A number of dividend investors become somewhat impatient when building an income portfolio. And with fairly good reason. After all, building a solid income portfolio takes patience and time. In some cases, it might desirable to buy a large amount of stock in a dividend paying company because the price is low, or because you are hoping to kick start matters.
In such cases, some investors decide to borrow in order to invest. While this can be a good strategy – especially in an environment where interest rates are low – it’s important to be aware of the risks.
Advantages of Borrowing to Invest
Recently, The Dividend Guy wrote a post about using leverage to fund your investment purchases. It’s an interesting post about how you can borrow money to be able to make a move right now on solid stocks. You can boost your income portfolio, plus get good deals that are likely to appreciate in the future, providing you with bigger capital gains down the road.
Borrowing means that you don’t have to have the capital sitting in your bank account right now in order to purchase stocks. Plus, with interest rates so low right now, you can borrow at a low rate. Hopefully, your income from dividends, plus the appreciation of the stock, will result in returns that more than make up for the low interest you are paying on the loan. When you use leverage, in many cases you can boost your returns since you aren’t using your own money to make money.
Risks of Borrowing to Invest
Of course, there are risks associated with borrowing to invest. The biggest risk is that your decision will backfire, leading you to magnify your losses. If the stock crashes, you still owe the money, plus interest.
Even if the stock doesn’t crash, it might not gain as much as you expected. As a result, your gains can be reduced by the combination of inflation, taxes, and the interest you pay on the loan. So, even if you don’t lose big time, you could still find yourself without as much as you had imagined. There is a chance that you might have been better off using dollar cost averaging to slowly build a portfolio without paying interest on a loan.
Leverage can help you magnify your gains – but it also magnifies losses. Before you decide to borrow to invest, consider the investments you want to make, and whether or not you are likely to see returns that will make up for the interest you pay on your loan. If you choose carefully, and get a low-rate loan, you should be able to maximize your investments. Make sure, though, that you will be able to handle the payments, and that you can absorb any losses that do come along.