Equity or stock is such an asset class which involves certain risks. Many people invest in the stock market with a view to generating better returns than the debt instruments or govt. Securities. But some become fail and exit the stock market suffering a huge loss. This loss of money turns into a major problem when you make the investment in the stock market by borrowing from a bank or any non-banking financial institutions. Let’s discuss why you should not make an investment with borrowed money.
Why you should not make an investment with borrowed money.
When you borrow money definitely you are subject to pay off the money to your lender. Now you have lost your money in share market. How will you pay off the debt? So to pay off the debt you will have to do anything. You may have to cut your household expenses or may have to sell jewelry or other valuable assets of your family. That is why it is suggested that you should never make an investment with borrowed money. Now let’s see some major risk factors associated with it.
Return Risk
First of
Interest Rate Hike
If the interest rate of your Personal loan is hiked by 2% what is your escape plan? With the increased rate of interest, an extra burden will come to you. The market does not guarantee a fixed return in short term. So it is not a wise decision to make the investment with the loan received at 14% interest and hope 30% return in 6 months.
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Chance of losing the Investment in stock Market
It is seen when the market touches its lifetime high many people borrow money and invest in share market hoping the market will reach towards its new lifetime highs. But after a week or month when the market moves into correction they get panicked and try to sell the stocks which have already corrected about 30% within a week. Let’s understand it with an example.
Suppose a retail investor invests Rs. 1 Lakh when the market is in its lifetime highs. There are instances that several stocks irrespective of Large-cap or Mid-cap or Small-cap that have yielded a 50% return in the past 6 months correct to 30% from their peak price. Suppose you bought Titan Company in December 2017 at the price of Rs.456/-. Now after one year titan hits its lifetime high of Rs. 999/share. Then the stock goes into correction and corrects from its peak price of Rs. 999/share to Rs. 780/share.
After this huge correction who invested in Titan Company in December 2017 had a return of 119% within one year which is great. Now as a trader if you bought the same stock at the peak price of Rs. 976/ share then after correction you made a loss of 28%.
Final thoughts,
Though the market will rise again and generate a profitable return it is quite a time taking. So we can conclude that you should buy a stock for a long-term perspective. If you are a long-term investor then you get a chance of buying the stock at lower valuation after correction. But when you are a trader and you have to repay your loan you will be compelled to exit the market with a huge loss.
From the above discussion, it is clear that there are more than 50% chances that you will end up with a loss when you invest with borrowed money for short-term duration usually for a month to one year. So sincerity is that never invest with borrowed money in the stock market as equity market is volatile in nature and does not guarantee any fixed return on investment especially when you make it for a short term. Investments take time to yield better returns. In this connection one famous proverb is relevant here “castles are not built in one day”. So invest for a long-term horizon to yield better returns with surplus money you have, not with borrowed money.
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