BORROWING to invest may sound like a tempting and easy way to maximise any potential returns in any equity type of investment.
This has become a common question on people’s minds, especially with the low interest rate environment.
Many are hoping to ride on a reasonable leverage with a good expected return on investment to maximise the profit, since the risk-free rate remains low now.
However, as attractive as it may sound, this is not the way to go, as investment returns are not guaranteed or predictable and can go up and down.
If and when returns do drop, it will affect the overall returns performance of that particular investment decision, with returns even running into negative territory.
Negative returns mean that the investment has made a loss for that particular year or season, contrary to expectations of a positive return.
Financial advisory firm Excellentte Consultancy’s Jeremy Tan told StarBiz that it is never a good idea to borrow money to invest in equities.
“It is a bad debt to begin with. The returns on equities are not certain, especially with the current market volatility and uncertainty in the economic condition in view of the impact the current Covid-19 pandemic has on the economy and the business embedded in the stocks/shares of the listed companies, ” Tan said.
He noted that stocks are considered “high-risk” assets.
“Capital preservation is not imminent, as investing in stocks/shares may result in loss of capital. While repayment is a certainty, returns are not in this case, ” Tan said.
He said that the banks may at any time, recall the loan.
“And if this happens, the borrowed money is ‘stuck’ in the stocks invested, and the value of the stocks are below the value bought.
“The borrower will not be only losing money in the stocks, but at the same time, be unable to make good the repayment, ” Tan said.
It is also prudent to remember that capital is a person’s hard-earned money and capital must be protected at all cost.
The latest Bank Negara “Financial Stability Review – First Half 2020” report, which was released in mid-October, revealed that there was a significant increase in retail participation in the stock market.
It was reported that retail investors had purchased a total of RM113.1bil worth of listed shares in the first-half of 2020.
However, Bank Negara also duly noted in the same report that these stock purchases had not been funded by debt or borrowings.
Loans disbursed and outstanding for the purchase of shares, including margin financing, remained low and broadly stable during this period.
Such loans continue to account for a small share of overall household debt (0.5%) and bank lending to households (0.6%).
With the statistics, it appears that many are aware of the dangers of using leverage to take on risks.
Others analysts also have said that there is strong enough evidence to conclude that the strong inflows into the equity market during this period had been driven by the additional cashflow from the loan moratorium which had already ended.
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