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| Borrowing to invest Investment funds and other securities may be purchased using available cash, borrowed money, or a combination of both. If cash is used to pay for the fund purchase in full, the percentage gain or loss will equal the percentage increase or decrease in the value of the investment funds. The purchase of securities using borrowed money magnifies the gain or loss experienced by the investor. This effect is called leveraging. For example, if $50,000 of investment funds are purchased with client equity, and the investment declines in value to $40,000 over 10 years, after which the investment is sold, the investor will have lost $10,000 with this strategy. However if the same $50,000 investment is purchased with an investment loan at an interest rate of 6.00%, and the value declines to $40,000 over 10 years, after which the investment is sold, the client will be in a worse financial position. To repay the loan the investor must raise an additional $10,000, to supplement the $40,000 raised from the sale of the investment. In addition, the investor will have paid $30,000 in loan interest over the 10 years. In other words, the investor will have lost $40,000 with this investment strategy. It is important that an investor proposing to borrow for the purchase of investment funds be aware that a purchase with borrowed monies involves greater risk than a purchase using cash resources only. To what extent a purchase using borrowed monies involves undue risk is a determination to be made by each purchaser and will vary depending on the circumstances of the purchaser and the investment funds purchased. It is also important that the investor be aware of the terms of a loan secured by investment funds. The lender may require that the loan be repaid at any time. If the borrower does not have cash available, the borrower must sell investment funds, possibly at a loss to provide money to reduce the loan. Money is, of course, also required to pay interest on the loan. Under these circumstances, investors who use borrowed funds to purchase their investments are advised to have adequate financial resources available both to pay interest and also to reduce the loan if the borrowing arrangements require such a payment. |
