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With the recent economic struggles due to the Covid-19 pandemic the stock market seems to be even more interesting for personal investments. Taking out a loan might be one of the ways to gather or boost the available assets.

I did a quick back-of-the-envelope calculation: I checked with my bank, I can get a credit for 20k EUR with a basic rate of interest of around 2.9 % p.a. for a credit period of 5 years. Including interest and fees I will have to pay back 21.7k EUR, amounting to an actual interest rate of around 3.8 % p.a.

Following this I checked the stock market for (rather) conservative investment options, and therefore considered the following products:

  • Government bonds
  • ETFs

My country, which has a Moody's rating of Aa1, issues (among others) bonds with interests of around 4.8 and 4.5 % p.a. with remaining bond periods of 5 or 6 years. Including fees and taxes the effective interest rate should still be in excess of 4 %, therefore being able to cover fees and interest of my loan as well as granting a small profit.

I can also put the money into an ETF (e.g. IE00BKBF6H24), which has a certain risk associated with it, but with a good chance to outperform the actual interest rate of my loan, maybe even significantly.

Is this a legit approach? If yes, which (maybe temporary) factors contribute to it?

Edit: I've misinterpreted the government bonds situation. There are bonds with such high interest rates, just not from countries with an Aa1 rating, as some of you have already clarified. Thank you for that.

