Can you invest borrowed money?

If you want to start investing in the stock market but don't have enough funds to do so or feel the need to diversify your investment strategy, you may have questions about whether it's possible to use borrowed money to invest.

If you want to learn more about investment options and how to leverage your money, stick around for more information.

Can I use borrowed funds to invest?

The short answer is yes--when it comes to ethical investing, you are able to borrow money to buy investments. When you take out a loan from your financial institution, a lump sum payment will be deposited into your bank account. Once the money is transferred, it's yours to use how you want. That said, borrowing to invest isn't for everyone and only makes sense in certain financial situations, which we'll talk about a little later.

Types of investment loans

There are many options available to you if you want to use borrowed funds to buy investments. Here's a look at some leveraged investing opportunities Canadian investors like yourself, may want to consider:

RRSP loan

An RRSP, also known as a registered retirement savings plan, is a type of investment account Canadians use to store funds for their retirement. With an RRSP loan, you can borrow money to make an RRSP contribution for the year. Because regular RRSP deposits are tax-deductible, using an RRSP to make payments to your RRSP savings could result in more tax savings and a larger tax refund for the year.

Most Canadian financial institutions provide RRSP loans, both short and long-term. Borrowing to invest in your RRSP is a great idea, especially because we have RRSP matching in Canada. Many employers will match the money you put into your account each tax year for your retirement savings. Furthermore, any money earned using your RRSP investments will be tax-free until you make RRSP withdrawals. So, if you want to double your potential investment returns, this may be a strategic approach to your overall financial plan.

Just keep in mind that interest rates on RRSP and GICs can change all the time, which may impact your returns.

Borrowing money against home equity

Another way you can borrow to invest is by applying for a home equity line of credit, also known as a HELOC. With a home equity loan, you can borrow the money you've put toward your mortgage, which is now equity in your property. With these funds, you can invest in mutual funds, stocks, and other financial products tailored to investing.

Margin investing

Margin account investing is a strategy that allows you to work with investors who borrow money from a financial institution to purchase investments. With this type of strategy, there's a general expectation that the investment returns will exceed the money borrowed, leading to a large profit in the end.

Sell stocks

Short-selling stocks occur when you borrow shares from your bank or investment firm when you believe the price of certain stocks is set to fall. The idea is that you'll be able to buy shares when the price is low and then resell them on the open market to make a profit.

That said, because the stock market can be unpredictable at times, the stock price could increase, which means you would lose more money than you invested in the first place.

Line of credit

Lastly, you may be able to apply for a line of credit from your bank or a union. With this type of investment loan, you'll be pre-approved for a certain amount of money, which you can use to invest. Similar to how a virtual credit card works, you'll be able to access the funds whenever you want to, up to your overall account limit. Additionally, you'll only need to pay interest on the money you borrow.

Advantages of borrowing money for an investment loan

Borrowing to invest can offer several advantages, depending on your overall financial goals. Here are some benefits you can experience when doing so:

Potential returns could be high

In many scenarios, when you borrow money to invest, you could potentially earn more money than the interest rates on your loan, which will give you enough to pay off your interest payments and principal loan while making money doing so.

Flexibility in the investments you purchase

Using borrowed money to invest also gives you the freedom to purchase numerous assets. Whether it be stocks, mutual funds, or other assets, investing using this strategy can help you diversify your investment portfolio for the better. Just keep in mind that you will have to follow the terms and conditions outlined in your loan agreement.

Purchase securities beyond what you could otherwise afford

Borrowing to invest also gives you the freedom to invest more than you would have been able to afford otherwise, leading to more opportunities for growth. Some of these are things you wouldn't have been able to achieve with your current income or bank account.

Disadvantages of getting an investment loan

While there are several advantages when borrowing to invest, there are some potential drawbacks that you need to be aware of before going this route:

Pay interest and other fees

When you borrow money, you'll still need to pay fees and interest until you're able to pay back the entirety of your loan. In the event that your investment fails, you could be left with a lot of debt. On the other hand, even if you do make a profit off your investments, these additional fees could end up lowering the overall profits you make.

Increase debt-to-income ratio

Depending on your financial situation, taking investments with borrowed funds can also worsen your debt-to-income ratio. This ratio measures how much debt you have compared to your income level. Anything over 40% can damage your credit and make it difficult for you to get a loan in the future.

Damage your credit score

And of course, borrowing money can significantly impact your credit score if you are unable to make your payments on time. Additionally, if you have a secured loan, you may be required to forfeit your assets to your lender if you are unable to pay back the principal loan and interest.

Not sure what your current credit score is? Get a free credit score check online and build your credit with KOHO!

Things to consider before borrowing money

Before determining whether borrowing to make an investment is right for you, there are some things you need to consider:

Interest rates

Take a look at the interest rate for your loan. The higher your interest rates, the more you will need to pay back to your lender in the end, which may not make it worth the investment.

Your risk tolerance (how much debt you currently have)

Ask yourself how much debt you currently have to determine if you have a high-risk tolerance or not. Having large amounts of debt with higher interest rates may not be the best time to make other investments, as it can lead to further financial difficulties.

Your ability to make your interest payments on time

While you won't be required to pay back your loan in its entirety before the end of your loan term, dragging out your payments will cost more money in the end. Ask yourself whether you're able to make your monthly payments on time. If you aren't certain that you'll be able to comfortably, it might not make sense to increase your overall debt.

Your financial goals

Another thing to consider is your financial goals. The best thing you can do in this scenario before you begin investing is meet with your financial advisor to get professional advice on potential loans and investment opportunities and your overall risk tolerance. They can also help you go over your plans for spending and saving and help you strategize your next financial moves based on your unique circumstances and income.

Invest in your future with KOHO

Using loans to make investments can be a great strategy if you want to increase your profits and diversify your investment portfolio, but it's not for everyone.

At KOHO, we understand that taking control of your finances can be daunting, which is why we're here to help you wherever you are on your journey.

Whether you want to know the difference between a tax credit vs. tax deduction, learn more about investments, or other financial topics, you can do so by taking a look through our free, online resource hub that's available at your convenience!

We can also help you with your short and long-term financial savings! Check out our high-interest savings account with overdraft protection coverage today!