When Does Debt Recycling Make Sense?

Financial Autonomy

Borrowing to invest he is unquestionably a frequent contributor to wealth accumulation. Few of us would buy a home without using a mortgage, and it is a rare business that is able to grow without some form of debt.

Borrowing to invest in the stock market has many positive attributes. Shares can be sold quickly, enabling you to reduce or clear your debt at short notice were your circumstances to change. Transaction costs are low. And diversification is easily obtained.

There are several ways in which you can borrow to invest in the stock market. Under a debt recycling approach, it is assumed you are using equity in your home.

Borrowing to invest magnifies an the outcome. If you invest $1000 and it increases in value by 10%, you have gained $100 in wealth. If instead you matched that $1000 with an equal amount of debt, and your now $2000 investment grew by the same10%, your wealth has increased by $200, double that of the original example. Now of course you need to back out the cost of the debt, but this simple example illustrates the impact.

Investments don't always go up however, so the magnification brought about through gearing works in both directions. If the value of your investment rises, gearing enhances your outcome. But if the value of your investment falls, gearing makes the situation worse.

For this reason, there's a few key criteria that you should tick-off before embarking on this strategy.

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