Should You Borrow To Invest?
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Most people borrow to invest in what they consider to be their biggest asset – their home. However, when it comes to investing money in shares few people consider borrowing to do so. Why is this?
Well apart from not even considering it, most people don’t even realise it is possible. Even if they understood how to do it, few people would do so because they would consider it risky but does this make any sense?
You see the purchase of a home isn’t in reality the purchase of an asset although most people think it is. Whilst in terms of measuring your wealth, it is indeed an asset. That’s because few people ever sell their home unless they downsize, separate/divorce or die. Of course, houses are sold and new ones bought when people move but that means that a home is still owned. However, from a cash flow perspective for most people owning a house is cash flow negative.
The problem with owning a home is that it is, in effect, a liability because it doesn’t usually generate any income and all you ever do is spend money on it whether it be mortgage repayments, routine repairs and maintenance or more substantial home improvements from time to time.
On the other hand, an asset that generates an income that more than covers the mortgage repayments plus all other costs, like a buy to let property, can more realistically be described as an asset because it is cash flow positive. It washes its face.
So why don’t investors usually borrow to invest in shares? Because it is risky I hear you say. However, is it truly risky? Let’s face it, most people’s pensions are invested primarily in shares, especially FTSE 100 Index shares. Shares usually pay dividends. Currently, the yield on the FTSE 100 Share Index is 3.42%.* The Bank of England base rate is 0.1%. Mortgages can be obtained at very low-interest rates currently including fixed rates at well below 3.42%. So borrowing to invest in Britain’s top 100 companies will cost you nothing. In fact, at a low cost, you will make a small profit currently on the dividend income which more than covers the borrowing cost. So it washes its face.
However in reality no mortgage lender will lend you money to buy shares.
Furthermore, the potential capital gain from owning these shares is very attractive. According to IG “Between 1984 and 2019, the FTSE 100 rose by 654% in price, and 1377% on a total return basis. On an annualised basis, this amounts to an annual price return of 5.8% and an annual total return of 7.8%.”**
So the capital gain annually has been 5.8% in addition to the dividend income. Pretty persuasive eh?
So borrowing to invest in shares does appear to have its merits. Why, then, do so few investors do it?
Well, firstly it’s because few lenders offer the borrowing facility to do so. Some investment banks will offer a low-cost borrowing facility where they will lend you up to 50% of the value of your portfolio but the caveat is that you have to invest in their discretionary fund management service. So on the one hand you may benefit from borrowing to invest but equally, you may end up with a poor performing investment portfolio.
An alternative approach is where you have plenty of cash savings and a low-interest rate mortgage. You might prefer to not pay off your mortgage especially if the interest rate is, say 2% or less, and instead invest the money.
Interestingly lenders are more than willing to lend you money to buy a home which generates no income and costs you money to maintain whereas they are unwilling to lend to you to invest your money in shares which provide dividend income which more than covers the borrowing costs. Perverse but true.
I know individuals who have mortgages with interest rates of less than 1%. They have no interest whatsoever in repaying these mortgages while rates remain so low. Instead, they invest money with us and enjoy very attractive rates of return which have exceeded the returns of the FTSE 100 Index for more than a quarter of a century.***Who can blame them?
So if you would like advice on borrowing to invest, speak to a Chartered or Certified Financial Planner. You know it makes sense.****
https://www.dividenddata.co.uk/dividendyield.py?market=ftse100
***Wealth And Tax Management’s Wealth Investment Strategy (WIS)
****The value of your investment can fall as well as rise and is not guaranteed. Your home may be repossessed if you do not keep up repayments on your mortgage. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation and regulations in the current tax year. Any levels and bases of and relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future.
