October 27, 2013   by
Borrowing money to invest – Should you do it?

Borrowing money to invest – Should you do it?

Is it wise for your Chama to borrow money to invest? Yes and No. If we borrow from one party to invest the money and make a profit, that makes sense. After all, you will beat the interest rate you are borrowing at, right? In theory this is a wise move. But is it the best? Let us look at this question in greater detail and look at the advantages and disadvantages.

Let’s start with the disadvantages. Why is taking a loan to invest not so good an idea?

Debt incurs more risk.

The longer you hold onto your debt the longer you owe someone something the more power they have over your Chama and the greater the chance you won’t be able to pay it back. This is a major risk. Think about all the Chamas that have winded up because of inability to make loan repayments. Nobody saw it coming before it was too late. Never forget that debt always incurs more risk.

Debt incurs higher costs.

When you take out a loan, you’re going to pay interest. Sometimes this interest becomes so great; it eats into your Chama savings.

Your investment might not outpace your loan.

Companies fail, stocks crash, and you might end up with a huge problem on your hands. If your return on investment falls below your loan’s interest rate, you’re in trouble.

Risky business

Borrowing money to invest is risky business. The high returns can seem fantastic in good times but the losses can be huge in bad times. Borrowing to invest is also called ‘leveraging’. Think twice before you decide if this strategy is right for you.

  • Is borrowing to invest right for you?
  • Beware of the risks
  • Cost of loan repayments
  • Tax benefits versus profits

On the other hand, some Chamas do borrow to invest and actually make a good return. How do they do it? The truth is that borrowing to invest is for experienced investors. It is only suitable if:

Your Chama has enough income from other sources, like a secure passive income from rental property or monthly dividends or have extra funds that you can use if there is a significant drop in the market

Sure, some Chamas have had success borrowing money to turn around and invest. But ask yourselves, do you think this is the norm? Is this really the best strategy out there? Well, think about the tortoise approach. We all know the story about the tortoise and the hare. The hare runs fast, jetting past his friend the tortoise with amazing speed. He wants to outpace the tortoise and teach him a lesson or two. But soon, the hare gets tired, complacent, and decides to munch on a nice juicy carrot. Meanwhile, the tortoise sticks with his philosophy slow and consistency wins the race. Sure enough, much to the hare’s surprise, the tortoise inches ahead to proclaim victory. This is much how investing is: slow and steady wins the race. Thus, instead of trying to become a wealthy Chama overnight with borrowed funds, why not save slowly and steadily then use this money to invest. However, if you are well established with several investments bringing in a steady income, you can go for it – leverage and make more money. At this point you can afford to take risks.

 

 

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This post was written by Chamasoft

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