There are many ways you could borrow to invest and the most common way is to utilise the equity you own in your existing home. For those that do not own their own home, a popular strategy to access funding for investment is via a margin loan.

While gearing is an attractive proposition, there are also risks involved. As investors, you should be aware of the following issues and consider if a gearing strategy is appropriate for you:

Your long-term objectives

The first question you should ask yourself is, what are you looking to achieve? This should be at the forefront of any financial and investment decision you make. It is essential for you to understand how borrowing to invest can fit into your longer-term objectives. You should also consider your investment timeframe and if the market were to experience a downturn, do you have sufficient time to ride out the market cycle during such times of volatility.

Take for example, if your goal is to retire in 5 years, and with your current rate of savings you will be able to accumulate sufficient wealth to meet your retirement needs, then gearing may not be suitable for you. However, if you are in your mid-40s and have just repaid your home loan and would like to put in place a wealth accumulation strategy so that you can retire as soon as possible, then gearing might be suitable.

Cash flow

If you are borrowing to invest, you should ensure that you are in a position to meet your debt obligations. While your investments might generate income (i.e. dividends and interest) which you could use towards funding the loan payment, you could be much better off funding the interest payment with your salary.

Allowing the income from your investments to be reinvested, as pointed out by my colleague, Nathan Lear, in his blog here could really see your wealth accelerate. This is what we refer to as the power of compound returns.

Risk and market volatility

Whilst gearing can accelerate the growth of your investments, it can also magnify your losses when the markets are moving against you. While it is all well and good when markets are performing well, it is important to assess how you would feel when the market is underperforming.

Appropriate income protection

Regardless of the performance of your investments, you are still required to continue making interest payments. If you had to stop work due to illness or injury, it is important that you have the necessary protection (i.e. insurance) in place to manage this.

What should you do?

Everyone’s financial position and objectives are unique and borrowing to invest is certainly not for everyone.

If you have ever thought of borrowing to invest but don’t know where to start, my advice is to talk to your financial advisor or seek independent professional advice.