While institutional and professional investors use the concept of leveraging debt funds on a regular basis, individuals can get burnt badly if they are not careful. According to Brian Davis, co-founder of SparkRental.com, a popular real estate blog, borrowed money can be a very powerful tool in accelerating the growth of personal net worth.
However, the risk of investing rises exponentially because you are employing more money than you actually have and if the investment tanks, there could be very real problems. Since financial security and safety should never be compromised, you need to consider the following tips before rushing in to borrow money for making investments:
Make a Detailed Analysis
If you are considering leveraging your home equity, mortgage or taking a 401(k) loan, you need to ensure that your investment appreciates to such an extent that the debt can be repaid on time. While on paper, this should not be a problem considering that the rate of interest on home equity is very low, the returns on investments are never certain even as the borrowing cost is fixed.
According to S. Michael Sury, a University of Texas, Austin finance faculty, it is usually the failure to recognize disconnect that results in a huge disappointment for even the most experienced investors. However, is some case, an analysis will reveal the gap between the cost of funds and return to be so wide that it could very well compensate for the risk involved.
Investors should ideally examine the risk very carefully and ensure that their investment portfolio is adequately diversified so that even if something does go wrong, it will not wipe them out.
Gain Experience Making Smaller Investments
A very common mistake made by inexperienced investors is to try to go in for the big kill that will boost their net worth to unimaginable heights. However, in their enthusiasm, they ignore the basic tenets of safe investing and end up risking their financial security.
Investors should first learn the basics of investing in a particular niche before they even think of leveraging debt to increase their profits. It is vital to understand the behavior of the market and especially how different asset classes react to different stimuli.
After understanding the fundamentals of investing, you should make your first investments with small sums of money, preferably under the guidance of someone who is more experienced so that you can learn the ropes without putting yourself at major risk. If you find your success rate to be positive, you can ramp up the investment amounts and only then consider borrowing money to invest more.
Play It Safe When Approaching Retirement
Investing can be extremely addictive, especially if you are making good profits. However, as you approach your retirement age, you should make a conscious decision to avoid borrowing funds for investing. Ideally, the best time of your life for investing is from the age of 25 to 50 years but thereafter, you should only invest in low-risk or risk-free asset classes so that you do not put yourself in danger of financial insecurity at a stage of your life when rebounding may not be possible.
Ideally, when you start investing with borrowed funds, you should have low personal debt and a relatively high disposable income. If you are finding multiple debts to be unmanageable you can consolidate them but not before getting debt consolidation loan honest feedback online,
Buy Undervalued Assets
As is evident to everyone, you can make more profit if you can buy cheap and sell for the maximum price the asset can reach. According to https://www.forbes.com, the optimum time for leveraging debt in the property market is when both prices and rentals are climbing.
Simple as it sounds, it can be really difficult to spot assets that are currently undervalued and have the potential to appreciate fast. You need to find out the reasons why the asset is undervalued at present and why it is ideally situated to appreciate fast to yield the desired profit.
Selling off the asset at its maximum value is also an art that has to be mastered over time; it requires a thorough understanding of the asset class and the ability to interpret market conditions. Also, waiting for too long may not be productive since the price may suddenly dip, however, sudden market movements are seen more in stocks while real estate tends to be more stable.
Buy on Margin
Investors in stocks can invest more profitably if they can do so using margin money. Essentially, this means that they use the value of their existing holdings to purchase more stock than the cash they have to pay for them. The investment pays off when the price of the equity shares increases allowing investors to liquidate their investment and pocket the difference.
While this strategy can be very effective in a rising market, it can result in very deep losses if the market turns bearish and the prices nosedive. Again, the only way of using this technique profitably is to understand in detail how the stock market works, why prices move up and down and how to interpret macroeconomic indicators as well as developments within the sector that may affect price movements.
Use Your Own Money to Invest While Using Cheap Debt
Since it is well known that the stock market can behave erratically, it may be difficult for an ordinary individual investor to handle; they can take advantage of using cheap debt to fund essentials like the purchase of a car or college tuition.
They can then invest their savings to make investments that can give them profits more immediately while the cheap debt can be paid back slowly. People in the age group of 25-50 can use this technique of using cheap debts to save money and build their overall net worth.
Even though investing with borrowed money can be immensely fulfilling, investors should be prepared for market downturns and have a plan ready of how to counter such events. They can either cut their losses by liquidating their investments or hold on till the market recovers, which also entails having enough resources to service the debt during that period.