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Is it a smart idea to invest in stock market with borrowed money?15 October 2020

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.