Why should you never borrow to invest in the stock market? MintGenie explains
Investing with borrowed money is never a prudent decision. Even the most astute investors, who allocate their funds to some of the most reliable stocks, are susceptible to losses because it’s impossible to accurately predict short-term stock behaviour.
In a tragic turn of events, a 26-year-old technical analyst named E Bhuvanesh in Chennai took his own life by jumping from the 10th floor of his office building. This heartbreaking decision was driven by the overwhelming weight of mounting debts. Bhuvanesh had borrowed money from a bank and invested it in the stock market, only to face a total loss. Despite his father’s offer to help with the debt repayment, Bhuvanesh chose a devastating path.
Investing in the stock market carries inherent risks, and there’s no assurance of profitability; in fact, losses, particularly in the short term, are a possibility. Therefore, it’s crucial to allocate only funds that you can afford to lose. Prioritizing the settlement of debts and fulfilling other financial obligations is paramount before embarking on stock market investments.
With the stock market not following any predefined path or behaving with due diligence, leveraging can only worsen the pain of borrowing money to invest in stocks. There are significant drawbacks to taking out loans to invest in the stock market, some of which include:
Possibility of extreme risk and financial liabilities
Engaging in leveraged investing is akin to wielding a double-edged sword; while it presents the opportunity for amplified returns, it also introduces the possibility of intensified losses. Before delving into leveraged investing strategies, it is essential to thoughtfully assess your risk tolerance and financial circumstances.
When you borrow money for investments, you are essentially increasing the scale of your bets. If the market takes a downturn, your losses will surpass what they would have been with only your original investment. In severe instances, you might even end up losing more money than your initial investment.
Adding to your costs
The expense associated with borrowing, referred to as margin interest, is the interest incurred on funds borrowed from your broker for buying securities. Margin interest is generally calculated as a percentage of the loan amount and accumulates on a daily basis. When determining your return on investment (ROI), it is crucial to consider the cost of borrowing, as it can have a substantial impact on your overall profitability.
It’s important to note that the interest on margin loans accumulates on a daily basis, contributing to your total investment expenses. This compounded interest has the potential to substantially diminish your returns, particularly if your investments do not meet the anticipated performance.
Unwanted anxiety
Leveraged investing is usually not appropriate for every investor; it is more suited to seasoned traders possessing a high-risk tolerance and a comprehensive understanding of associated risks. Engaging in this type of investing can be emotionally taxing, given the increased pressure of potential losses and margin calls. This stress may compromise your judgment and decision-making skills, potentially resulting in suboptimal investment decisions.
Damaged credit score
If you are unable to repay the borrowed funds, your lender may categorize the debt as delinquent, causing substantial damage to your credit score. A diminished credit score can pose obstacles when seeking reasonably priced loans in the future, affecting your chances of securing mortgages or seeking any kind of loan, be it for a car, home, or personal use.
Even if you manage to repay the borrowed funds, recent losses in the stock market may make lenders apprehensive about extending credit to you in the future. This restriction could impede your ability to borrow funds for vital purposes, such as buying a home or establishing a business.
To minimize undue risks, it’s essential to thoughtfully assess your financial situation and risk tolerance before engaging in investment with borrowed funds. Only invest an amount that you can afford to lose. Crucially, conduct thorough research on your potential investments before making decisions on buying, holding, or selling stocks. If you are new to investing, seeking guidance from a financial advisor can help evaluate your suitability for leveraged investing.
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