The two major goals of investments are capital preservation and capital multiplication. Good investors know that they must strive to keep their investment capital intact and that the capital must yield an income or record an increase in value. However, the building block for investments is the capital and you won’t have any shot at booking gains on an investment if you don’t have the capital in the first place.
People raise investment funds through savings; others get a lucky break or windfall, and some people take the long route of starting small and reinvesting all the gains from their assets. A large number of sophisticated investors also borrow money to invest through leverage and margin trades. Interestingly, some people also raise investment funds by taking out a personal loan. The fact that you have relative “freedom” to spend money from a personal loan as you please makes it a viable source of capital.
Is it smart to invest with personal loans?
Borrowing money to invest is a smart business move because you are using other people’s money to make money for yourself. However, it is not risk-free because you’ll be left with a bad debt if your investment doesn’t pay off.
Hence, the only time it makes sense to use a personal loan or other borrowed funds to invest is when you are sure that return on investment is high and the inherent risk in the investment is low. You need to know how to find the right loan for you based on your current financial stability, appetite for risk, and the type of investments you want to pursue. It also makes sense to look for an investment with a higher payout than the interest you’ll pay on the loan.
4 points to note before taking a personal loan for investments
- Consider your loan rates versus potential ROI
Nothing could be potentially more devastating for an investor than a situation in which your investment doesn’t yield enough ROI to cover the interest rates on the loan. Before you take out a personal loan for investment purposes, you need to be sure that the interest rate is significantly lower than your expected ROI. A general rule to follow is that your APR on a loan must never be more than half of the expected average return rate on your investment.
- Pay attention to the tiniest details on payments
Most loans (including personal loans) will require you to make regular repayments usually on a monthly or bi-monthly basis. Hence, you might want to invest borrowed funds in an investment that yields a regular rolling income so that you don’t get behind on payments and attract penalties.
If you want to use borrowed funds for a long-term investment – you’ll be putting yourself under pressure because the lenders will be on your neck even before your investment matures. However, you can still use borrowed funds for long-term investments if you have other sources of income that you can apply towards repayments.
- Be critical of investment performance
Investing funds comes with a measure of risk but the risks are usually magnified when you are using borrowed funds. Hence, you’ll need to invest a great deal of time and energy into you due diligence in order to choose an asset with the best odds of yielding enough ROI to pay off the loan plus interest while leaving you with a tidy sum.
If you want to invest borrowed funds into stocks, bonds, mutual funds, or other assets, you need to dig deep into the previous performance of the asset. The fact that an asset is enjoying a bullish run today does not necessarily mean that it will still be booking gains six months down the road. Before you use borrowed funds to invest in an asset, make sure that you have checked out its past performance in relation to its current performance in order to get an insight into its potential performance in the future.