Should You Borrow to Invest?

Faster Returns

For investors who don't have a large amount of money, borrowing a relatively large lump sum to invest can potentially result in greater returns more quickly. A larger investment means a larger dollar value of your returns. For example, a return of 10 percent on $100 results in a profit of $10, but if you had borrowed $5,000, your return would be $500. If you continue to invest your profits, you can continue to build your portfolio even faster.

Borrowing to invest can be used as an effective means of sheltering money from taxes. When you take out a home equity loan, for example, the interest you pay is tax deductible as of 2011. If you place the money into an investment vehicle where your earnings grow on a tax-deferred basis such as a traditional IRA, 401k plan or annuity, you won't have to pay taxes on the money until you withdraw it. If you're retired, you'll likely be in a lower tax bracket so your tax burden may also be lower.

Whenever you borrow money, you always run the risk that you could default on the loan. A sudden job loss or illness can make your income disappear, leaving you in dire financial straits. You may need to cash in the investment just to stay afloat, which could result in penalties for early withdrawal. If the loan was collateralized, such as the case with a home equity loan, you could lose valuable property and negate any positive investment returns.

With many types of investments, such as stocks, mutual funds and real estate, there is no guarantee that you will make money, and you may actually lose some or all of your money. It's also possible that the rate of return on your investment will be less than the interest you pay on a loan. Even if your investment yields a positive return, it may be so small that it cannot keep up with the rate of inflation.