InvestorQ : Should I take a personal loan to invest in stocks or equity market?
Ishita Jain made post

Should I take a personal loan to invest in stocks or equity market?

3 years ago

Building wealth for your future starts with good investments and equity or shares is one asset class that can definitely play a bigger role in achieving your goal quickly. But what option do you have when you don't have enough cash to invest in stock market? Taking a loan to invest can pay off very well only if you understand the risk taken in it for investment. If you’re considering a personal loan to play in the stock market, here’s what you should consider.

Check and compare loan rates

Before you start dabbling in stocks, you will have to find out the interest rates charged by various lenders. One should calculate the net returns made on investment after deducting the interest cost paid to the banks during loan tenure. If the loan’s interest cost is more than half of the investment’s average return generated, you will end up making few bucks out of the entire process.

Consider the case of Kunal, a trader, who takes loan of Rs 10 lakh for one year at 15% to invest in stocks. At the end of the year, Kunal made a profit of Rs 2,00,000. After paying the interest amount, his net gains were Rs 50,000 on an investment of Rs 10 lakh. Returns are even less than interest earned on fixed deposits. Thus, one has to make sure that you not only earn more than interest amount but also generate high returns which are enough to beat returns generated from risk free instruments.

Weigh the payments

One should also be clear about the time horizon for investment. Let's assume you are taking a long-term investing approach which is buy-and-hold approach. If the desired gains takes longer time than anticipated before booking profits, it’s important to make sure you can afford the loan payments for the extended period.

The situation can become even worse if you already have existing loan such as education or home loan. If you fail to pay your current loan because of the extended period, you will open yourself up to a world of financial trouble.

Study Investment Performance

It is not a good idea to jump into the stock market without doing proper research, especially when you’re doing that investment with borrowed money. If you’ve narrowed your research on a particular stock or mutual fund, you’ll need to look at its performance since its listing and not just over the last few months.

A stock which is doing well right now does not necessarily will perform the same after six months. So one should do a thorough research of the stock or mutual fund before investing with borrowed money.

Review fees

Along with interest cost, lenders might charge certain fees when you get a personal loan. Even if it’s a small processing fee, remember that every penny counts in your net gains from the entire exercise.

Apart from interest cost, one should also consider other costs associated with investments such as brokerage costs and other taxes that can increase your overall investment amount and reduce net gains. Some mutual funds also have exit loads if the invested money is redeemed before a certain period.

Taking a personal loan to invest in stock market can be a big gamble and it’s definitely not advisable for the faint-hearted. Before you make the move, it’s important to assess the pros and cons from every possible scenario to make sure you have a clear knowledge of what you stand to gain and potentially lose.

Loan against shares is another facility that is given by the brokers and banks to invest in shares. In this scheme, you get a loan after a stipulated haircut based on the current value of investment. Say if you have 1000 shares of Reliance Industries, stock is trading at Rs 1000 and current value of investment is Rs 10 lakhs. After applying a haircut of 20% by the broker, you can get a maximum loan amount of Rs 8 lakhs. Interest will be charged on the loan until you repay it. One can also consider this option if they have idle shares and want to leverage on it.