Sunday, November 05, 2017

Never invest with borrowed money

Someone posted an investment in a unit trust where the bank is willing to lend money at a low interest rate to increase the investment.

I gave my view and advice: NEVER INVEST WITH BORROWED MONEY

Let me share this real story. A retired teacher went to a bank and was recommend to invest $200,000 in a dual currency investment. It gave a return of about 5% per annum but in the event that the invested currency drops, the investor has to convert into that currency. He was told that he could hold on to that currency and wait for it to recover.

The bank offered him a loan of $800,000 at a low interest rate. He could earn 5% and pay interest at 1.5%, keeping the difference at a profit.

During a crisis, the invested currency dropped 10% within a few days. He lost $100,000 on his total investment of $1 million (i.e. the original $200,000 plus the borrowed money of $800,000).

The bank asked him to top up $100,000. As he was not able to, they liquidated the investment, leaving him with a loss of $100,000 from his original $200,000.

If he did not take the loan of $800,000, his loss would only be $20,000 (i.e. 10% of $200,000) and he could afford to wait for the invested currency to recover. He did not have to liquidated the investment.

I have always advised investors - NEVER INVEST WITH BORROWED MONEY. You can invest your own money and hold it for the long term. It will recover. But when you invest with borrowed money, you cannot take the loss and have to liquidate at a bad time.

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