A common strategy in the field of securities is "borrowing to invest," also known as "leveraged investing" or the "leverage loan". Mutual funds is another area where leveraging is gaining in popularity in recent years. The practice involves borrowing money to increase investment returns. But because this method can either earn you a fortune or ruin you, it must be used with care.

The advantage of leveraging

For investors, the advantage of leveraging is that it quickly magnifies returns by increasing the initial investment. Thus, the loan amount granted by a bank may create a "two for one" leverage effect (2:1) or "three for one" (3:1), that is, two or three times the investor's initial outlay. There is no restriction on the amounts that may be invested and part of the cost of the loan may be tax-deductible, insofar as the proceeds of the loan serve to generate income.

Example

Take Paul for instance, who wishes to invest $10,000. With a 10% return on his basic investment, he will earn $1,000, without leveraging. However, if he decides to apply a 3:1 leverage, which means he will borrow $20,000 from the bank, the initial amount of his investment will be $30,000. This way, Paul will have a 10% rate of interest on a much bigger amount, which will generate a higher return. A 10% return on this tripled amount is equal to a 30% profit on his initial $10,000 investment, that is $3,000 in income (less interest charged on the loan).

As illustrated above, this strategy can be more profitable than trying to save $300 or $500 at a time with no interest. But one must not be risk-averse.

The risk of leveraging

The leverage effect is a two-edged sword. This type of investment is for investors who have a high tolerance for risk and who are financially stable.

As long as markets are rising, leveraging is an appealing alternative. However, the risk of loss is always present. In fact, when the markets go south, losses can be quite significant.

Example

Let's look at Paul again, who invested $10,000 but, this time, with a 10% loss, which represents $1,000 without the leveraging effect. With a 3:1 leverage loan, this 10% loss translates into $3,000, which corresponds to a 30% loss on the initial investment.

Exercising caution is essential when it comes to leveraging. This investment strategy must be part of a rigorous investment approach with an investment horizon of at least five to ten years. This way it is possible to reduce the short-term effects of market fluctuations on investments.

In short...

In short, borrowing to invest can be very profitable to investors who plan carefully and make wise investment choices. It's simply a question of good strategy!