Should you borrow to invest? The truth about taking a personal loan for stocks

The Indian stock market continues to remain volatile due to the ongoing geo-political issues such as: Trump’s tariff threat, Russia-Ukraine war, global inflation, high interest rates etc. All these issues have cumulatively resulted in India’s benchmark Nifty 50 index suffering a swift correction of more than 10% over the last six months. Nifty 50 has now lost more than 3500 points from its all time peak of 26,278 points.

Due to this intense correction, the Indian markets are now attracting investors again and many are considering taking personal loans to leverage their investments. This is a high risk strategy and should not be taken casually. One should consider approaching this idea with caution and after proper consideration.

The allure of leverage

Taking a personal loan to invest in the stock market is often referred to as leveraging. This in simple terms means taking money on loan or borrowing funds to put them on the line in high risk and volatile investment tools such as equity markets.

Now this definitely allows investors a larger pool of funds, still, there is no guarantee of increasing their returns. Personal loans are particularly appealing because they do not generally have user restrictions, meaning the borrower can use the funds for any purpose, including stock market investments. Further, personal loans are unsecured, eliminating the risk of losing collateral. This makes the chance of misusing funds high as less informed investors casually use these funds for equity trading and investments.

Risks and considerations

Now in spite of apparent potential benefits leveraging personal loans and investing in highly volatile and risky stock investments can have disastrous consequences. The stock market is fundamentally volatile and unpredictable and there is no assurance of returns in the markets.

Hence, if the stocks do not perform well, the borrower will be left with a substantial debt to repay, alongside potential losses to deal with. Further, personal loans often come with high interest rates, especially for those with lower credit scores, which can reduce the likelihood of making a profit.

For example: Say you opt for a loan at 15% interest rate per annum. You do it thinking that the stock market will quickly provide you with exceptional returns. Still, due to a sudden global development like a pandemic, a war or some other unforeseen event the global markets take a tumble and are hit by a recession. This results in a severe downturn for the next few months and your stock investments also take a hit.

Now in this kind of a scenario how will you manage your personal loan repayments along with numerous hidden charges? Won’t you end up building debt over debt due to the interest costs? That is why it is crucial to take into account all such considerations before considering a loan for stock market investments.

Current market trends

The recent data shows that retail credit growth in India has slowed. This has happened in part due to a decline in unsecured loan distribution. The current slowdown is attributed to higher interest rates and increased risk weights on such loans. Still, the personal loan market in India is primed for consistent growth in the coming years due to rapid digitalisation and urbanisation.

Conclusion

Hence, while taking a personal loan to invest in the stock market can offer availability to more funds, it is crucial to weigh the risks carefully. Do remember the EMI or interest you will pay on your loan will be a fixed cost on you. Whereas the returns that you think you will make from the investment of such a personal loan will be variable and completely market driven.

As famously explained by Warren Buffett: “Only when the tide goes out do you discover who’s been swimming naked.” This means that it is only when the market cracks and the question of debt repayment arises that we realise who actually holds the real funds.

Investors therefore, should ensure they have a solid backup plan for loan repayment and conduct thorough research on potential investments. For this focus on understanding what compounding interest is as a concept. Given the volatility of the stock market and the costs associated with personal loans, this strategy is best suited for those with a strong financial foundation and a well-thought-out investment plan.

Disclaimer: Investing in the stock market using personal loans involves significant financial risk; consult a financial advisor before making any decisions.