Why Taking out a Loan to Invest is a Bad Idea

Since the dawn of the Internet, the modern person has grown to be more and more educated and capable.

On the average.

This rings true for financial savvy as much as anything else. As a result, during the most recent decade, more and more people have ventured into the vast and ever-growing investment pool. We as a species have gained access to tools and knowledge previously only available to a very elite group of people. You could, with merely a flick of your thumb, invest money while sitting wherever you are right at this moment. And, as long as you make a well-educated choice – go at it!

When you’re first starting off, the total invested amount as well as the ratio of investment-return might be rather on the low end of the spectrum. This is largely due to the limited funds available for investing. However, as you’ve probably already guessed (the clue’s in the header of this article), it might not be the greatest idea to stray from the safety of this deliberate path and borrow to invest.

What makes it a not-so-good-idea?

Well, first of all – any loan you take out will actually hinder the growth of your wealth. To be precise, even if you stand to earn an enormous amount of money from the investment, unless you invest with your own funds – the principal amount invested will still go back towards repaying your loan. Plus interest. This means that you’ve actually made less with the help of a loan than you could’ve with your own resources. Thus, the hindering.

Secondly (and more importantly), by taking out a loan and using these funds for investments, you assume the all-too-real-risk of losing money that isn’t yours in the first place. This can, unfortunately, create a series of issues down the road either for you personally or for your business – depending on what you borrowed the money for.

So, all in all – taking out a loan to invest can put you in a high-risk situation, with the benefits being far outweighed by the risks. To proceed with this sort of venture, you must calculate everything – all constants and all variables of both the loan and the investment. In fact, when investing with borrowed funds, try to employ even more prudence than with your own money.

Yes, it’s easy to fall into temptation

The potential benefits from investing more than you can afford on your own are definitely there. That’s why many individuals and organizations around the globe do it. Whenever an investor catches the scent of what they believe is the deal of a lifetime, they would want in on the action with all they have. And more. Because the simple truth is this – the more you invest, the more potential returns you can receive.

Apart from the straightforward increased return benefit, there’s also other enticing rewards. Here’s some of them:
• Time. Yes, time is the one thing you’ll never get back. And borrowing for the sake of investing can save you months or even years, allowing you to invest earlier and more ‘heavily’.
• By having additional funds at your disposal, you can actually diversify your investment portfolio. It’s always better to not have all eggs in one basket, especially if some of those eggs aren’t even yours to begin with. This isn’t necessarily a reward as much as simply a better investment strategy.
• Depending on what you invest in, there may be potential tax returns coming your way each year. For example, if you borrow to invest in a retirement savings plan or a certain life insurance plan, in some countries you’re entitled to tax returns on your personal income tax. These tax returns can in turn be used to repay a part of the loan each year.

Still, you shouldn’t borrow to invest:

• If you’re new to the game

If you’re just starting out as an investor, it’s much safer to play with your own money as opposed to someone else’s. And playing it safe in the investment business can mean the difference between being stuck with a due loan on top of losing everything, and making slow but steady progress with your investment portfolio, thus all but ensuring the growth of your wealth. Remember, you might be leveraging someone else’s money – but it’s your own future on the line.

• If the proposed investment is either high risk and/or matures after the loan is due

Typically, the high risk investments tend to garner higher rewards. However, to avoid being stuck with a loan that you have no more means to repay as agreed upon, you should steer clear of any risky dabbles. But, here’s the catch – less risky investments usually mean less yearly returns. And, with a loan to cover, it might make little-to-no sense for you to borrow to invest. Even more so if the nature of the investment is you only receive the interest after the investment matures.

• If the type of investment you’re planning does not fit the type of loan

Take in consideration the amount of interest you will be charged for using a loan. It should absolutely always be less than the amount of interest you will garner from the investment. Moreover, a bank will often not issue a loan, so you could make an investment.

In conclusion

Taking out a loan to invest isn’t inherently bad. It’s just more demanding in terms of preparation and managing your investment. This is not to say that investments made with your personal funds should be dismissed in these same terms. But there’s a clear line between your responsibilities lying with yourself or someone else, be it a person or an organization.

It may seem tough to build a solid investment portfolio using your personal funds, especially in the beginning. However, by making sound choices yourself or by consulting with a personal broker/portfolio manager, you can get along quite well.

Certain situations may warrant you to use this practice, but do so at your own peril. Perform due diligence towards all of your calculations and research. Make sure you cover every detail. And, be patient. Various short-term market fluctuations can cause you to panic, but once you’re in it – stick it out till the end.

This is an informative blog entry and should not be taken as financial advice.