If you’re young and more than willing to take on more risk for a shot at bigger gains over the medium- and long-term, it may be tempting to go for more speculative, high-momentum types of investments. Whether we’re talking about Bitcoin or any other fast-rising stock, it can be pretty exciting to extend oneself on the assets that are the hottest of the hot. Some gain-hungry investors may go to extreme lengths for a shot at outperforming the markets.
In this piece, I’ll react to a recent Reddit poster and tech worker, 28, who asked the folks on the r/fatFIRE subreddit about their thoughts on investing with leverage.
Investing with leverage takes the risks to the next level.
Leveraging up to invest may seem like a wise idea to jolt your wealth-creation journey. Still, it takes the risk factor to another level, especially if the borrowed funds are used to chase performing assets that may eventually face a punishing sell-off, one that could cause investors investing on a margin to have a dreaded margin call. Undoubtedly, it’s easy to get the math wrong or overestimate your ability to tolerate the elevated risks that accompany borrowing to invest in risky assets.
Even for those who opt to invest borrowed funds on safer securities (think defensive dividend stocks, gold, real estate investment trusts (REITs) or some lower-beta assets), leverage tends not to be a good idea, as it can make a seemingly sound investment plan and turn it into a rather risky one.
At the end of the day, even “safe” stocks, REITs, or even precious metals can implode in price in a rather unpredictable fashion. And if you’re too deep in the leverage, you may not be in good enough shape to recover compared to those investors who didn’t borrow to invest.
The great Warren Buffett once warned investors about the pitfalls of levering up to invest: “If you don’t have leverage, you don’t get in trouble. That’s the only way a smart person can go broke, basically.” Indeed, these are some wise words from the Oracle of Omaha that I believe investors of all ages can heed.
With the rise of leveraged exchange-traded investment products and other derivatives, borrowing to invest may be normalized for some smaller retail investors. In any case, I think Buffett is right on the money when he says leverage can even make smart people go broke. Like for inexperienced users of nunchucks, you may only wind up hurting yourself with leverage. That’s why I (and probably most financial advisors) would advise against leverage to invest.
What about those who are still young and willing to take extreme risks?
Even if you’re young and able to recover from a financial setback, why even take a chance on a proposition that could cause you to have to start all over again? Indeed, utilizing leverage can raise the risk profile in a way such that you may suffer a catastrophic hit to the chin. For those who are keen on “juicing” their net worth, I’d advise consulting a seasoned financial advisor who can help you mitigate the risks of margin trading, leveraged ETFs, or anything of the sort.
At the end of the day, leverage is a double-edged sword that can cut viciously in both directions. Sure, you could “juice” your returns if things go your way. However, if they don’t, you may find yourself having to start from zero or even below zero. For most, that risk/reward just is not worthwhile, regardless of one’s age.
In short, investing with leverage is too risky for most, including those market newcomers who have a tendency to overestimate their risk tolerance. If one is making a good wage from their job (in this case, tech), why not just invest the money that comes in rather than upping the ante with leverage?
Top Gaining Stocks
Top Losing Stocks