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Risk of investing with borrowed money
18 May 2021 (290 views)

The low interest rate environment creates a risk that ordinary people may not be aware.

With interest rate on loans from the banks currently at about 1.5%, many financial advisers are recommending to their clients to take a loan from the bank and invest the money in stocks or life insurance policies.

They reasoning is - the dividend yield on some stocks are more than 3% and some life insurance policies give a yield of more than 4%. The cost of the borrowings is at 1.5%. You can earn on the spread. 

Here are the fallacies that the ordinary investors should be aware of:

a) If interest rate moves up by 1%, some stocks could fall by 10% or more. This can occur within a day.

b) The life insurance policy does not provide a return of 4%. They use 4% to "illustrate" the projected return from the policy, but they state that this is not guaranteed. Even if this illustrated return turns out to be correct, the actual return has to allow for the expenses and profits that are taken by the insurance company. The reduction in yield is 1.5% or more. A 4% illustrated return can turn out to be only 2.5% after the deduction.

c) The interest rate on the bank loan is currently at 1.5%. This is adjusted monthly. During a period of financial turmoil, it could jump to 10% or higher, albeit for a short period. During this time, the borrower may be unable to pay the higher interest rate and may have to sell their investment at steep losses.

Financial advisers earn high commission from selling life insurance policies or from trading in stocks. They have the incentive to get their customers to increase the investment, even with borrowed money. The ordinary investors have to be aware of this big risk.

Lesson - never invest with borrowed money.

Tan Kin Lian


Risk of investing with borrowed money
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The low interest rate environment creates a risk that ordinary people may not be aware.

With interest rate on loans from the banks currently at about 1.5%, many financial advisers are recommending to their clients to take a loan from the bank and invest the money in stocks or life insurance policies.

They reasoning is - the dividend yield on some stocks are more than 3% and some life insurance policies give a yield of more than 4%. The cost of the borrowings is at 1.5%. You can earn on the spread. 

Here are the fallacies that the ordinary investors should be aware of:

a) If interest rate moves up by 1%, some stocks could fall by 10% or more. This can occur within a day.

b) The life insurance policy does not provide a return of 4%. They use 4% to "illustrate" the projected return from the policy, but they state that this is not guaranteed. Even if this illustrated return turns out to be correct, the actual return has to allow for the expenses and profits that are taken by the insurance company. The reduction in yield is 1.5% or more. A 4% illustrated return can turn out to be only 2.5% after the deduction.

c) The interest rate on the bank loan is currently at 1.5%. This is adjusted monthly. During a period of financial turmoil, it could jump to 10% or higher, albeit for a short period. During this time, the borrower may be unable to pay the higher interest rate and may have to sell their investment at steep losses.

Financial advisers earn high commission from selling life insurance policies or from trading in stocks. They have the incentive to get their customers to increase the investment, even with borrowed money. The ordinary investors have to be aware of this big risk.

Lesson - never invest with borrowed money.

Tan Kin Lian