Negative Carry
What it is:
Negative carry means that the price of borrowing money is higher than the returns earned on borrowed money. It is the opposite of positive carry.
How it works (Example):
For example, let's assume John borrows $10,000 from Bank XYZ so he can invest it in his brother's business. Bank XYZ lends John the money at 8% interest per year. John takes the $10,000 and gives it to his brother in return for a 5% stake in the business.
Three years goes by, and John decides to sell his stake in his brother's business for $11,000, which equates to a 3.18% annual return. Because John borrowed money at 8% but only earned 3.18% on it, he has a negative carry on the investment. In other words, John essentially lost 4.82% per year on the investment.
Why it Matters:
In general, a negative carry on an investment is not a good thing. There are some silver linings, though: tax losses can be deductible, meaning that negative carries can reduce the investor's tax bill. Additionally, if the interest on the loan is tax-deductible or the interest on the investment is tax-exempt, the investor might actually receive a positive return on the investment even though it appears to have a negative carry.
