Is It Wise To Take Out a Personal Loan for Investing?

This was originally posted on Planner Bee.

The idea of using a personal loan to invest can be tempting, especially when financial opportunities arise. However, the decision to leverage borrowed funds for investing comes with both potential benefits and risks.

In this article, we will explore the types of personal loans available, the pros and cons of using them for investments, the concept of margin trading, and considerations for determining the appropriate loan amount for investing.

What are the types of loans available?

Personal loans generally fall into two categories: secured and unsecured.

Secured loans require collateral, such as a home or car, to secure the loan. These loans often come with lower interest rates due to the reduced risk for the lender.

Unsecured loans, on the other hand, do not require collateral but typically come with higher interest rates as the lender assumes a higher level of risk. In Singapore, the majority of personal loans offered in the market are categorised as ‘unsecured loans.’ Notable banks providing personal loans in Singapore include OCBC, DBS, Standard Chartered, UOB, and others.

What are some of the advantages of taking a personal loan to invest?

Taking a personal loan to invest can offer certain advantages, but it’s important to carefully weigh the benefits against the potential risks.

Here are some potential advantages:

• Access to capital: Personal loans provide an immediate influx of cash, allowing you to seize time-sensitive opportunities in the market.
• Diversification: Borrowed funds can be used to diversify your investment portfolio, spreading risk across different assets.

• Potential for higher returns: If the returns on your investments exceed the interest rate on the loan, you stand to make a profit.

What are some of the disadvantages of taking a personal loan to invest?

While taking a personal loan to invest may offer some advantages, it also comes with significant disadvantages and risks. It’s important for you to carefully consider the following drawbacks before deciding to use borrowed funds for investments:

• Risk of loss: Investments inherently carry risks, and if the market performs poorly, you could end up losing not just your investment, but also end up in a situation where you have to repay that loan with interest.
• Interest costs: Personal loans often come with higher interest rates, potentially eating into your profits and making it harder to achieve a positive return.
• Stress and pressure: Using borrowed funds for investments can create emotional stress, as the pressure to meet loan obligations can affect decision-making during market fluctuations.

Investing on margin

What is margin trading?

Other than taking out a loan from a lender, another option is to borrow on margin from your broker. Brokerage firms frequently extend the opportunity for qualified clients to leverage their investments via margin. This entails borrowing funds directly from the broker to acquire investments, anticipating that the returns from these investments will surpass the borrowing costs. The profit generated from this approach is often regarded as “free money” to some extent. This technique is commonly referred to as “margin trading”.

This approach amplifies both potential gains and losses. While margin trading is a form of leveraging, it differs from taking out a personal loan, as it is usually facilitated through a brokerage account. Although margin trading has the potential to significantly amplify your gains, it equally has the capacity to magnify losses in the event that your investments take an unfavourable turn.

How much personal loan should you take for investing?

Determining the appropriate loan amount for investing requires careful consideration of various factors:

1. Risk tolerance: Assess your risk tolerance and ability to handle potential losses. Investments are inherently uncertain, and borrowing magnifies the stakes.
2. Interest rates: Evaluate the interest rates on personal loans. High-interest rates can significantly impact your overall returns and increase the financial burden.
3. Investment strategy: Consider your investment strategy and goals. Ensure that the potential returns align with the cost of borrowing.

4. Market conditions: Assess current market conditions and potential risks. Economic uncertainties may impact the success of your investments.

What are some alternatives to taking out a personal loan for investing?

1. Tap on the power of compounding interest

The significance of compounding has been underscored by investment experts, financial advisors, and investment firms alike. Initiating your investment journey at the earliest opportunity is crucial. This approach enables you to navigate through market volatility, maximise your time in the market, and minimise the opportunity cost associated with keeping your investment capital in a low-interest bank account.

Tip: Explore our investment calculator to gain insights into the workings of compounding effects.

2. Start saving to increase investment capital

To boost the available capital for investment, consider putting greater focus into saving more.

Trimming expenses contributes to increased savings. The positive effects of Covid-19 and the shift to remote or hybrid work have prompted financial prudence. In addition to reducing expenditure, explore supplementary income options from your primary employment. Engage in a part-time job or initiate your own side hustle to bolster your financial resources.

The bottom line

Taking out a personal loan for investing can be a double-edged sword, offering opportunities for profit while carrying substantial risks. Before making such a decision, investors should thoroughly evaluate their financial situation, risk tolerance, and investment strategy. While there are potential benefits, the cons, such as the risk of loss and interest costs, should not be underestimated. It is crucial to approach the decision with caution and, if necessary, seek advice from financial professionals to make informed choices that align with your overall financial goals.

Read more: Are You Risk-Averse? Here Are 5 Safer Investment Options