What you need to know before borrowing money to invest
Turbo charge your net worth
So I’ve seen a growing trend over the last 6-18 months. The average Millennial and Gen Z investor is accelerating the amount they are borrowing in order to invest.
In the process they are becoming highly leveraged with their investment portfolio. Leverage is just another word for taking on debt.
Essentially a growing number of young people are borrowing money from their bank in order to invest in the stock, crypto or real estate markets.
With the promise of getting rich quick, and fortunes to claim.
In fact, according to a Business Insider Survey which collected results from 2,000 US consumers during 2021.
80% of Gen-Z investors and 60% of Millennials surveyed took on personal loans to invest, whether that be buying stocks, real estate or cryptocurrency.
Let that sink in. 4 out of 5 Gen Z’ers surveyed are borrowing money to invest! As a reminder Gen Z is people born from 1997 – 2012, ages ten to twenty five. Whew, I feel old!
I don’t know about you but when I was that age, and that wasn’t too long ago ;), I had no idea what the stock market even was, never mind that there was an option to borrow to invest in it.
The survey found that the younger group of GEN Z’ers were more likely to take out a loan to plunge into the markets – the amount borrowed being upward of $5k or more. While older generations still took on debt to invest, but far fewer.
On the one hand I am really encouraged that young people are taking an interest in the markets, as it is the best way to achieve financial freedom and retire with a net worth of $11 million!
But on the flip side, there is a lot of risk to taking on personal debt at such a young age especially if you don’t have the foundational understanding of how and where to put that money.
If you are new to investing, make sure to check out my complete beginners guide here.
Another interesting response was that most said they would do it again, and take on even more debt to invest.
… and I can see why!
Interest rates across the board for personal loans are under 4% in some cases even under 2%.
At the same time, inflation is currently at all time highs meaning paying back that loan in 1, 2 or 3 years time will actually cost you less.
Along with stock market returns being far above the historical average. In 2021 the US S&P stock market grew 26% versus the historical average of 7-11%.
That got me thinking whether I or you should follow a similar strategy and borrow money to invest?
Given my net worth has recently grown to $350k at age 30, could we turbocharge our net worth by taking on cheap loans and investing all of the money for the long term.
Using the returns and dividends generated to pay off the loan and banking the profit.
This seemed too good to be true.
So I decided to ring up my bank and break it down into the pro’s and con’s of how to actually go about this successfully.
*As always, I am not an expert or financial advisor, so nothing on this website should be considered financial advice. These are just my opinions, everyone is different. Always do your own research and have your own independent thought process.
80% of Gen-Z investors and 60% of Millennials surveyed took on personal loans to invest, whether that be buying stocks, real estate or cryptocurrency.
Pros and cons of taking out a loan to invest
As I mentioned, the ultra low-interest rates across the Globe but particularly in North America have made this an enticing option for many young investors who haven’t had time to build up their savings or income levels.
Lots of young people (and old) are actually doing this day in, day out… and profiting from it.
But is this a good idea?
Particularly for those looking to gain financial freedom or as part of the FIRE movement… similarly for me on this journey to retire at age 35 having recently quit the corporate world and follow my passions.
The answer is not black or white. The decision to pursue this strategy will depend on your particular circumstances, namely:
- What you are investing in and the level of volatility
- Your time horizon – how long are you going to HODL! before selling
- Your mentality to cope with market drops or losing money
- The loan size and payments you are taking on
- Your take home pay and current financial situation
There are actually a number of Pro’s from taking out a loan to invest if you have the right personal / financial circumstances. Some of the biggest include:
– Increase your credit score – by building a history of taking out loans and making sure to pay them back in full and on time. Your bank will trust you going forward and be willing to lend you more for your next big purchase, whether that be a car or house.
While also giving you a better interest rate, so your repayments will be lower and you keep more cash in your pocket. If you want more information on how this works, check out this Investopedia article.
– Make it rain – as every investor should know the biggest power of long term investing is compound growth. The longer you leave your money in the market the more you will earn and the faster your net worth will increase. Assuming you follow a diversified approach, my favourite form being Index / ETF investing.
So the earlier you have your money in the market the longer it has to grow and compound. As a young person you might not have the income power to build your savings / investments up as quickly as you would like – so borrowing to invest will turbo charge your savings and your returns over the long run.
