Local government units (LGUs) are allowed to issue bonds to raise funds for their various projects. There are basically two classifications of LGU bonds: revenue and general obligation.
A revenue LGU bond is a type of financial security where the repayment of both the interest on and principal of the bond can be taken from the LGU’s internal revenue allotment (IRA) and from revenues that can be generated from the project that is being funded. On the other hand, a general obligation LGU bond is a financial security where the repayment of both the interest on and principal of the bond is sourced only from the IRA of the LGU, or in other words, the LGU’s regular income.
The same holds true for borrowing money to invest. Since stocks are long-term investments, it stands to reason that only long-term debt should be contracted to buy stocks. Nevertheless, long-term debt will still require immediate payment of interest and principal. In accounting, long-term debt payments that will fall due within one-year from the current period are lumped together as the current portion of long-term debt.
As a general rule, the current portion of long-term debt should be paid by assets that can also be converted to cash within one year and/or from income that will be earned within the same year. A stock investment typically has a long gestation period before it generates enough cash flow not only for the repayment of the debt that funded it but also for producing a decent return to the investor. Therefore, any long-term debt incurred for buying stocks can only be considered as a general obligation debt (i.e. loan repayments are initially funded by a combination of short-term assets and income). Borrowing to buy stocks based on the assumption that the latter will have a short payback period is being too aggressive.
Moreover, with risks present in any investment, the expected return from stock investments should be many times higher than the cost of the debt.
On the other hand, unless there is some financial wizardry involved, it is also not wise to contract short-term debt to invest in short-term fixed income instruments. Short-term fixed income instruments usually have low yields that will not be able to offset the cost of borrowing.
So does this mean that the average man on the street will not be able to invest? Of course not; this only highlights the need to have excess net income or recurring savings for investing. And to have such savings, people should instill financial planning discipline. Such discipline will also avoid having to sell investments prematurely (or during the gestation period) because of lack of funds to pay the debts from which such investments were funded.
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