SIMPLY defined, leveraged investing means borrowing capital for an investment and expecting the profits to be magnified.
Borrowing to invest, also known as leveraging, is more common than you think. We seldom think of property purchases as leveraged investments, but that is in fact what it is.
Property investors borrow money (home loan) to invest in an asset they would not otherwise be able to afford (a home), expecting investment returns in the future (property value increase).
Other than property investments, you can also use it to invest in Amanah Saham Bumiputera (ASB) through ASB Financing, as well as options and futures.
Although the idea of amplifying your returns sounds like a great idea, it should be used sparingly, until you understand how it works and the risks involved.
It’s a fact that any investments come with risks. The basic logic is that the bigger the potential returns, the bigger the risk.
Leveraged investing can be a double-edged sword. If you get it right, you can potentially make a lot of money.
However, if your investment goes south, you would still have to continue servicing your “leverage” even when your investment value is lost.
This is why it is important for any investors to follow these five golden rules when they are considering leveraged investing:
1) It must match your risk tolerance
When it comes to investments, one should always weigh the potential rewards with the risks. It is important to ask yourself, what your risk appetite and tolerance is.
Risk appetite is the amount and type of risk you are willing to take to meet your investment objectives, while risk tolerance is about what you can actually cope with.
This is applicable even when you are not using leveraged investing because your investment portfolio should always reflect your risk appetite and tolerance.
However, when it comes to leveraging, you need to ask yourself; how much investment debt do you feel comfortable having and assess the best and worst case scenarios before deciding to leverage.
If you have a low risk appetite and tolerance, it doesn’t mean that you should never use leveraged investments. It just means that you need to understand how it works and learn how to mitigate the risks by investing in a diversified portfolio.
2) The cost of borrowing must be lower than the return on your investment