In the current scenario of Indian markets, everybody wishes to earn more money in this growth phase. Looking up to grab this opportunity people usually find ways to have more money than they can afford to invest it in equity markets. Borrowing is an excellent way to gain money for investments.
Although borrowing or gearing comes with elements of risk. There are some benefits of investing borrowed money. Many think of it as a sure shot recipe for financial blunder due to the fact that markets move in a nonlinear fashion. But if this task is pulled off well, then it can bring fortunes. Warren Buffet acknowledges that some people do become rich with borrowed money, while others become poor. He adds that leverage magnifies the gains and is very addictive once people start enjoying its benefits.
The benefits of borrowing include having more money in hands for investments. This excess money can then be used to get higher returns. For example, if a person borrows ten thousand rupees. He then invests twenty thousand in stock by adding his own personal money. Suppose the stock is appreciated 20% then the returns will be 40% of the investment. The risk is definitely worth taking. The returns can be increased by diversifying the investments.
Similarly, the opposite can also happen. The stock can get depreciated 20% and the same person can end up with loses of 40%. This could further get worse if the stock declines substantially ahead. That is one of the major risks associated with borrowing. Other risks include that of higher interests associated with higher investments. If someone puts up the house as a leverage then the risk of losing the house becomes very high compared to the value of the investment.
According to S. Michael Sury, lecturer of finance at the University of Texas at Austin, “The decision to invest with borrowed money comes down to comparing the cost of borrowing versus the expected investment returns and if the returns exceed the cost, then the transaction makes economic sense.” To manage borrowed money well and reduce the risks Sury suggests to diversify the investments.
According to Tejas Khoday, CEO and Co-Founder, FYERS, an online stockbroking firm, such investments must be made when the markets have hit lower marks and are in an upward momentum or when there is consistent earnings growth. Investments based on borrowings should never be done when a person is close to retirement or for a long term as markets tend to be volatile.
Whether or not to borrow for investment depends on the individual, his age, financial situation and his future goals. Borrowing is a double-edged sword and it must be handled carefully. With proper planning, knowledge and guidance a person can definitely have a windfall.