The pitfalls of investing borrowed money at 14
percent interest in a short period of time
It’s a big NO.
In the present times, it is
increasingly becoming easy to qualify for a personal loan through:
1. Banks
2. Credit unions
3. Friends/Relatives
4. Non-banking financial companies(NBFCs)
5. Digital options like Peer to
peer (P2P) lending platforms
6. Mortgages
7. A(401) k
Coupled with easy availability of
loan, if the stock market becomes robust, it boosts investors’ confidence to
plunge in equities but this path is not without apparent risks. In May 2020, a
35 year old software engineer from Noida ran into huge losses. He had taken a
personal loan of Rs.10 lakhs and invested in futures and options. The stock
market tanked during the lockdown and his investment went south. It wiped the
entire leveraged amount and left a gaping hole in his
finances, in addition to the loan burden.
Professional traders have used
borrowed money to invest in ETFs and subscribed to initial public offerings (IPOs) and
earned huge profits and have repaid their loans successfully but this practice
can be very dangerous for the average individual investor.
To quote Warren Buffet, the
Oracle of the stock market, “If you’re
smart you’re going to make a lot of money without borrowing”. He has
never borrowed a significant amount of money in his life. He firmly says, he
never will.
WHY YOU SHOULD NOT BORROW:
· You have to pay monthly interest, so you start to take risks which are generally not recommended by professionals.
· You can lose your job/ steady income or perhaps the money is callable
· Borrowing costs are fixed but stock market gains are variable and unpredictable
· Debt amplifies the volatility of the portfolio. Markets will bounce up
and down and if you happen to go down
before going up, the portfolio value becomes lower than the loan value and the
pressure really mounts
· The interest rate on some loans are not fixed. There might be major
policy rate changes. Usually, banks follow with the equivalent change in their interest rates (sometimes it can go up by 2 percent) following few weeks after the policy announcement.
· Short term
trading provides shorter time to make crucial decisions. Predicting the
direction of a stock for next six months is more challenging than predicting it
for six years. There is virtually no competition in a long term game
· You panic a lot more than other traders
Certain pertinent questions
need to be answered before you take the plunge
1. f the investment fails, how do you plan to return the money?
2. Is the risk worth the promise of return?
3. What is the probability of guaranteed returns/results?
4. What is the timeline of these returns?
STICK TO THE FOLLOWING SUPERTEXT
Sophisticated investors with low
debt, high disposable income and who are between ages 25 and 50 are in the best
position to invest with borrowed money says Levar haffoney, Principal at
Foyohne Advisors, a New York Financial advisory firm.
Stock markets only give you good
returns when you hold patience and you cannot hold patience once you have
borrowed money with interest mounting up. Even if everything is right, you need
to wait for the stock to reach its potential. The most accurate math will not
play out.
Cardinal rule: So never leverage, no matter how accurate your
calculations are.
Use this blog to carefully think
and decide if borrowing is the best decision for you.