The BSE Sensex has risen to 40,000 despite the Indian economy not doing so well. Rising Sensex figure is often seen as a proxy for future expectations; hence many investors look to get into the race and make some money in the short term or the long term by investing in stocks and shares of various companies. However, any investment in stock markets does need capital in the form of money.
Off late, personal loans are easy to avail, as it is easy on documentation and the loan need not be tied down to any end-use. In addition, personal loans are one of the easiest to avail, especially with the advent of fintech lenders from where you can avail instant personal loans in just 2hours.
Therefore, investors look to borrow money to invest and earn handsome returns from the stock market. However, the question on the minds of many investors is if borrow money in the form of a personal loan is good to invest in the stock market.
This article aims to through some light on the pros and cons of investing in the stock market on borrowed money so that you can take an informed decision and secure your financial future.
When Should you Invest in the Stock Market on a Personal Loan?
The potential of earning good returns on equities or investments associated with stock markets is high and is advised by many investment experts as well.
The process of investing in the stock market on borrowed money or a personal loan is called gearing or leveraging. While the returns on a stock market investment might be tempting and exciting, it is also important to understand that the same is also risky.
Before investing in the stock market on borrowed capital it is important to do your research well and understand the risks involved in investing. Also, it equally essential that you pick your stock based on strong fundamentals which is based on the performance of the company and its financials rather than on tips and recommendations from friends or websites.
Advantages of Investing with a Personal Loan
● More Capital to Invest
If based on your research a stock has the potential to perform well, with the extra capital from a personal loan, you can have more capital to invest in; thereby increasing your returns. The returns from the investment may have the potential to compensate for your interest and the other costs associated with the personal loan.
● Costs Associated with the Personal Loan can Reduce your taxable Income
A personal loan comes with costs like processing fees and interest costs. These costs can be used to set off the income earned on stock market investments. This can, in turn, reduce the overall tax paid on the income, thus making your investment more profitable.
Disadvantages of Investing with a Personal Loan
● Possible Loss of Capital
Sometimes despite all the research, your investment in the stock market might not turn out accurate. In that case, you may lose all your investment which may be a bigger blow on your finances. In this case, you would need to pay the EMIs out of your own pocket which might turn difficult. So, you may need to have an alternate source of income to pay the loan EMI.
This may especially be true when you invest in options or derivatives where the risk is much higher.
● Lower Returns than the Cost of Capital
The stock market or equity returns may look good on the face. However, the returns may not match up to the cost of the capital (personal loans) used. Depending upon where you avail of the personal loan, the rate of interest may vary between 10.99% and 25% or even higher. You would also need to consider the cost of processing fees paid to avail the loan.
Only when the returns from the stock market surpass these returns would availing a loan make financial sense.
● Mismatch in Tenures of Returns and Capital Repayment
The investment in the stock market could comprise of both short term and long-term investments. Short-term could be anything from intra-day trading investment or a few days/months. On the other hand, the long term could mean anything over a year.
However, the EMIs for a personal loan must be paid immediately from the month on which the loan was availed. The tenure of the loan can be anywhere between 1-5 years. So, it becomes impossible to wait until you sell off your stock market investments before repaying the personal loan.
● Credit Score may get Affected
If the loan EMI remains unpaid, then your credit score may get affected which may, in turn, create problems for availing credit in the future.
So, you see that there are advantages and disadvantages of using a personal loan as capital for investing in the stock market.
Here are a few pointers for you to consider when you think of investing in the stock market using a personal loan.
● Do extensive research on the equities before investing.
● Understand your risk appetite and possible risks involved in stock market investments.
● Consider the interest and other costs involved in availing of a personal loan.
● Do not miss an EMI for any reason.