Pros of borrowing a loan for the purpose of investment
The biggest advantage of borrowing for investing, also known as gearing, is the profit margin. The gap between loan repayment amount and the investment return is the profit that is earned in the transaction. However, this strategy is beneficial only if the investment return has a huge margin over the total cost of the loan, including interest fee, processing fee, besides other charges. It is recommended not to adopt this strategy if the overall return is very low or negative.
Applying for a personal loan to invest will be a profitable decision only if you are well-versed with how the investment will work in the long run. In case you wish to invest in the stock market, you will have to depend on your technical knowledge to make a profit. It is necessary to understand that this decision will reap good returns if the market is performing well, however losses may be devastating if the market falls. Hence, do not invest in the stock market without conducting a thorough research, especially when you are gearing. Remember, a stock may perform exceptionally well at one point, and may show a downward trend in months to come. Also, assess your risk profile. Identify how much risk you are willing to take with your investments. Taking a bigger risk may possibly mean a higher reward if the market performs well and vice versa.
Cons of borrowing a loan for the purpose of investment
One of the biggest disadvantages of gearing is the possible rise in the interest rate of the personal loan. If the rate of interest increases over the period of the loan, you will have to make greater payments through installments. This means that the cost of servicing the loan will increase.
Apart from the interest rate, you also have to consider the cost of investment. You may have to pay commission to your broker to complete the transaction. Additionally, some instruments like mutual funds also carry a management fee. Moreover, if the investment fails to perform in the market, you may not be able to repay the outstanding loan balance. In such a situation, you will require additional funds to repay the loan.
The right choice
It is imperative to conduct a thorough analysis of the pros and cons of applying for a personal loan for investment purposes before making a decision. Identify those instruments that entail minimum risk and provide steady returns. You may seek professional financial advice from a financial expert to ensure whether this strategy is right for you.