user3753318
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pat3d3r
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    Is the loan repayment in one lump sum at the end, or via monthly payments? – RonJohn Jan 12 '21 at 08:17
  • @RonJohn: The repayment is done with monthly payments. – pat3d3r Jan 12 '21 at 08:33
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    Then you won't be able to invest the whole 20K for 5 years. You'll either have to fund repayments to the loan separately or sell your investments gradually. The back of your envelope needs to have more room for the corrected calculation. – Robert Longson Jan 12 '21 at 08:41
  • @RobertLongson exactly. If the loan was repaid as a lump sum at the end, then borrowing at 2.9% to earn 4%, you'd earn 1.1%. That's not much, but it's still a profit. However, as you rightly stated, that's not the case here. – RonJohn Jan 12 '21 at 08:43
  • @RobertLongson: This is true. I was planning on funding the repayments seperately by taking the amount from my basic work income. – pat3d3r Jan 12 '21 at 08:50
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    Well you could have invested your basic work income directly in the stock market instead. You'd need to check whether that was more profitable. Maybe you just need a bigger envelope altogether. – Robert Longson Jan 12 '21 at 08:55
  • @RobertLongson: I've also checked a savings plan (ETF) considering monthly payments with the amount of a loan repayment, this does not yield better profits. Using a monthly savings amount of 370 EUR (analog to the loan rate), MSCI World indication (3.1 % p.a. performance) and 60 months of savings period gives a little less profit than the government bond. – pat3d3r Jan 12 '21 at 09:03
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    Are the bonds denominated in EUR? An interest rate of >=4% on EUR bonds in today's world sounds highly unlikely unless your country is a huge credit risk. – GS - Apologise to Monica Jan 12 '21 at 11:51
  • @GS-ApologisetoMonica: This is the one I am referring to in my question: AT0000A0DXC2. – pat3d3r Jan 12 '21 at 11:56
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    @pat3d3r from: https://www.boerse-frankfurt.de/bond/at0000a0dxc2-oesterreich-republik-4-85-09-26 it looks like you are confusing the face coupon rate (confusingly listed as interest rate) with the rate that you would get by buying the bond now. That is only true if the price is 100. In this case the price is about 128.94 so paying that much your effective interest rate (the yield) is -0.6639% (using last prices) does that change your decision making? – MD-Tech Jan 12 '21 at 12:36
  • note to other readers: I know I simplified the yield at price = 100 above but it is close enough. Strictly it is only true at origination – MD-Tech Jan 12 '21 at 12:41
  • Can you show your calculations for the effective rate of the bank loan? – tendim Jan 12 '21 at 13:23
  • @MD-Tech: You're right, I confused this indeed. Thanks for the clarification! – pat3d3r Jan 12 '21 at 13:35
  • but surely you can get an interest-only loan? – Fattie Jan 12 '21 at 13:39
  • @tendim: The numbers I've cited are from the bank calculation sheet. I've checked it with an online tool, which gives a slightly lower actual interest rate. The calculation inputs are: 20k loan, 361.71 EUR monthly payment, 198 EUR account fee, 60 months loan period. – pat3d3r Jan 12 '21 at 13:41
  • @Fattie: I've not checked yet. Apart from reduced monthly payments, is there another benefit for this exact situation? – pat3d3r Jan 12 '21 at 14:05
  • hi Pat - well indeed when you get a loan against some object (eg, real estate, painting etc), so as to invest - you inevitably do that indeed as an interest-free loan. it would make no sense at all to get a "pay-it-back" loan, to make an investment. what you do is get the loan on your house (interest only - say, X%) and then you buy your banana leaves or whatever it is. Hopefully earning Y%. Whenever you make a trade, you eventually close it out. So 1 month, 18 months, whatever later you sell all the banana leaves, and then close out the house loan. How else could you do it? – Fattie Jan 12 '21 at 15:02
  • @pat3d3r Does "I checked with my bank" mean that this is a current advertisement by your bank, or that you actually went through a credit application and personally got offered that rate by your bank afterwards? 2.9 % p.a. does sound like one of those advertised rates, which few if any people get when we are talking about a loan without any collateral (google for "2/3-Zins" if we are talking about Germany). – s1lv3r Jan 12 '21 at 15:11
  • On 2 occasions I have taken a loan against real estate to make some "big trade" ie over a year or so. Fortunately one was wash so that was, well, a wash. The other I doubled the cash (on a currency position) so that was a win. If I had had two massive losses I'd probably be telling you "don't try it" :O – Fattie Jan 12 '21 at 15:21
  • @s1lv3r: It is indeed an advertisment, and I have no offical confirmation from the bank. There is an example calculation, where it says that "50 % of the customers get 4.67 % p.a. nominal and 5.3 % p.a. actual.". This seems similar to your hinted "2/3-Zins" concept. However, the application process is going through my online banking account, and as soon as I've entered the relevant data (income, housing situation, expenses, ...) it jumps back to 2.9 % and 3.8 % respectively. I do have quite good credibility, but still, I might not get those interest rates, this is true. – pat3d3r Jan 12 '21 at 15:32
  • @Fattie: Can you elaborate on the "banana leaves" story? I can't quite keep up there. – pat3d3r Jan 12 '21 at 15:35
  • @pat3d3r , by "banana leaves" I just meant "any investment". You know how folks sometimes invest in oddball things like gold, oil, tree plantations or whatever. For "banana leaves" please just read "your investment" :) – Fattie Jan 12 '21 at 15:40
  • @Fattie: OK, I understand. But to close the topic, why does it make no sense to use a "pay-it-back" loan for this purpose? – pat3d3r Jan 12 '21 at 15:51
  • @pat3d3r Okay. Generally loans backed by any collateral will (naturally) result in better rates. If you are already invested, you may check with your broker what their rate for lombard credits are. Rates from 1,25% to 2,5% are definitely available in the current market environment for those type of loans, which make them way more attractive for leveraged investing. (Nevertheless this is of course risky, as everyone here points out, so you still need to do your due diligence here :-) – s1lv3r Jan 12 '21 at 15:51
  • Have a look at the historical chart of the Japanese Stock index. It doesn't always go up. May or may not happen elsewhere. Nobody knows for sure. – DonQuiKong Jan 12 '21 at 17:57
  • @s1lv3r: I understand that there's always a certain risk associated with it. I trying to contribute to my due diligence by exploring and asking about different strategies. Thanks for the advice! – pat3d3r Jan 12 '21 at 19:19
  • @DonQuiKong: I know it does not automatically go up all the time. For this question I am assuming a more positive outlook to see if it even makes sense. – pat3d3r Jan 12 '21 at 19:23
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    You are talking about doing a backdoor margin investment. It probably won't end well as you can easily end up in a position where you owe much more than your have and much, much more than you "invested"... You are also unlikely to get a credit line extended with enough money in a worthwhile manner without useful assets for collateral. https://www.investopedia.com/terms/m/margin.asp – Matthew Whited Jan 12 '21 at 19:26
  • @MatthewWhited: Thanks, the linked article basically describes pretty closely the situation I've asked about! – pat3d3r Jan 12 '21 at 19:59
  • @pat3d3r everything but the safest investments (a savings account or things like US treasuries) are going to look great if you only assume positive outlooks. by literal definition really. the whole idea of something being able to offer returns that are much higher than the interest you get in the bank or the prime rate is predicated on the idea of risk. i mean i get your point of trying to feel out edge cases but it's kinda like saying playing golf in a thunderstorm is perfectly safe so long as you assume you won't be struck by lightning. – eps Jan 13 '21 at 00:21
  • @eps: I think it depends on how you look at it. My thought train went like this: If it does not make sense even under favorable condititions, it is certainly not worth the risk. – pat3d3r Jan 13 '21 at 11:36
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    You mentioned paying fees and taxes in the calculation of the profit but did you include any type of capital gains tax your country might have? It seems like Germany has a 25% tax on profits like this (I could easily be wrong) which would reduce your nominal profit of 4.8% well below 4% and that's ignoring any other fees you might have to pay. – Eric Nolan Jan 13 '21 at 17:37
  • @EricNolan: You are correct, there is a capital gains tax of 27.5 %. I already edited my question with the information that I misinterpreted and misunderstood the details of bonds. – pat3d3r Jan 14 '21 at 08:10
  • @EricNolan the bad news is also, that as a private investor in Germany you can't deduct the loan expenses. So your capital gains are completely taxable without you beeing able to deduct the interest payments for your investment loan. Depending on the ratio between rate of return and loan interest rate, this may also eat up a larger percentage of your after tax results. – s1lv3r Jan 14 '21 at 11:49
  • @s1lv3r: As far as Austria is concerned, at least you can offset the capital gains with possible losses within a year, to reduce the capital gains tax. – pat3d3r Jan 14 '21 at 12:36
  • This post is the sell signal. I am getting out of the market now. Thanks for the information. – Five Bagger Jan 14 '21 at 12:41
  • FYI, some banks specifically specify that "money loaned from this service cannot be used to invest into stock markets". – Clockwork Jan 14 '21 at 12:45
  • @Clockwork: Out of interest, how would they check something like that? Or is it just a topic of voiding any insurances the loan bank might grant otherwise? – pat3d3r Jan 14 '21 at 12:56
  • @pat3d3r Honestly, that's a good question. I only know they mention it on their offer, but I never bothered thinking about how they'd check. Even worse if you have several bank account, you could loan on one bank, send it to the other and invest there. – Clockwork Jan 14 '21 at 12:58
  • @pat3d3r On the basis of what you actually Posted, please don't even think about it. Sorry to point this out and the wording of your Question indicates that you're relying on the most basic understanding of some of the terms involved. – Robbie Goodwin Jan 15 '21 at 20:02
  • @RobbieGoodwin: The scenario I asked about is purely hypothetical, it should aid in furthering my understanding of the topic. – pat3d3r Jan 16 '21 at 20:22
  • @pat3d3r Don't you think every Answer or Comment will treat the scenario as real? What else could we do? Why not explain how far your own research had taken you, and where that failed? – Robbie Goodwin Jan 20 '21 at 23:48
  • @RobbieGoodwin: I think there is a misunderstanding about "hypothetical": I meant to say that I am interested in possible advantages and disadvantages of such a scenario, free of any personal bias. I just find it more easly explained with a practical example. I am asking to gather general knowledge about the topic, and not because I want to go through with it next week and desperately and hastily need someone to check the numbers. – pat3d3r Jan 22 '21 at 06:59
  • @pat3d3r I suggest there is not misunderstanding about what you meant by hypothetical and less about bias, personal or otherwise… merely what you're asking.