– Lower your taxes – you can actually benefit from lower taxes on certain forms of investments. For example in Canada, you can claim a dividend credit on certain equity stocks to lower your tax bill on dividends received and even deduct the interest you pay on that loan against your tax bill. But make sure to look into your local tax laws as they will change depending on your location.
– Force good saving habits – for many Millennials and Gen Z’ers when you get your paycheck it’s straight to the club or nearest Indian or Thai restaurant (I do love a Massaman curry) to splurge and burn through your pay-check as fast as you can. It’s hard to put money aside every month to save and invest. When you borrow money from a bank to invest – it forces you to get into good habits, as you will have to pay back a fixed amount every month in accordance with the loan repayment schedule.
– Understanding the money process – going through and understanding the actual process of borrowing money is a valuable skill to have in life. I recently put this to the test and called up my bank (traditional big 6 Canadian bank) to borrow money and invest. I figured out that I could lower my loan interest rate even further if I secured the loan against my investment portfolio. Since I now have a sizeable net worth this was an obvious channel to follow. I managed to get an interest rate of 2.25% because of this, which is crazy low. That means if I just achieve the historical average return in the stock market of 7% to 11%, I’m way in the money.
For secured loans I actually physically had to go into the bank for some strange reason (traditional banks are dinosaurs on some of their processes). Call up your bank to test it out, what have you got lose? At the very least you will understand the process for when you need to eventually borrow more in the future (e.g. mortgage). A lot of famous people have become rich off borrowed money, in fact the majority use leverage to become millionaires.
Think Donald Trump. He was using other people’s money to finance Real Estate deals in New York, and using the returns to pay back those loans and borrow even more. The more you know, the more you can play the game of money and become rich off of it.
Let’s play this out in a real example based on my recent bank visit
1) Cost to borrow: My bank offered me a 2.25% interest rate on a secured loan of $10,000 over a 3 year term. This worked out at around $285 dollars (rounding) per month in repayments, and the total interest I would pay over the 3 year term was only $350 dollars! See image above for the details using a repayment calculator.
Depending on your location and stocks selected, you can actually offset the interest ($350) against your taxable income, further reducing the interest amount. My marginal rate of tax is around 40% so this would reduce my interest by $140 dollars. So the updated total cost of the loan after 3 years would be only $290 dollars. That’s almost free money.
2) Conservative returns: As you may know, my favourite form of investing is low cost, broad based ETF and Index funds – like Vanguards VTI and VOOV. If I earned a typical conservative average return of 7% (last year’s return on VTI was more than 25%) compounded over 3 years.
Using a simple compound growth calculator, that 10,000 dollars I borrowed would be worth around $12,250 at the end of the 3 years.
3) Profit potential: Assuming you don’t sell (i.e. excluding Capital Gains taxes) after 3 years, your total return would be $2,250 minus the $290 of interest which equals $1,958 of profit.
That’s nearly a 20% return! You can now see why this was so popular among the Millennials surveyed – and the best part, if you don’t touch the money and keep it invested over the next 10, 20 years that money will continue to compound and grow into hundreds of thousands!
But hold your horses!
There is no guarantee that the stock market or crypto / real estate market will continue to go up in value over the period of the loan.
Many commentators have suggested that the stock market is overvalued and we are long overdue for a correction.
The markets can always go down over a short time horizon. Also the stocks you select may reduce their dividends payouts which would further reduce your potential return.
But if as suggested you HODL for the long term and follow a low cost, broad based Index Fund / ETF strategy, history has shown there is only one trend for stocks over the last 100 years and that is up and to the right!
So what are my options to actually borrow the money?
There are a number of avenues you can follow, these include,
Opening a margin account, be wary of margin calls
Investment and Retirement (401K, RRSP) loans
Using a mortgage or line of credit to invest
Taking on a standard personal secured/unsecured loan
Money sense have a great article explaining some of the above avenues here.
The key point is to ring up your bank and shop around for the best terms and lowest interest rates.
Anything under 4% is considered good, given inflation is at more than 6% right now. Secure your loan against your current investments or mortgage and you will get an even lower interest rate.
Okay great, we now know some of the key benefits on when and how to borrow to invest along with a real life example.
