There has been a bit of commentary recently proposing New Zealanders use the equity in their homes more aggressively to grow their wealth. We’ve even heard suggestions that people borrow against family members’ homes to get into the property game.
This isn’t necessarily bad advice. Most wealthy people have gotten where they are by taking risks, and this often means borrowing to invest in something, be it real estate, businesses or farmland.
The financial term for using other people’s money to invest in something is “leverage”. In a rising market leverage can make you very wealthy, supercharging your returns and leading to the massive gains many property speculators have enjoyed in recent years.
However, it comes with a catch. In a flat or falling market leverage can do the opposite, by magnifying your losses. That’s the tricky bit when it comes to borrowing to invest. The timing is crucial and the concept only works if asset prices are rising.
Will those large gains continue over the next few years? I would suggest that’s highly unlikely, given the strength of recent years, and with interest rates now rising from all-time lows. A highly-leveraged investor isn’t quite as well positioned to make a quick buck if we’re heading into a sideways market.
Come On Mark, Say It! A deflating market. Will it be a slow collapse or a sudden BANG!