Is Borrowing to Invest Really a Cardinal Sin? A Closer Look at the Risks and Rewards
https://www.straitstimes.com/business/invest/borrowing-to-invest-here-are-4-things-to-note — Borrowing to invest is not a sin
Conventional wisdom states that borrowing money to invest is one of the gravest mistakes you can make in personal finance. But is this investment “cardinal sin” really always bad advice? A closer look reveals legitimate arguments on both sides.
The case against borrowing to invest focuses on the amplified risk. Combining investing with debt creates a double-edged sword — if your investments underperform, you still have to repay the loan plus mounting interest costs. This dangerous leverage can multiply your losses quickly.
As the famous saying goes, “Don’t speculate with borrowed money; it is the most dangerous of speculative operations.” This prudent philosophy has dissuaded generations of investors from crossing the line into owing money to fund further market speculation.
However, some believe judicious borrowing to invest within reasonable limits can be justified. Interest rates remain near historic lows, meaning low-cost capital is abundant for those with good credit. If loan interest rates are significantly below your expected investment returns, the arbitrage can generate added profits even after accounting for risk.
Legendary investors like Warren Buffett have borrowed strategically at select opportune times to juice returns. And financial theorists argue that low-cost borrowing and lending improves capital flows and market efficiencies overall.
Nonetheless, treading this fine line between savvy arbitrage and reckless overleveraging remains tricky. As with any investment, assessing your personal risk tolerance and worst-case scenarios is key. Borrowed money can dangerously accelerate losses just as it boosts gains.
Taxes also matter. In some cases, the IRS limits deducting interest paid on loans used for investing purposes. This erodes the theoretical arbitrage spread. And if investments underdeliver over the long run, the leveraged losses often outweigh the temporary upside.
Perhaps the biggest risks are psychological. The temptation to overextend and double-down on shaky bets rises when playing with borrowed money. The added leverage warps your judgment and amplifies confirmation bias. And recouping losses to repay debts can lead to desperation.
So while nuances exist, the conventional wisdom against borrowing to invest stands strong in most scenarios. The allure of juicing returns through cheap leverage is often a siren’s song leading to financial wreckage upon the rocks. Opportunities to profit from arbitrage spreads are elusive and require razor-sharp risk management.
In the end, nothing replaces making sound investments using money you can truly afford to lose. But for those with meticulous discipline, an arbitraged portfolio leveraged responsibly within strict limits may deserve consideration.
Just know the dangers of speculation with borrowed money remain ever present. While not always a definitive cardinal sin, prudent investors should think multiple times before crossing that line. The risks rarely outweigh the rewards.
