Borrowing to Invest

The answer to this question is dependent on the issue of what is the nature of the investment to which the borrowed funds will be applied. But prior to exploring the nature of the investment, what is really meant by investment must be properly understood .

 Investment refers to the contribution of something such as money, time, energy or effort to an activity or project with the expectation of deriving a net benefit. Within the context of this discussion, focus will be on the investment of money i.e. borrowed money to determine if a profit is attainable from the project or activity. Contrary to common understating, investment activities are much wider in scope than merely buying company stocks, mutual funds or debentures. In fact, investment activity extends to establishing or expanding a business, buying real estate, obtaining higher education with a view to the attendant increase in future earning power and to just about any activity designed to extract a monetary benefit from an initial outlay of cash.

 Having looked at investing in its most generic form, the topical issue of the prudence of borrowing to invest may now be attended to. To determine the viability of any investment decision a comparison must be made between the costs involved in opting to undertake the investment and the revenues to be obtained from the investment. As a general rule of thumb, where the anticipated revenues are in excess of the projected costs, the investment is deemed to be viable, but only on the basis of its ability to generate a positive Return on Investment (ROI).

 Even in the context of a positive ROI there will be other considerations in determining whether or not to proceed with a proposed investment. Such items include time lines for projected cash inflows,and  the amount of time the investor requires to be devoted to the investment. Also relevant is the sufficiency of the positive ROI i.e. is it big enough to induce the investor to undertake the investment, whether or not there are competing uses for the investors funds that could generate a better ROI, and the degree of determinable risks associated with the proposed investment.

 As the topic indicates however, a determination is being sought as to whether or not it makes sense to borrow for investment purposes. Borrowing forms part of the cost of the investment, both in terms of interest costs and principal repayments-as the investment should yield enough to pay both and still generate a positive ROI.  To assess the topical issue therefore involves a comparison of the projected ROIs in the instances of borrowing and equity funding for the project or activity. If the ROI is either insufficient or negative the investment should not be undertaken whether or not the investor is borrowing. If the use of borrowed funds will produce a sufficient (see previous paragraph) positive ROI, then ceteris paribus, the investment should be undertaken.

 Prospective investors should be cautious to ensure that all the factors involved in determining the viability of an investment are examined. Borrowing as part of the cost structure of the investment, while critical in the decision to proceed or not with the investment, should not be assessed at the exclusion of other financial and non-financial factors. Borrowing to finance an investment activity is not in and of itself a bad thing, as it allows investors to take advantage of investment opportunities now rather than later. It is the holistic process we undergo in assessing the viability of the investment that must ultimately determine whether or not the borrowing makes sense.