Considering leverage [closed]

Question

I started investing two years ago. Currently my situation is as follows:

• I earn 1700 € per month and manage to save 1200. To be Conservative and as rents are going up in my country, we can assume that I save 1000 € per month. Note: this is a country where we have universal healthcare and this is a "decent" salary. Not very high, not very low.

• I have 5000 € in my account and 24000 € invested in the stocks market.

• No debt. No other assets.

• Dividend yield is around 900€ yearly after taxes.

My bank has offered me a credit of up to 60000€ with an interest rate of 3.95%, meaning that if I borrowed 60000 € I would have to pay a total amount (capital + interest) of 68775 € over 7 years, i. e. 818.75 € monthly.

I would borrow the money for investing in blue chips with temporal diversification.

Borrowing 60000 € seems like too much for me, so I wonder which quantity would you think could be reasonable in my situation. For example 30000 € would mean 409.36 € per month. This does seem like a good compromise between risk and profit.

What do you think? First, should I use leverage? If so, how much should I borrow.

The intention is to kick-start my Investments in order to invest as soon as possible to make use of compound interest.

Answer 1

I wonder which quantity would you think could be reasonable in my situation.

How about zero? You are borrowing at a fixed rate of interest in order to invest and get a risky variable rate. I don't know what markets are like in your country, but in the US, we've had a great run as of late, but historically returns in the broad equity market have fluctuated between -30% (crashes) to +40% (recoveries after crashes). with an average return of about 10%. So you might be OK. But you might also be forced to liquidate your investments in order to make your fixed loan payment, and risk losing ALL of your investments (but still have to make loan payments). Remember that leverage multiplies your gains and your losses. That leverage will really pummel you in the down years.

I appreciate the desire to jump start your investing, but with just two years of investing under your belt, I don't think leverage is the wisest move for you. Saving 1,000 a month at a conservative 5% average rate of return, your investments will be worth over 800K in 30 years. At a more moderate 8% average return, the end value is nearly 1.5 Million. And that does not take raises into account. Certainly your income will go up over that time, raising your savings amount even more.

I would not get too impatient. Keep doing what you're doing, saving regularly and you'll be fine.

Answer 2

With an interest rate of nearly 4 per cent, I believe that this is gambling. On average, you would beat that, but even with blue chips, there isn't certainty. Your odds aren't bad, assuming an average annual increase of 5 per cent but they're not good either. You might argue that it's a conservative number because the historical increase is higher but I wouldn't be to enthusiastic about your investment.

I like the concept of constant investment to avoid "bad timing" so why not build the stock with your left overs at the end of the month? With a big credited investment, you might have to sell your stocks out of need, forcing you to sit out a small crisis which might also affect the money remaining at the end of the month. Consider limiting this risk to no more than 10k so that your accumulated money is much higher than the credit you paid.

Edit: What are conditions at your broker for buying and selling? For diversification, you should buy 'single' stocks in the 2 to 5k€ range. Fees can be a noticeable drain on the income.

Answer 3

You say that the reason you want to invest the money now is to make use of compound interest.

But compound interest is relative to your original investment; you don't get a higher rate of interest for having had the money invested for longer, it just means that you have more money earning interest.

In other words, if in seven years' time you have €60,000 in investments, then in eight years you will have €60,000 plus one year's interest/ROI; it doesn't matter whether you've had that €60,000 in the account for seven years or for none.

So the question is actually: how can you have the most money available to invest in seven years' time?

How to do this depends on how profitable your investments will be over the next seven years. If you expect a high rate of return, then by all means borrow the money - but it is definitely gambling, and remember that the bank is taking €8,775 of anything you make. If they fail to perform as well as you expect, then you'd probably be better off just investing what you can save as it comes in. That'll compound too, but without the bank taking a cut.