Mailbag: Should I take a Loan to Invest Now? (because Markets are making New Highs everyday)

This is going to be a short post. It’s more of a warning for those who have questions like one in title of this post….in their mind.

Yesterday, I received a mail from a reader asking me the following question:

My portfolio has moved up almost 50% in last 3 months. Some shares of small companies are up more than 100%. Do you think it is a good time to invest more? I don’t have lots of spare cash to put in markets but I am thinking of taking a personal loan to invest. A loan would cost me around 15% and that is much less than what can be easily made in these rising markets.



I replied to this reader’s mail instantly and without any hesitation.

But I felt that right now, there would many people thinking on similar lines. And that is because in recent times, markets have been moving in just one direction. And that is upwards. And this gives a perception that it is very easy to make money in stock markets.

My personal interaction with people tells that they have now started feeling that Fixed & Recurring Deposits offer just 8% in one year….whereas some stocks can give that kind of return in a day. True. It is possible. But can we be 100% sure about this? Can we be 100% sure that we will be making 5% to 8% every day kind-of-a-return on regular basis in stock markets?

The answer is no. I can’t do it. I am pretty sure nobody I know has done it. And neither have people like Warren Buffett done it. And since we are not sure about the returns, it would be a big mistake to borrow money for investing. 

It’s possible that when you take a loan and put that money in markets, your expectation is that markets will move up, like they have been doing for a while now. And probably in a year’s time, you will make much more from your investments than 15% interest that you need to pay on your personal loan.

But what if markets do not rise as expected?

What if returns are less than 15% in one year?

What if markets just stay at same levels after one year?

And what if markets fall…say by 15% in one year? What will you do then?

I hope you are getting what I mean here. 

Market returns are unpredictable. You can never be sure of returns or losses which come your way in markets. But if you take a loan, your EMIs would be predictable and fixed. You can be quite sure that you will have to pay around 15% every year for the loan.

I have seen people make this mistake in 2008 during Reliance Power’s IPO. People took loans, liquidated FDs to invest in the hottest IPO of that time. And what happened after that is known to everyone. Everyone lost money. Those who borrowed to invest lost much more than just money. They lost their sleep and faith in markets.

So, please understand that its not wise to borrow and invest in markets.

Even if you are 100% sure that markets will go up, please don’t borrow money to invest. If you do, I think it would be the biggest financial crime you can ever commit.

Note – Some months back, someone asked me just the very opposite question. I have a loan. Should I pay it back before investing? 

Seems like the question of this mailbag post is a side-effect of a bull market 😉

_______

2 comments

  1. This article mentions that if you borrow to invest in stock markets, it is a financial crime. I beg to differ.

    It is surprising that whole financial fraternity advocates equity investing with your savings but not for your loan money. We talk about debt/equity ratios of companies, loans for start-ups but discourage if someone wants to invest in markets with loan.

    The way I see is, investing in markets is like any other business (retail, dealership, franchise and so on). Lot of people borrow to start a simple general store to big hotel, school or hospital. No one knows whether these are going to be successful or not, but these budding entrepreneurs are going all out with lot of new hopes to start these businesses. Stock market investment or trading is like starting above businesses and I feel one should encourage. Even if some one fails, the lessons would be invaluable. There is nothing wrong in 'failing'but good part is he tried and it did not work out.

    One of my friend wanted to go into sports and everyone on the street discouraged him. They could not imagine that one can make career out of it. He played active sports for 10 years, later turned coach and become a sports council member, conducted national, international games and he retired as like any engineer, doctor or teacher.

    Our society should adopt different thinking and encourage if someone wants to do anything as long as it is legal. Instead of discouraging loan taking, I would have talked to him in detail about strategies he is going to adopt to make money from the market.

  2. Hi Krish

    The article assumes that reader is an average investor. And being an average investor, one does not have a large risk appetite. It also means that for an average investor, return of capital is more important than return on capital.

    But I would also say that there is a difference between taking a loan for starting your own business and taking it for putting in stocks. I agree both are risky. And chances of complete failure are more in doing one’s own business. But in stock markets, you can in no way control the actual business behind the stock. But same is not the case with own business. It has controllables, even though there may be very few of them.

    In no way I mean to say that risk taking should be avoided. Its an individual’s decision and everyone has different risk appetite. But personally, I am a risk averse person when making my investment decisions. And that is behind the core thought of this post.

Leave a Reply