    I meant to say that I am interested in possible advantages and disadvantages of such a scenario, free of any personal bias.

    If you want a lecture like "Investment 101" why not say so, or ask a search engine?

    Either way fairly clearly, you are asking someone to check the numbers.

     – Robbie Goodwin Jan 24 '21 at 20:12

9 Answers9

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Any scheme of borrowing money to "invest" is in fact a gamble and should be avoided. Stick to your own money for investments.

Nobody can predict the market and neither can you. 4% interest rates for a government bond sounds like a banana republic given the amount of money central banks are pumping into the market to buy government bonds. Even worse, your assumption of risk-less interest is severely flawed. There are already open thoughts about defaulting. Of course they do not call it defaulting but rather package it nicely by "encouraging" the central bank not to insist on repayment. But this is effectively defaulting on debt.

Similar goes for investing borrowed money into an ETF. Stock markets are at an all-time high despite a pretty bad fundamental situation with lockdowns likely to go on for months. Nobody knows what will happen next. Maybe this is just reflecting inflation after the money printer went crazy in 2020 and this is the "new normal". Maybe this is just a huge bubble and we will see wholly different prices in a year.

Think about the case where your loan will be due and you have a substantial loss. Can you cover this by savings? Likely not, because then your savings would be used for the investment directly and not borrowed money.

Note:
I am aware that the opening statement is a blanket rule and there are valid exceptions to this rule. However, the gist of it holds true. Unless you really know what you are doing, do not borrow money for the sole purpose of a volatile investment

