Beware of Taking a Personal Loan to Invest in Stock Market! Know Pros & Cons
Before you contact a lender to apply for a Personal Loan to invest in stock markets it is important to know that the RBI discourages borrowing for speculative reasons. It is thus quite likely that a lender may disapprove your loan application for investing in stocks.
Nevertheless, you are not required to disclose the reason for Personal Loan to bank. So, if you happen to use the borrowed money for investment purpose, you should understand the pros and cons of this decision clearly.
When you avail of a loan, expecting a higher return it called as leverage investing. Always consider the worst case scenario when planning to leverage investment corpus. Answer if you can serve the loan EMIs, despite losing out in the markets. Yes, markets can be highly volatile and there is always an ingrained risk of unexpected oscillations. If you cannot sustain the financial loss in the market, you should not borrow ever for investment reasons.
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Certainly there are benefits of leveraging funds for greater returns. But first of, know about the pros and cons of this decision.
Benefits of using Personal Loan for Investment
1. You earn returns from money that you do not have
When you use a loan to invest in markets and make profits, you basically earn returns from money you do not have. As such, a lender will not lend you for speculation purpose in India. If such is the case and you are unable to meet the Personal Loan Eligibility, you can always use your existing stocks to avail of a loan against securities and re-invest that money for buying the desired stocks. This will work like margin financing.
However, pledging securities can result in sale of stocks in case of non payment of EMIs. If there is a surplus after the sale, the lender will return you the balance amount.
2. You can additional stocks when you do not want to sell the current ones
In falling markets, the investments can be overtly risk, yet profitable. However, it may require deep pockets to keep the current stock and continuing buying new ones at the bottom. In this case, a Personal Loan can help you avail of the funds required for making the right investment move. But, it is a contrarian call and has a massive risk involved.
3. You can diversify & stick to Asset Allocation
With additional funds, you can leverage to diversify and stick to original asset allocation. However with low funds, selling is the only option to get back to rebalancing the portfolio.
Downsides of using Personal Loan for Investment
1. Interest Cost
Markets can be highly volatile and there is a larger risk involved if you borrow money to test the depths of water. It is thus important to assess your risk appetite before investing in stock markets.
Besides, whether you make money or not you are obliged to repay the loan in time. The interest needs to be served each month, no matter what happens to your stocks. Most of the times, you will not be able to time the returns precisely.
Thus it becomes more of a challenge to earn enough to serve the loan and get home some profits at the same time.
2. Additional Charges
It is extremely important to pay due diligence to all the associated costs with the loan. Besides the Personal Loan Interest Rate you are also required to pay processing fee, foreclosure charge, penal charge, cheque/mandate bounce charge, duplicate documentation charge, mode of payment swapping charge, etc as well. So, you should always pay out loan in time or the cost of the debt may escalate & hit your profit calculations.
3. The risk of losing out
This is one of the greatest risks involved with such loans. Besides the fear of making wrong choices in the market, there is always is a greater risk of non payment of returns. For instance, the company may file bankruptcy and dump the stakeholders. There is no way you can make the claim in short run for your loan repayment.
Thus, it is always recommended to adopt a balanced approach. You should consider following points before taking a Personal Loan for investment purpose.
Things to consider
1. Evaluate the cost of loan
Explore the lending marketplace and choose the best interest rate offer. For instance, if you are opting for Axis Bank Personal Loan it is important to check the interest rate and all the associated costs beforehand. You must be able to pocket at least 40 per cent of returns from investments. Thus choose carefully the lowest possible interest rate.
2. Assess your repayment capacity
It may take a while before you start making enough profits from the investments and thus it is important to gauge a repayment back up. It is important that your finances are aligned to repay for all of your EMIs and credit card bills, whether or not you are making profits in the market.
3. Do your homework
It is recommended to do some home work and analyze the stocks before you start investment. You should study the historic returns and have some hold on expected market returns. Also you should have some ground for facing the negative investment returns so that you can stay put and do not switch the strategy too frequently in wake of losses.
4. Understand your risk appetite
It is important to know your risk appetite before opting for opting for leverage investing. Know if you are a risk averse or risk taker or a risk manager. Always take risk prudently according to your financial health.
Market sentiments can change in a heartbeat and thus it is important to evidently understand the pros and cons of availing of a loan for investment purpose. Even the best of investors make mistake, so you should be well prepared for north & south oscillations.
It may eventually turn out to be the best financial decision; nevertheless, the associated risks are not meant for all! So weigh in negative consequences before moving ahead.
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