KT explains: Should you borrow money to invest?

Dubai - The price of the cryptocurrency has since plummeted to almost half.

Should you borrow money to invest? While this may go against the grain of established financial wisdom suggesting that debt is usually bad, some people are keen on using it to create wealth.

Dave R., for instance, made some intellectually rational arguments at the start of this year to gain from low interest rates and use debt to create wealth. He reverse-mortgaged his fully paid house and invested some $200,000 in Bitcoin.

The price of the cryptocurrency has since plummeted to almost half — from the highs of $58,000 to around $34,000 now.

“I lost my job in March this year and have been unemployed since then. I have a bit of cash reserve to sustain myself and service my bank commitments for at least six months, but I understand that if I don’t secure a job by September this year, this bet can go horribly wrong,” said Dave.

The lure of low interest rates

Generally, it is better to invest in US dollar assets if the investor is taking a loan from the UAE, said Vijay Valecha, chief investment officer at Century Financial.

“Interest rates in the UAE are low since the currency is pegged to the US dollar, and many might be tempted to take a loan from here and invest in high-yielding assets back home. However, practically, it is a dangerous strategy,” he warned.

Investors taking a UAE dirham loan and investing in another currency asset should remember that they are selling US dollar and buying another currency. Therefore, investing in the same currency of the loan will help reduce exchange risk.

Nevertheless, there are a lot of risks with this strategy. Investors who are at the risk of a liquidity crunch should never take leverage.

Investing in home countries

This is not a great idea, Valecha said. “The UAE dirham is pegged against the dollar, so from a currency perspective, the loan’s dollar value will be stable. This is not true of emerging markets. If their currency depreciates, the value of the asset bought with a loan comes down. This doesn’t make economic sense. This is especially true in the current scenario where the US Federal Reserve is withdrawing monetary stimulus and is forecast to raise interest rate in 2023. These developments are likely to lead to a strong US dollar, and it is not advisable to invest in EM assets with a UAE loan.”

Vishal Dhawan, CEO of Plan Ahead, added: “Leverage helps when returns from assets are headed upwards but can significantly work against you when asset prices correct, as one has seen at multiple points in the past. In addition, when you are investing in a different currency from the currency you are borrowing in, you could also be exposed to the risk of currency movements working against you. Therefore, it is ideal to avoid using leverage to invest.”

Leverage doesn’t only help you on the way up but it certainly compounds pain on the way down.

“Using personal loans in a situation where job uncertainty is high needs to be avoided as there is the additional risk of a loan needing to be repaid against an asset that may have seen a price correction. We need to remember that very often, at times of major asset corrections, job uncertainty also gets heightened,” Dhawan said.

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