Manziel
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  • Thanks for your input. I've already realised that there was a misunderstanding about the government bond. Apart from that I consider investments into the stock market as a gamble generally, either using my own money or even more so with borrowed money, I strongly agree with you here. Still I am interested in different approaches, to get a better grasp of the topic. – pat3d3r Jan 12 '21 at 14:48
  • Stock market investments are considered relatively safe if you diversify and invest long-term. One always has to keep in mind that stocks not only gain or lose value but also pay dividends in the good years which make up for a good portion of the risk. However, 5 years is mid-term at best and a fixed payday is just making things worse – Manziel Jan 12 '21 at 15:37
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    @Manziel: Yes, you invest for the long term, but the loan usually has to be repaid in the short(er) term :-( – jamesqf Jan 12 '21 at 17:29
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    "Any scheme of borrowing money to "invest" is in fact a gamble and should be avoided. Stick to your own money for investments." I find this logic flawed. If someone has a mortgage should they not invest until it is paid off? Every dollar they invest while having a mortgage is essentially a borrowed dollar. – Hart CO Jan 12 '21 at 17:39
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    @HartCO Investing earned wages in the market during the years you are paying on a mortgage is one thing. Actually taking on additional debt for no other reason than to invest in the market is quite another. – Ross Presser Jan 12 '21 at 18:57
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    @RossPresser Can you tell me how it's different? If you invest money instead of paying extra toward your mortgage it is equivalent to borrowing money to invest (at the same rate as your mortgage). There can be tax-nuances that shape the decision, and I'm fine with the notion that it might be a bad idea, but the blanket statement I quoted is flawed. – Hart CO Jan 12 '21 at 19:20
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    While the risk is much higher margin investment is normal and not "flawed" at all. – Matthew Whited Jan 12 '21 at 19:23
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    The difference as I see it is: taking out a separate loan raises your total debt amount, but using "spare" money from wages after paying your mortgage does not raise your total debt amount. While they are similar, the former may be much harder to recover from if you happen to lose your gamble and your investment is wiped out. I am, however, a money novice, and am ready to be told how I'm wrong. – Ross Presser Jan 12 '21 at 20:55
  • Perhaps the difference is encapsulated in what @MatthewWhited said: "the risk is much higher". Being a novice, I feel like if I took on that much risk, the ghosts of my parents would haunt me for quite a while. – Ross Presser Jan 12 '21 at 20:59
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    @RossPresser If you have $100 extra each month and you have a mortgage at 3%, the decision to invest that $100 instead of pay extra towards the mortgage is the decision to pay 3% interest on that $100 in hopes of getting greater returns through investment. If someone has $200k cash and wants to buy a $400k house, they could put down 50%, or they could put down 20% and invest their cash, that is borrowing to invest as well. Saying that "any" borrowing to invest should be avoided is saying that you shouldn't invest unless you have no debt. I don't agree, I think more nuance is needed. – Hart CO Jan 12 '21 at 21:11
  • I also don't think holding shares of a company or vehicle that borrows to invest is significantly different from borrowing to invest yourself. Holding shares of Tesla or Brookfield Property has the same risks as investing with borrowed money since that's what both those things are themselves doing. – David Schwartz Jan 12 '21 at 23:13
  • @HartCO i mean in many cases yes, you absolutely should be using any extra money you were thinking about investing in the stock market or whatever and instead pay it down. the exception to this is retirement accounts that have company matches and things like HSA accounts that give huge tax advantages. – eps Jan 13 '21 at 00:31
  • i guess if you actually have a 3% mortgage the situation is more murky, but the majority of people aren't getting rates like that, once you add in fees and such most people are looking at 5+ – eps Jan 13 '21 at 00:36
  • @eps Prevailing rates are now below 3%, I just refinanced below 3% on investment properties, it's definitely a harder decision at these rates. – Hart CO Jan 13 '21 at 02:20
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    There is a difference between investing excess money while paying off a mortgage at a healthy rate and taking a loan for the sole purpose of investing. Of course it makes sense to invest while paying off your home. Interest for a 15 year fixed mortgage is currently ~1% here in Germany and at this rate it makes sense not to put every last cent into your home. I will of course keep my ETF plan running as this will likely do better. BUT - and this is important - I am under no obligation to sell this investment at a given time. Even if they got worthless over night I won't be in trouble to repay – Manziel Jan 13 '21 at 07:31
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    And yes, this is a blanket statement but I made it intentionally. If someone is asking whether to take a loan that are not the experienced investor and should keep their hands off gambling with borrowed money. If you are able to challenge this statement on a solid basis, it is probably OK to take decisions such as not repaying your mortgage as fast as possible and invest some money instead. – Manziel Jan 13 '21 at 07:35
  • Is the phrase "banana republic" unfriendly to warm countries? Not every republic where bananas grow have poor political or economic management and not every country with disastrous economic management can grow bananas. – gerrit Jan 13 '21 at 08:23
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    Note that 4% interest doesn't necessarily mean "banana republic" and has happened before in a Aa1 rated country. Back in November 2011, at the height of a financial and political crisis that ravaged Europe, The Leterme II caretaker government in Belgium issued 5 year bonds with an interest rate of 4.2% for Belgian nationals because it was significantly lower than the 5% international investors asked for: https://www.theguardian.com/business/2011/nov/25/eurozone-crisis-belgium-bond-sale-public. Those bonds ended up collecting almost 6 billion Euros. – Nzall Jan 13 '21 at 10:12
  • Well, there was a time when Germany was paying 9% on government bonds. But those times are long gone. The bond market nowadays is basically risk without reward as for "safe" countries you won't get the expected inflation rate if there is any positive interest at all. If you are getting close to 4% at the moment, this is considered extremely risky. This may change in the future but for the time being... – Manziel Jan 13 '21 at 13:10
