Open Journal has already considered various nuances of investing credit money in financial markets. Today we will analyze how to correctly correlate the benefits and disadvantages of using loans for investment.
Compare the pros and cons
Advantages of investing credit money:
- If the investment project succeeds, then you can get more significant profits using not only your own, but also borrowed funds.Let’s say there is a reliable project with an annual profitability of 50%. If an investor invests his million in it, he will receive a profit of 500 thousand rubles. But if he takes another million on credit, for example at 20% per annum, then his profit, even taking into account bank interest, will be 800 thousand rubles. (before taxes).The larger the loan, the higher the potential profit. In theory, this pattern is called financial leverage.
- Loans give access to larger and more innovative projects. This is especially important when there are not enough fixed amounts to move up to a higher level.
- The investor improves credit history, which reduces the cost of further loans.
Cons of investing credit money:
- Additional psychological burden – you need to take into account the need to make interest payments on time.
- Emergence of new payment obligations. Moreover, these obligations are almost always unconditional – the lender is not interested in what difficulties the borrower has, for what reason, and so on. In situations of high volatility and uncertainty, this minus can have an extremely negative impact on the investment project.
- Additional risks in case of project failure. Potential losses of an independent investor are limited by his capital. But if he uses borrowed funds, then if he fails, he risks not only completely losing his money, but also remaining in debt.In the example above, if the project fails, the investor not only loses his million, but also owes the bank another million and interest on it.
To these disadvantages, you need to add the specifics of loans in the current situation, when:
- banks often refuse loans;
- the average rate on loans increased following the growth of the key rate of the Central Bank.
Thus, if a reliable investment project with high profitability is planned (with today’s risks and loan rates, it starts from 30% per annum), then you can consider the option of taking a loan – but even here you need to limit the amount of loans and use hedging and diversification. With lower profitability and / or doubts about the reliability of the loan, it is better to refrain. Separately, for financial markets, volatility should also be taken into account – the higher it is, the greater the risk of trading with leverage.
How using loans for investment looks like in practice
Let’s take an example of what risks and opportunities bear credit money in transactions in the securities market.
Alexey learned from the media about the plans of a large corporation to buy out company A. Often such transactions lead to an increase in the capitalization of the acquired business. Suppose Alexey is hoping for a 10% increase in the value of Company A’s shares. Now he has 1 million rubles. – therefore, if he buys shares without a loan, he will make a profit of 100 thousand rubles. (hereinafter we will not take into account commission and other similar expenses). Alexey has the following options:
- take a short-term bank loan for a month;
- use the service of trading with leverage, which is provided, for example, by ” Opening Investments “.
After weighing all the pros and cons, the investor decided to take advantage of these opportunities:
- took a loan of 1 million rubles. per month at a rate of 24% per annum;
- acquired shares of company A with a leverage of 1:5 for 10 million rubles. at 24% per annum (here it should be taken into account that the cost of a loan from a broker is calculated for each day).
Let’s say that immediately after the purchase, the stock went up and grew in price by 5% in a week. Alexey has two options:
- Satisfied with the profit.His income will be: 10 million rubles. * 5% = 500 thousand rubles.Minus interest to the bank (1 million * 2% = 20 thousand rubles) and broker (8 million * 24% * (7 days / 365 days) = 37 thousand rubles).
Total profit: 500 thousand – 20 thousand – 37 thousand \u003d 443 thousand rubles, from which 13% of personal income tax will still have to be paid.
- Wait for further price increases – but here the risk of borrowing may appear. For example, the information was not confirmed, and the next week the shares not only lost all their growth, but also additionally fell in price by 10% relative to the original value.The loss will be: 10 million rubles. * 10% = 1 million rubles. To this must be added 20 thousand rubles. interest payments on a loan to a bank and 74 thousand rubles. broker for two weeks.The result – Aleksey will not only lose all his money, but will also be obliged to find 94 thousand rubles. to pay off debts.
From this example, it is clear why the Central Bank does not recommend unqualified investors to trade with leverage. This is stated in the Letter of the Bank of Russia dated December 15, 2020 No. IN-01-59/174.
The current situation associated with the mass withdrawal of Western (and not only) business from the Russian market, with all the minuses, contains some pluses. 147 million people live in Russia; 3.274 million legal entities, 3.705 million individual entrepreneurs and 3.862 million self-employed operate (at the beginning of 2022). Anyone who successfully engages in import substitution will be able to make good money – after all, only bank deposits of individuals and legal entities amount to 61.5 trillion rubles.
Also, as the example of Iran shows, the securities market has significant growth potential (the TEDPIX index rose by 12% from the beginning of the year to mid-May). Consequently, there are real investment opportunities in our country, thanks to which it is possible to realize the advantages of attracting loans. But the problems associated with loans should also be clearly understood, especially those that are currently present. These include high borrowing costs, significant uncertainty and lack of a clear risk map.