What is Leveraging?
Leveraging is quite an unfamiliar term with many people. However people leverage all the time, sometimes unknowingly. The minute you took on a debt or a loan, you are already leveraging.
From housing loans to car loans and even your credit card debts are the most common forms of leveraging.
People leverage on banks for money they do not have to buy property they would like to stay in and to some for investment. People leverage on finance company for money they do not have to buy a vehicle for their convenience and to some a form of status. Banks and finance company in turn depends on the borrower’s promise to pay back principle plus interest before lending out their money.
For example, when you buy a 5 rooms HDB say at $500k, you pay a deposit of $50k, the remaining $450k you borrow at 2.6% for 25 years. Not only you promise HDB to pay back the principle amount, you will pay an interest on top of that. Over a period of 25 years, you will have paid back $612,453 even though you have just borrowed $450k.
Leverage for investment
Leverage for investment however is less common and sounds more like a rich man’s game, seems only possible with high net worth. Leveraging for investments sound expensive and risky.
Unbeknownst to many, leveraging for investing can be safe and inexpensive. In fact I came across a free financing instrument offer by an insurance company that offer to invest both your principle and the financing component into a percent bond fund! It can be offered to anyone whose risk profile classification ranging from conservative all the way to aggressive.
Here’s an illustration on how it works. When you create an account of $100k, the insurance company will deposit $180k into your account. The entire $180k is lend to you at interest free. Yes you hear it correctly, you do not need to pay a cent of interest on the amount you borrowed. Not only that, the amount that you need to repay is also lesser than the amount you borrowed. The entire $280k will be invested into a bond fund that generates 5% dividend which are reinvested. The rate of return excluding fees will be pushed up from 5% to 14% in this context in a one year period.
My five cents worth: Leverage is not a new concept and it’s been around for a long time. Almost everyone is leveraged at some point in their lives. Leveraging for investment isn’t new either but it’s made popular by the financial industry. While free leveraging sounds interesting and to a certain extend lower risk, investors should still exercise their caution by ensuring they fully understand the terms and condition associated with the free financing, alongside the risk of leveraged investing.