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    @gerrit "Banana republic", at least in US usage, has a particular connection to the unstable South American states of the early 20th century, which were heavily influenced (for the worse) by American companies like the United Fruit Company. See https://en.wikipedia.org/wiki/Banana_republic – Ross Presser Jan 13 '21 at 14:50
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    @HartCO Thank you very much for this explanation. – Ross Presser Jan 13 '21 at 14:51
  • @Manziel There are too many generic rules in the realm of personal finance already. You say "Of course it makes sense to invest while paying off your home" but that depends on interest rate, equity, age, income, goals, etc. In any case, I think it's a good answer otherwise and I didn't downvote, I just think the first line is flawed. – Hart CO Jan 13 '21 at 15:07
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    @RossPresser I know the history, but I still wonder if using the phrase today should still be considered respectful or maybe not. – gerrit Jan 13 '21 at 15:16
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    I haven't seen anyone else mention this but buying on margin is borrowing money to invest. – JimmyJames Jan 13 '21 at 15:38
  • @gerrit Gotcha. Yes, I agree that it's not a very respectful description, and should be avoided. Yet it's been in the news recently; I think a Congressman or Senator used it recently. – Ross Presser Jan 13 '21 at 15:39
  • @HartCO One of the other nuances here is that once you've paid that principle off, you can't easily access that equity. For example, someone who invests in income generating securities can use that income for food, taxes, repairs, vacations, etc. If you want to stay in your home and access the equity, you need to either get another loan against it or do something like a reverse mortgage. The former is like going in circles and the latter comes with significant risks of it's own. – JimmyJames Jan 13 '21 at 16:59
  • Yeah, taking out a loan to invest is a bad idea. You can easily lose all your money if the company you invested in ceases to exist, like they often do when the market crashes, which it does. I talked about debt vs investing in the "Dividends" section of my Answer here: https://money.stackexchange.com/questions/134024/can-you-really-always-yield-profit-if-you-diversify-and-wait-long-enough/134070#134070 – computercarguy Jan 13 '21 at 17:33
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    Your opening sentence is profoundly out of touch with reality. Most investing is done with borrowed money. It's what the bank is doing. It's why corporations exist. It's why the US stock market can have a capitalization of $30 trillion when there's only $1.2 trillion of cash in circulation. – Phil Frost Jan 14 '21 at 00:10
  • @RossPresser - there's simply and literally no difference. Indeed: one is rather "living in a fools' paradise" if one doesn't realize it is actually just as risky. – Fattie Jan 14 '21 at 12:09
  • @JimmyJames .. [when you own a house] "... you can't easily access that equity". I'm always confused when folks say this. I've only ever done it twice, but on two occasions I've taken a house/flat, and taken all the value out of it as a loan to use to invest in something. In each case it took maybe 1, perhaps 2, phone calls and I had to sign my name maybe 3? times. Banks *salivate* to make loans, they are like *rabid dogs given a dead pig*, they're worse than politicians chasing donations or alcoholics chasing whisky. The bottom line is "1 phone call and 3 signatures". – Fattie Jan 14 '21 at 12:16
  • @Fattie OK, that's not what it like where I live. But regardless, that's still harder than selling some investments on a brokerage site and/or cutting a check from an account where you receive income. And if you need that money and don't have any income, how do you pay i back? That leaves reverse mortgages, which In the US at least, are widely regarded as semi-scams structured to claim the properly early e.g. for not cutting your grass. Lastly what's the point of paying off a mortgage just to turn around and take out another loan which is highly unlikely to beat my current 2.675%. – JimmyJames Jan 14 '21 at 15:22
  • JJ - I'm not at all saying one should do it; (I've actually completely lost track of what the question is about at this point - heh!) I'm just stating that it's no harder than any other loan .. a car loan, whatever. It's a couple signatures. – Fattie Jan 14 '21 at 15:25
  • @Fattie And I'm not saying you shouldn't do it. There are many good reasons to leverage your home's equity. The point I'm trying to make is that taking all your extra money and using it to pay off a mortgage in lieu of other investments is not such an obviously good idea, even if you judge that the rate of return is better. Even that is based on shaky assumptions. My first home loan was at 6.5%. 6.5% for 30 years is at the very least competitive with e.g. the S&P. But a couple years later I refinanced to a lower rate and reducing the rate of 'return' on prepayments already made. – JimmyJames Jan 14 '21 at 17:58
  • I fail to see the logic in this post - every investment is the same gamble no matter where the funding comes from. All investing is simply a question risk versus reward and what level of risk you're comfortable with for the given set of outcomes. – corsiKa Jan 15 '21 at 02:35
  • @corsiKa Maybe this is your point but investing with borrowed money increases the risk (and reward) of the investment. – JimmyJames Jan 15 '21 at 17:01
  • @Jimmy I don't feel investing with borrowed money increases the risk of the investment. The investment has the same risk no matter where the money comes from - it's why we use currency! – corsiKa Jan 15 '21 at 17:25
  • @corsiKa But it does. See leverage: "The result is to multiply the potential returns from a project. At the same time, leverage will also multiply the potential downside risk in case the investment does not pan out." [emphasis mine] – JimmyJames Jan 15 '21 at 17:30
  • @JimmyJames The investment itself is the same no matter where the money comes from. If you take out a loan and I use savings, and we buy into the same investment and it tanks, we will both lose the same amount. How we pay off those losses is irrelevant. – corsiKa Jan 15 '21 at 17:34
  • @corsiKa When you take out a loan (e.g. buy on margin) to buy an investment, your losses can go negative. You can also be forced to sell that investment at the worst possible time. On the other hand, if you do well, you get to keep the returns on the borrowed funds. This increases both potential downside losses and the potential returns and a.k.a risk/reward. Effectively, a leveraged investment acts like the same investment without leverage in a more risky asset. You don't have to believe me, though. There's plenty of information about this. The article I linked to above is a start. – JimmyJames Jan 15 '21 at 19:38
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Personal rule for borrowing money in order to 'invest' in any kind of generally available thing:

