If you need to borrow to invest, you can’t afford to borrow to invest

30 December 2018

reading time:  minutes

I caught up with an old friend recently. He asked why more people don’t borrow money to invest.

My first thought was that people borrow money to invest all the time. It’s called property investment, where you borrow from the bank to buy a rental property.

My friend didn’t think that this counts. Somehow, borrowing to buy property doesn’t seem to count as borrowing to invest in the same way that borrowing money to invest in shares do. He was talking about investing in shares.

My second thought was that there are one or two prominent commentators who love leverage. For example, Hannah McQueen, who has mentioned the “power” of leverage many times. I wondered whether he’d heard her on the radio recently. It turns out, he had.

My third thought was to recall when I flatted with this friend in university. He had a betting strategy that made him a lot of money. When I say the strategy made him a lot of money, I mean it made him a lot of money – until it didn’t, and he lost all of his previous gains and much, much more. (He’d bet on a rugby match one week with fairly even odds, and if he lost that week he’d bet enough the following week so his winnings could make up for his past losses. Who would have thought he’d lose six bets in a row?!

But I digress.

I’ve seen leverage go wrong. It breaks my heart.

I haven’t recommended leverage to a client yet. I won’t rule the possibility out. But it would be a rare situation where I’d recommend it.

And in my past life, when I reviewed advice files prepared by hundreds of financial advisers, I noticed it was pretty uncommon.

When I came across this sort of advice, it was usually on my desk because things went wrong. People borrowed money for investments that went pear-shaped.

I’ve seen leverage go wrong. It breaks my heart.

If you need to borrow to invest, you can’t afford to borrow to invest

There are costs involved with being “poor”. If you’re living paycheck-to-paycheck, you can’t afford to buy in bulk and save money over the long-run. When you buy things you have to buy the cheapest rather than the best, when quality is often cheaper in the long-run. You defer maintenance on the car and it breaks down for something that was unavoidable (and is expensive).

If you’re like most working people, unless you have a lot of wealth, you probably have to pay thousands of dollars per year in insurance premiums to manage risks you can’t afford to self-insure against. If you were Bill Gates (or, more modestly, Graeme Hart) you wouldn’t need to pay premiums for life insurance or income protection insurance because your family will be just fine.

And likewise, unless your financial circumstances are unique, you can’t afford to lose a lot of money with your investments.

If you’re a young surgeon, and you have a very high tolerance for risk, then it might be suitable to borrow to invest. If things go wrong, you’ve got plenty of high-income earning years ahead of you to make up for your losses. You can afford the loss.

But if you’re worried about whether you’ll have enough to retire? There’s no way you can afford to lose money unnecessarily.

Leverage magnifies returns and losses

Hannah McQueen talks about the “immense power of leverage”. I agree that it’s powerful.

The problem is, it’s powerful in two directions. It can magnify gains, but it can also magnify losses.

And if you’re borrowing to invest because you think you need to generate better returns, you can’t afford to run the risk of these losses.

Build wealth slowly

One of the exercises I do with most of my clients is run them through a “flawcast”, where we make some guesstimates about their financial trajectory. We make a number of assumptions, and see how they’ll end up financially when they reach retirement.

An example relating to decumulation is here.

Most people are surprised to find that they’re often on track to end up in a decent position.

They don’t need to borrow to invest. They don’t need to rely on a windfall. For most clients, they don’t even need to assume that their savings rate will increase.

They just need to be disciplined, spend less than they earn, and invest appropriately. They don’t need to borrow to invest.

Build wealthy slowly. If you need to borrow to invest, you can’t afford to do it.


borrowing, debt, investing, leverage, risk

About the author 

Sonnie Bailey

Sonnie provides financial planning services via his business, Fairhaven Wealth (www.fairhavenwealth.co.nz). Fairhaven Wealth provides independent, advice-only, fixed-fee financial planning services. Sonnie is also a “recovering lawyer”: he has specialised in financial services, trusts, and estate planning.

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