest, you put yourself in the position of owing money. If your investment falls through for any reason, you could lose your credit rating and your reputation, not to mention any monetary losses you may incur.
Another downside of borrowing to invest is the cost of loan you took out. Obviously, before you take out the loan you’d want to make sure that what you make on your investment is more than what you borrow plus interest. But two things can happen here. The first mistake can be in forgetting to calculate fees attached to your loan. If you’re using money from a property refinance, you’ll probably have to pay points. If you’re borrowing from some other sources you may have to pay a loan origination fee. Other loan structures may have interest payments based on market indexes, which you can’t accurately predict.
The second mistake that can happen regarding the cost of the loan you took out involves late payment charges. If your investment pays you later than planned, you could be stuck with late or skipped payment charges on the loan you took out to invest in the first place.
Times When It Makes Sense to Borrow Money to Invest
Now that you know the potential downsides to borrowing money to invest, there are times when it makes good sense to use this strategy.
Throughout history, there have been extremely successful business men and women who borrowed money to invest, either in their own company, in someone else or in a company. The facts are:
- sometimes a loan is the only way you can get into an investment
- most companies borrow money to get started in the beginning
- certain kinds of investments carry very little risks
- there are ways to borrow money that carry little risk
Have you ever wondered how some of the most successful people in history got their start? A lot of them did it by borrowing money. Daymond John, famous founder of FUBU, a clothing brand, borrowed money from his mother to start his line of streetware clothing. Barbara Corcoran built the Corcoran Group, a multi-million dollar real estate company, with a $1,000 loan from her boyfriend. Jeff Bezos, founder of Amazon, borrowed a whopping $250,000 from his parents to start the company the entire world now recognizes. As you can see, borrowing money to invest can sometimes make the difference between success and failure.
So when does it make sense to borrow money to invest? The first step might be to consider the odds. But that doesn’t really make sense because first, investments aren’t gambling decisions and second, many awesome investments have bad odds. What were the odds that a kid living in the ghetto would convince a sports star to wear a certain t-shirt in public so FUBU could get off the ground? What were the odds that a guy selling used books in his garage could convince people that his online shopping store was better than everyone else’s? Very bad odds indeed. Yet here we are. Clearly, odds have little to do with whether you should borrow to invest.
Better indicators of when it might make sense to borrow money to invest include:
- the investment is from a reliable/certified source
- the investment is from a source you’ve previously worked with
- the investment is something you’ve wanted to do, and time is running out
- you can get a low interest or zero interest loan
- your loan repayment schedule carries no penalties
- your return rate is guaranteed
- your loss/lien position is guaranteed
- you can get a partner to invest with you
Places to Borrow Money to Invest
If you’re looking to borrow money to invest, there are numerous sources to consider, depending on how much you need. You could borrow from friends or family members, as many entrepreneurs have done. If you decide to go this route, just be sure to make it very official, with a written understanding of the terms. No investment is worth jeopardizing personal relationships.
Another option is to borrow from your self-directed retirement account. This is an excellent choice because there is no interest on the loan and the money you earn goes back into your IRA or 401k account, tax-free or tax deferred.
Another way to borrow money to invest is by getting a cash advance from your credit cards. This is particularly risky because a) the interest is likely high and b) if you can’t repay it could hurt your credit rating. Most financial experts wouldn’t recommend this option.
You could borrow from others who want to get in on an investment with you. Sometimes called angel investors, these are people who have cash but need help finding deals. If you have the deal but no cash, this could be a good partnership.
Whether or not you borrow money to invest is a decision only you can make. Remember that every investment carries certain risks, but there are times when that risk is well worth it, and other times when you should think twice.