Assume your investment will lose all of its value and you lose your job and need to live off your savings for 6 months to a year while still repaying the debt. (If you think losing its value is unrealistic, then assume the brokerage goes bankrupt and it takes 5 years for them to sort through the mess and finally release your assets back to you).

In that scenario, are you OK?

If yes, then consider the investment.

If no, then don't even consider it in the first place.

If you were genuinely being offered lower interest than the rate on your own government's bonds then this would be more interesting as that's pretty close to arbitrage territory, but you've already indicated that's not the case.

And, in fact, it should never happen in real life. Because if it did, why would a bank loan you the money when they could loan it to the government instead and get higher interest with a better chance of being repaid?

Kaz
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Is it risky?

One of my colleague's answers reads "Any scheme of borrowing money to "invest" is in fact a gamble and should be avoided."

That sentence is not really correct.

ALL trading is a gamble.

It's more like this: "you are risking losing cash you don't have".

  • Say I have a million bucks cash. I also have a job to live off. It's 1988. Every single living human in the world agrees that the Japanese stock market is about to start a huge boom, so I put the $1m in to the Nikkei. From there it went straight down for 20 years. So I have now lost all or most of the cash. I have no cash. At least I still have the job to live on.

  • Say I have a house worth a million bucks. I also have a job to live off. I get a loan on the house for a million bucks, and invest it in the Nikkei, and I lose all the money as above. The problem is I now OWE a million bucks on the stupid house.

You can see that "B" is, in a sense, much worse.

HOWEVER ... that being said, note that in "B" I can then simply sell the house, and pay off the million bucks. So ....... it can be naive to say "B is absolutely worse and stupid".

Indeed: there's a serious danger in thinking that "A" is "less risky".

The fact is this:

trading anything risks you losing heaps of value. You can either "lose your house" (if you get an interest-only loan on it to gamble with) or you can "lose all your cash" (if you simply gamble with your cash).

I can assure you that when you make a big swing trade, and lose a few hundred thousand in cash, you do not feel smart. I have fortunately never lost a pile "on a house" but my guess is that would also suck.

I think the overwhelming takeaway is:

  1. Sure, what you describe is completely commonplace, people do this all the time with assets

  2. You do have to realize you can lose.

Fattie
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    "example, "Warren Buffett", an epic loser, approaching 100 billion with a B so far" Where is this from? I see Berkshire Hathaway returning 17%/year avg since 1985 as of 2019 data, this past year will drop the average a little bit. – Hart CO Jan 12 '21 at 16:13
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    @HartCO: That bit alone should be a warning about the whole answer. If stocks are causing that much losses, why do rich individuals, pension funds, sovereign wealth funds, university trust funds etcetera all continue to invest in that market? Wouldn't the more likely explanation be that this answer is just wrong? – MSalters Jan 12 '21 at 17:12
  • ? https://www.forbes.com/sites/sergeiklebnikov/2020/05/02/berkshire-hathaway-lost-50-billion-last-quarter-as-warren-buffetts-investments-took-a-hit-from-coronavirus/?sh=79ba3aa37fcf – Fattie Jan 12 '21 at 17:17
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    the (correct, major news item) example of "some trader losing a fortune" is of no consequence, I just deleted it. – Fattie Jan 12 '21 at 17:19
  • @MSalters - there seems to be some overwhelming confusion. the question on the page is about "is it a good idea to get a loan on some asset, to trade with, make some sort of investment with" that trade or investment could be anything - a small business, bonds, "day trading", commodities, gold, other real estate etc. for example, as I mention in a comment up top, I once did what the OP asks and invested it in actually a small business (like a physical business). regarding stock markets, there must be 500 posts on this site by me saying "BUY AN INDEX FUND". Some confusion? – Fattie Jan 12 '21 at 17:21
  • @Fattie if someone gained 1 million one year, and then lost 500 million the next year, it would be pretty disingenuous to say that they are a terrible trader and that they are scamming people because they lost 500k. That paints a very different picture from reality. – trallgorm Jan 12 '21 at 17:21
  • hi @trallgorm .. "all trading is a gamble" ie trading on anything .. rice, real estate, the Nikkei, gold, whatever. (there were a few examples there of "how you can lose money investing or trading!" which seemed to confuse folks, so I just deleted them) – Fattie Jan 12 '21 at 17:24
  • @Fattie I was commenting more on your statement about Warren Buffet which I see has now been removed. No worries, I think the answer is much improved now. – trallgorm Jan 12 '21 at 17:26
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    @trallgorm - we rock :) – Fattie Jan 12 '21 at 17:26
  • There's still the problem that this answer assumes cash is the ultimate store of value. If you sit on a stack of Zimbabwean dollars, you might not have lost a single ZWL. The numbers say you're not a bit poorer. Reality says you lost it all. Had you borrowed a billion ZWL and invested it, you'd have struck gold. Of course, that's the same sort of hindsight investing. – MSalters Jan 12 '21 at 17:31
  • @MSalters Borrowing money in order to sit on cash is probably not an investment advice anybody would give either (on the other hand, any debt denominated in Zimbabwe Dollars should be trivial to repay?) – gerrit Jan 13 '21 at 08:53
  • I don't really follow the last two comments. Sure, in any discussion, ever, whatsoever, about any aspect, at all, of trading or investing: you can add the caveat "And don't forget about inflation." I mean - sure. That's just a given. When you say "investing..." or "trading..." you simply mean "... to beat inflation." – Fattie Jan 14 '21 at 14:57
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Think about it this way, the bank would rather trust you to pay back the loan with interest instead of denying you the loan and engaging in the scheme themselves.