What about when you should avoid borrowing to invest?
We saw from the previous example that there was a profit from running the numbers, but even so there are some circumstances where you should avoid this strategy, and steer clear of borrowing and getting further into debt. These include:
– You have a ton of debt already, adding even more debt with the hopes of making a profit is not the way to go. This could potentially force you to miss payments and fall behind, which can have drastic impacts on your credit score and your ability to borrow in the future. Let alone the mental health impact it could have on you from having so many loans to worry about.
– You are not in a secure job, if you are in part time work or short term contracting work. Taking on debt is ill advised, if your income dries up how will you pay back your loan?
– You don’t know what you’re doing, if you haven’t built up a good understanding of how to invest, definitely do not borrow money to do just that.
I had a silly escapade into crypto currencies in my early twenties and invested all the money I had at the time without knowing what I was even investing in. I panicked and sold a month later at the worst time and lost over 50%. Lesson learnt!
– Your tax bracket is low, this will impact the potential tax savings you could offset your returns against.
– You don’t know how to cope with losing money in the stock market, if you panic sell like I did in the crypto market you will wipe out any potential profit from borrowing.
Taking on debt to invest in the markets can be profitable and can turbo charge your net worth.
But you have to consider your own financial and personal situation before going down this path.
There is no one size fits all. Before doing this, make sure to do your research and run the numbers. Consider the factors noted on when to avoid borrowing.
If you are in a good financial situation and have the mentality to hold over the long term with a diversified approach. Then borrowing to invest might be a sure fire way to take years off your financial freedom journey and put you in a position to wave good boy that that job you’ve always wanted out of.
The math does work right now. And it’s because of interest rates. When interest rates are as low as they are today, the investment return you need to achieve is much lower and so when running the numbers it makes sense.
For me, I am looking to take the next steps to actually finish the process of borrowing to invest. I will keep you updated on how this goes, and how much debt I actually take on against my portfolio.
Let me know whether this is something you would consider in the comments? It seems to be a hugely popular strategy at the moment!
I hope you find some of these areas helpful in your own journey.
Follow along on my journey and subscribe to my newsletter and never miss a post, I keep my net worth updated here.
Appreciate you making it to the end! Have an awesome week.
6 thoughts on “What you need to know about borrowing money to invest – turbo charge your net worth”
I can’t speak to the Canadian market, but mortgage debt in the US is relatively easy to qualify for and banks are typically willing to lend much more money that they would for a personal loan. For example, an individual might be able to borrow $400,000 for a half million dollar home. Even if the home only appreciates 3%, the borrower would have made $15,000 in home equity.
Therefore, one of the important risks that follows on from a drop in credit score is the inability to use greater leverage at lower interest rates to purchase an asset with less volatility. These are easier gains that someone might be forgoing if they were to impact their credit score.
There also seems to be a recency bias. For Gen Z aged 10-25, they have never experienced a major drop in the stock market except perhaps in elementary school. Because of the long bull run we’ve had in the market and the rapid increases in crypto and stocks in the past year and a half, I think younger investors underestimate the risk of a correction in the market.
Thanks for your comments Ryan.
Completely agree on the risk of a drop in credit score.
Also great point on the Gen Z’ers. Even personally as a 30 year old, I haven’t really experienced investing during a recession. The mentality around losing money in the stock market and panic selling was a key area I wanted to ensure was highlighted. Something I am working on too.
I wrote a previous post to highlight this further:
Thanks for your feedback as always Ryan!
Anytime! And I’m right there with ya at 31
Thank you for this post. Would you be able to clarify exactly how using a loan would work (I guess I didn’t fully understand).
Let’s say you borrow $10,000 to invest in stocks, would you be paying back the bank every month inclusive of principle and interest? Will those payment be funded by the potential returns or dividends from the investment?
Thank you in advance
Appreciate your kind words as always.
Yes, depending on how your long was structured you would pay both the principal and part of the interest every month.
This could be financed both by dividends received from more so from your emplyoment income.
One of the key benefits from this strategy is having more money invested in the market earlier to take advantage of compounding.
While also at the same time your repayments (in inflation adjusted terms) will actually become cheaper and cheaper time goes by – given the inflation rates of 6+% we are currently seeing.
Thank you MTM 🙂