Investment – “Investment of economic value with a hoped-for future return” according to the dictionary. What is not there is that an investment almost always involves a risk, that you can lose some or even the entire amount invested. Despite the risk, many are willing to invest precisely because they have the chance to earn a return, that is to make money.
A basic rule is usually that you should never invest money that you do not have and that you should only invest money money that you would manage without, ie that you should not invest the money that will go towards food and bills etc. However, this does not prevent people from sometimes borrowing money to investing them.
Using borrowed money for investments
Is an even greater risk than investing their own. If you lose your investment in whole or in part, when it comes to your own money, then of course it is sad but you survive and life goes on. At least as long as you have not invested everything you have.
If you instead borrow money that you then invest, and lose these, then you have double problems so to speak. A loan must always be repaid and in addition costs in interest. When the investment goes bad, it obviously becomes a worse situation because you have lost money that is not even your own.
Just because the borrowed money is gone, of course, you do not miss the interest or amortization on that money. These remain and will continue to cost you money. In other words, you are sitting with your bad investment that has lost you money plus the cost of your loan, which you now find it more difficult to repay.
That being said, it is not an impossibility to borrow money for investment and it need not be bad either. What I am saying is that one should be aware of the risk and that it is a somewhat unsafe way of doing things. It is simply better and less risky to use your own saved money for this purpose.
To weigh a loan against an investment
When comparing loans and investments over the whole, the interest rate on the loan should be weighed as a first step towards the annual return on the investment. This is a method that you can use, for example, when you have two options for saving. If, on the one hand, you can repay on, for example, your mortgage loan and on the other you can buy shares or funds for that money.
Amortizing the home is always good and it is a very safe form of saving when you take no risk. Each time you amortize, you also save the interest cost for the amortized amount. Thus, if the interest rate on the mortgage is, for example, 3 percent, an amortization equals that one would invest the money in something that has a 3 percent annual return.
Since mortgages are so cheap right now and the interest rate is around 1.5 per cent on average, it is thus often better to invest the money in cheap funds instead. There, the annual percentage rate of return is usually around 7 percent, so that’s a pretty big difference. However, the interest rate will rise enough in time and when that happens, each amortized krona becomes more worthwhile.
The disadvantage of investing the repayment money in funds instead of paying off the loan is that there is always a risk that that investment will go bad. It is conceivable that the value of the funds goes down instead of up and then they have lost X percent instead of earning, for example, 3 percent. On top of that, there is some uncertainty about future interest rates.
This is, of course, just one example that addresses how to do if you have money that you want to spend in one way or another. Then you have the choice between amortization and investment. It is a completely different thing to take out a loan to use for an investment.
When you borrow money to invest
It then becomes extra important to consider several factors such as the level of risk on the investment, expected return, the cost of the loan, its own financial stability, etc. Since the risk is higher and more factors are involved, you must also consider more things before making the decision.
Of course, one must keep in mind that a loan costs money. If you were to take a regular private loan of say 200,000 USD with a plan to invest these to make money over the next 10 years, then you have to count on what it costs each month.
If we think of an example where you have 5 percent interest on your loan of USD 200,000 with a repayment period of 10 years, it will be USD 833 a month in interest (which then goes down slowly if you have a loan with straight amortization) and the amortization will be USD 1,676 per month. A total of around USD 2,500 is due out each month. You must be sure that you can manage this expense within your budget if there is a possibility to take out a loan at all.