They probably use larger envelopes for their math...

MonkeyZeus
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    Yes, but while there are certainly some similarities, banks surely have different circumstances and probably even motives than the average Joe private investor. At least in my opinion. – pat3d3r Jan 13 '21 at 11:45
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    Don't banks get money from the government specifically to be used for mortgages? In that case their hands are tied - either make money from giving loans for mortgages or don't take part at all. – cjnash Jan 14 '21 at 20:46
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    @cjnash My understanding has been that local banks secure a qualified borrower and supply funding for the transaction. The bank can then choose to keep the loan till maturity or they can sell it to a larger agency such as Fannie Mae or Freddie Mac and earn a profit without having to wait 30 years. I'm sure this varies slightly from bank to bank especially when comparing large vs small banks. – MonkeyZeus Jan 15 '21 at 13:47
  • @pat3d3r Correct, banks know to diversify; taking out $20k to let it ride on stocks is far from the former. – MonkeyZeus Jan 15 '21 at 16:35
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I, for one, am rather confused by your calculations. According to my noob-friendly financial calculator, for a 20K investment to reach 21.7K in 5 years it needs to have an annual equivalent rate (AER) of just 1.64%.

You seem to be able to borrow at very good rates, and the idea of using some kind of leverage to supercharge one's investments during raging bull markets is not a particularly original one.

I don't think European quality debt will default, or rather will be allowed to default, so that bet is most likely a safe one.

The one on the MSCI World index is not.

Based on its track record (to be taken with a pinch of salt, because "past performance is no guarantee of future results"), as far as I remember it (I don't have the numbers at hand) if you had invested in Oct 2007, you would have managed a painful recovery all the way to those levels (in EUR terms) only in Jan 2013, and this is assuming you had not panic sold in the meantime.

Also, as you plan to pay back your debt by using your primary source of income, bear in mind that your employment may react procyclically to economic shocks. In other words, you may end up in a trifecta where your broad market ETF is down 45% and won't recover any time soon, you have lost your job, and you still have to pay back your loan.

  • Thanks for your input. Your last point is rather important, and one of the reasons I did not straight out proceed with this plan. It is definitely a calculated risk, even with a moderate investment strategy like ETFs. – pat3d3r Jan 12 '21 at 11:29
  • The interest rates for the loan calculation are from the bank sheet. Your numbers are lower, as are the ones of my own calculation, but I stuck with the higher values for this example. The loan itself is still subject to discussion, of course. – pat3d3r Jan 12 '21 at 11:43
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    As I mention in the comment up top, obviously you can only do this if it is an interest-only type loan (which more or less exists for that purpose) – Fattie Jan 12 '21 at 15:04
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Borrowing money to make an investment is called leverage. If the interest rate of the borrowed money is less than the return on the investment (considering of course all taxes and fees) then it is a profitable proposition.

Leverage is common in investing, though perhaps not in the specific way you describe. Some examples:

A widget factory might issue a bond to purchase an automated widget machine. They believe the return they will get in investing in the machine is greater than the interest they will pay on the bond.

Many brokerage accounts offer a margin account, which is effectively a loan the brokerage gives you, with your assets at the brokerage as colateral. The brokerage can lend you cash which you can use to buy more shares of a thing you believe will increase in price, or you can have the brokerage lend not cash but securities. You can then sell them to someone else, then buy them back later at a lower price and repay your loan. This is called short selling.

An individual that has a mortgage on their home may choose to invest some excess income in the stock market rather than paying down the mortgage balance. This is effectively deciding to pay more interest on the loan for a chance at making returns to cover that interest and more in an alternative investment.

Leverage multiplies gains, but it also multiplies losses. Additionally, it adds expenses of its own because the creditor will want to be compensated with interest on the loan. That interest diminishes your returns.

As such, leverage also increases risk and volatility. Before deciding to leverage your investments, you should think about the risks. Without leverage, you can't lose more money than you initially invested (the "cost basis"). But with a leveraged investment you can lose more than that. Your investment can lose all its value, and you still have to repay the loan.

