Should you invest borrowed funds in stocks?

Should you invest your loan amount in the stock market? The simple and emphatic answer to this question is: NO! And it’s not just because no bank or financial institution will give you loan to invest in the stock market, so you would be actually violating the terms of the loan if you did so. There are many reasons why stocks should not be bought on borrowed funds. Let us look at some of the compelling ones.

Investing in stocks on borrowed money can land you in a financial soup. This is because a loan comes with a cost in the form of interest to be paid on the loan amount. The loan amount has to be repaid along with the interest amount. So, you have a fixed financial liability to meet every month (usually), and there is no escaping this liability unless you wish to be a wilful defaulter and face the consequences.

But when it comes to stock market investment, there is no guarantee that you will make a profit that will help you pay up the principal and interest amount on the loan. In fact, there is no guarantee that you will get back even the principal amount invested by you in stocks. So, forget about earning profit to pay back the loan along with interest, the risk of loss of capital is too high to even contemplate investing borrowed funds in the stock market.

Let’s look at this in terms of returns on equity investments and the interest rate on personal loans (as personal loan can be used for any purpose). The investments in equities can give returns in the range of 12-15% over the long term of 3 to 5 years, while the interest rate on personal loan is anywhere between the 13-15%. Now, does it make any sense to invest the loan amount in the stock market? Clearly not, because you would be barely earning returns on your investments to pay for the interest amount on loan, that too only if you invest for the long-term (5 years and more). But personal loans are typically for tenures ranging from one to three years, so if your investment horizon does not match with the loan tenure, you would end up getting negative returns on your equity investments, which can land you in a big financial trouble.

In short, investing borrowed money in stock markets is a very bad idea. Don’t even think about it!