The Risks of Borrowing to Invest

What does borrowing to invest mean?

Borrowing to invest refers to using borrowed money to purchase investments rather than investing only personal savings or available cash. This approach is often called leveraged investing because it uses debt to increase the amount of capital invested in financial markets.

The underlying concept is relatively straightforward. An investor borrows funds through a borrowing product such as an investment loan, line of credit, margin loan, or another form of credit. The borrowed funds are then used to buy investments such as stocks, bonds, exchange-traded funds (ETFs), mutual funds, or other assets.

The goal is often to generate investment returns that exceed the borrowing costs associated with the loan. If investment returns are higher than the interest costs and other fees, the investor may benefit from the additional market exposure. However, if investments decline or borrowing costs increase, the investor may face losses while still being responsible for repaying the debt.

Unlike investing with only personal savings, borrowing to invest adds a second layer of risk. The investor is exposed not only to changes in investment value but also to interest payments, loan obligations, and potential cash flow pressures.

Borrowing to invest can take several forms, including:

• Using an investment loan to purchase securities

• Using a line of credit to fund investments

• Borrowing through a margin account

• Borrowing against eligible investments held in a non-registered account

• Using a home equity line of credit to access funds for investing purposes

Regardless of the borrowing method used, the investor remains responsible for repaying both the borrowed funds and any associated interest costs.

How borrowing to invest works

Borrowing to invest involves combining investment exposure with debt. While the process may appear simple, the financial outcomes can vary significantly depending on investment performance, borrowing costs, and market conditions.

In a typical scenario, an investor obtains a loan or accesses a source of credit. The borrowed funds are then deposited into an investment account and used to purchase investments. Over time, those investments may increase or decrease in value.

At the same time, interest begins to accrue on the borrowed amount. Depending on the loan agreement, the investor may be required to make monthly payments, interest payments, or other recurring repayments.

Why some investors consider borrowing to invest

Some investors consider borrowing to invest because it may allow them to increase the amount of money invested in financial markets without waiting to accumulate additional savings.

There are several reasons why borrowing may be considered:

• Increasing market exposure

• Purchasing more investments than available cash would otherwise allow

• Maintaining ownership of existing assets while investing additional funds

• Accessing investment opportunities without immediately liquidating other holdings

• Exploring investment approaches that may have tax considerations in certain circumstances

For example, an investor may have long-term retirement savings goals but limited available cash resources. Borrowing could provide access to additional investment capital while allowing other assets to remain in place.

Others may be interested in maintaining an existing investment portfolio while accessing liquidity for other purposes. In some situations, investors may also explore whether loan interest could have tax implications, depending on how borrowed funds are used.

However, each potential benefit comes with additional risks involved.

While borrowing may increase exposure to financial markets, it also increases exposure to losses. While investors may gain access to more money for investing, they also take on debt obligations. While investments may appreciate over time, borrowing costs and interest payments can reduce overall returns.

Because of these trade-offs, borrowing to invest is often evaluated as both an investment decision and a borrowing decision. Investment returns, cash flow, interest rates, financial circumstances, and risk tolerance may all influence the outcome.

The biggest risks of borrowing to invest

Borrowing to invest can increase exposure to financial markets, but it can also increase financial risk. Understanding the potential downside is an important part of evaluating whether leverage fits within an investor's broader financial situation.

Losses can be magnified

Leverage increases both potential gains and potential losses.

When investors use their own money, losses are generally limited to the amount invested. When borrowed funds are involved, losses may affect both the investment value and the investor's ability to repay the debt.

For example, if an investment falls in value, the investor may lose part of their invested capital while still owing the full loan balance. This can create a larger financial impact than investing with personal funds alone.

Interest costs can reduce or erase returns

Investment returns are uncertain, but interest costs are generally predictable.

Even if investments generate positive returns, those returns must exceed borrowing costs before leverage provides any potential financial benefit. Interest payments, loan interest, and other fees can reduce overall performance.

If investment returns are lower than borrowing costs, an investor may experience a negative outcome despite earning positive returns on the investments themselves.

Payments continue even when investments fall

One of the primary risks of borrowing to invest is that loan obligations typically continue regardless of market conditions.

When markets drop, investors may see the value of their investments decline while continuing to make monthly payments and interest payments. This can create additional pressure during periods of market volatility.

Unlike investment returns, repayment obligations generally do not disappear when investments perform poorly.

Interest rates can change

Many borrowing products use variable interest rates.

If interest rates rise, borrowing costs may increase as well. This can affect cash flow and potentially reduce any difference between investment returns and loan costs.

Investors evaluating leveraged investing often consider how higher interest costs could affect their ability to manage the debt over time.

Cash flow pressure can increase stress

Borrowing introduces ongoing financial obligations that may affect day-to-day finances.

Unexpected events such as job loss, reduced income, emergency expenses, or changing financial circumstances can make loan payments more difficult to manage.

Even investors with long-term investment plans may experience short-term cash flow challenges when carrying investment-related debt.

Investors may be forced to sell at an unfavourable time

Certain borrowing arrangements may be secured by investments or subject to margin requirements.

If investment values decline significantly, investors may be required to deposit additional funds, reduce borrowing, or sell assets. In some cases, a margin call may occur if account equity falls below required levels.

Selling during a market downturn may lock in losses that otherwise might have remained unrealized.

Borrowing to invest often requires evaluating downside scenarios as carefully as potential upside outcomes. The ability to continue meeting repayment obligations during difficult market conditions may be just as important as the potential for future returns.

Borrowing to invest vs investing with personal funds

Investing personal savings and borrowing money to invest both provide access to financial markets, but the risks and obligations can differ significantly.

When investing with personal funds:

• There are generally no borrowing costs

• No loan repayment obligations exist

• Losses are limited to invested capital

• Cash flow remains unaffected by loan payments

• The investment process may be simpler to manage

When investors borrow money to invest:

• Interest costs are added to the investment equation

• Loan payments may be required

• Gains and losses can be magnified

• Cash flow may be affected by repayment obligations

• Additional risks associated with debt are introduced

For example, an investor who purchases securities using only their own money may experience gains or losses based solely on market performance. An investor who uses borrowed funds faces the same market risk while also managing interest payments and loan obligations.

How borrowing against investments may work

Some borrowing solutions allow investors to access funds without immediately selling eligible investments.

In these arrangements, investments may serve as collateral for a borrowing facility. Instead of liquidating assets, investors may be able to borrow against a portion of the value of eligible holdings.

This approach may provide access to funds while allowing investments to remain invested in the market. However, it also introduces borrowing costs, repayment obligations, and the possibility that changes in asset values could affect borrowing capacity.

As with other forms of leverage, risks remain important considerations.

Some investors interested in learning more about borrowing against eligible investments may explore products such as Questrade Margin Power and similar borrowing structures. Understanding how these arrangements work, including their costs, risks, and collateral requirements, may help investors evaluate whether this type of borrowing aligns with their broader financial circumstances.

Final thoughts: The risks of borrowing to invest in Canada

Borrowing to invest combines two powerful financial forces: investing and debt. While leverage may increase exposure to potential investment returns, it can also increase exposure to losses, borrowing costs, and repayment obligations.

Investment performance remains uncertain, but interest payments and loan obligations generally continue regardless of market conditions. For that reason, borrowing decisions often involve evaluating more than just potential returns.

Risk tolerance, financial goals, cash flow, emergency savings, debt levels, and long-term plans may all play important roles in determining whether leverage fits within an investor's broader financial picture.