Consequently you'll find more leverage in situations where there are limits on liability. For example, startup corporations are often extremely leveraged. They can do this because the liability of the corporation doesn't extend to the personal assets of the shareholders. If the company fails it can declare bankruptcy and the shareholders still have their home. For an individual however the stakes are higher: you could lose all your assets.

If you've duly considered the risks and still want to leverage your investments, I'd suggest looking for other ways to accomplish it besides what you've proposed. Your bank will probably want something for collateral, like your house. Or, they may be able to garnish your wages. You shouldn't risk more than you can afford to lose. Can you afford to lose your house or your income?

Instead, see if your broker can offer a margin account. Check the details, but in most cases the broker's recourse is limited to liquidating the assets in your account. This way you have some bound on the worst case outcome that doesn't leave you homeless.

In general though, I wouldn't recommend leveraging your investments as an individual. Keep in mind that anyone can do what you are proposing, and so if it truly was a "can't possibly lose" strategy, everyone would do it. This would then mean banks would have high demand for loans so they could charge more interest, and companies seeking investors would have many people offering them money, so they could get away with lesser returns. This dynamic creates pressure for the bank's interest rate and the return on investment to converge, making this scheme less profitable.

So if the market is efficient, the risk adjusted return of your loan and your investments should be the same, so by investing in this scheme you are betting that the market consensus has misjudged the risk of investing in the stock market or loaning money to individuals. If you don't have any particular data to support that view, then it is not a prudent investment.

Phil Frost
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I didn't see the numbers themselves analyzed in the other answers. Do you understand that according to your own estimates you would likely be earning below 5 EUR per month?

Including interest and fees I will have to pay back 21.7k EUR, amounting to an actual interest rate of around 3.8 % p.a.

My country, which has a Moody's rating of Aa1, issues (among others) bonds with interests of around 4.8 and 4.5 % p.a. with remaining bond periods of 5 or 6 years. Including fees and taxes the effective interest rate should still be in excess of 4 %, therefore being able to cover fees and interest of my loan as well as granting a small profit.

Let's assume your best scenario. You take money at 3.8% fee and invest it on 4.8%. 20k EUR that you have to return at the end of the period. So you gain 1% per year. That is 200 EUR. I would say that this number is small enough to just not bother with this hustle/hassle.

Let's get more realistic. You have to return the debt continuously, so on average throughout the period you will have 10k invested. You also estimated that because of fees and taxes you would get less, but "in excess of 4 %". Would 4.3% be fair estimate? We've now halved your investment and halved your margin. 50 EUR per year. 250 EUR total. Below 5 EUR per month.

Are you willing to go through all of that hassle for 250 EUR? Are you willing to log into your account each month to sell a small amount of your investment and return the debt? For 5 EUR?

Džuris
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"Never invest anything you aren't comfortable losing" is some of the best financial advice out there.

If you lose everything, are you ok? Will you still have a house, food on the table, will your relationships endure the strain, etc.?

If your investment is borrowed money, then losing everything doesn't bring you down to $0, it brings you way past $0. That's why all the investing forums fill up with suicide hotlines whenever the market dips. You don't want to end up in that kind of situation.

Mirror318
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  • Doesn't that advice imply we shouldn't borrow to buy a house? Most people aren't comfortable losing their house, but most people who buy houses borrow money to do so. Is that unwise? – gerrit Jan 13 '21 at 08:55
  • @gerrit Yes, it's unwise, and the fact that people are forced to borrow to buy a house (or choose not to have a house) is partly because other people chose to do so in the past... – user253751 Jan 13 '21 at 15:38
  • @gerrit if you can't pay for the house, then you give the house back, so your end state (no house) is the same as before the investment (no house). So in that sense it's not as bad as e.g. losing the house but keeping the debt for it—which is what happens if you borrow to buy stocks that plunge to nothing – Mirror318 Jan 13 '21 at 21:43
  • @Mirror318 Sure (unless it sells for less than the remaining debt); but as stated in this answer, we shouldn't invest the house. – gerrit Jan 13 '21 at 22:19
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Depends, how easy is it to discharge the loan you mention?

How certain are you that you will best the interest required? How would you arrive at your conclusion?e.g. What research have you done and why do you believe this is enough?

What are your plans if your investment loses in value? How much could your investment most likely lose? 10% of principle, 20%?

For the answers that say what if you lose everything. I have not seen many broad ETF's loose everything. Oh no, the sky is falling.

So if the market is efficient, the risk adjusted return of your loan and your investments should be the would be true but it is not efficient. There are many entities that are not permitted to do as you suggest by law. There are many who believe oh no I might loose everything.

P.S. Stop-loss is your friend.

P.P.S. My doctor did something similar. He was offered 0% credit card cash advance, bought a CD at 3%. cha-ching. But if the market was efficient, he could not do this, thankfully, it's not. Some people will take the cash advance and by a new car. Nothing like a depreciating asset.

paulj
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