In theory investment is fairly straightforward; you buy a share when it is cheap and sell it when it is fair value or even overbought. However, like so many things which are simple in theory in practice it is not as easy to make gains with every investment – indeed it is impossible. So, against this scenario you have to wonder why some people choose to fund their investment portfolio using borrowed funds.
Timing is everything
If you borrow for example $20,000 over a 36 month period at a rate of 5% per annum then your monthly repayments including interest and capital would be around $640. So in theory you are paying back 3.2% of the money you borrowed each month for a 36 month period. If your initial investment secures a 30% return then in effect you are $6000 up which would wipe out your loan leaving you with about $3000. However, life is not that easy!
Even if you invested the full $20,000 into a share which created a return of 30%, how are you going to fund the monthly repayments if you’re fully invested and it takes six months to create the 30% return? Do you bank relatively small profits along the way? Do you keep some money back to cover for example 6 months interest and capital repayments – leaving you a little extra time to make money on the funds you invested?
One bad investment
Many people are too quick to bank a profit but then again if running against a loan you will have to have some kind of liquidity to cover monthly capital and interest repayments. However, what does human nature tell us about loss-making situations?
You will likely be able to relate to this situation; that time when an unexpected negative announcement knocks the shares you are invested in by 10%. Do you re-evaluate the situation and bailout with a loss if the short to medium term prospects are not good? Or do you hold your nerve and shares in the belief that you know better than the market? For many people the idea of holding on is the easiest option because they don’t have to face the truth that they actually got one wrong. However, as the shares continue to drift and drift and drift there comes a time when “it is not worth selling” and a serious financial situation begins to emerge.
The pressure of investment is enough
Those who invest with their own funds will feel pressure with each decision they make but this pressure is significantly ramped up when they are running against debt, interest rates and regular capital repayments. You can choose the best share in the world but if your timing is off then you may not benefit. One bad loss can wipe out many sizeable profits, leaving you one step from financial Armageddon.
So, where possible you should avoid running your investments against debt therefore avoiding additional pressures and repayment schedules. Pressure does, fact, impact the human brain and our decision-making process. Give yourself the best opportunity to shine and actually make some money by avoiding any form of debt.