Should you take a personal loan to invest? Pros, cons, and expert advice

It may be appealing to take out a personal loan to invest in real estate, stocks or even other types of mutual funds. However, there are several risks associated with gearing. This article will explain when it may be appropriate, when it is not, and how to effectively assess the outcomes.

What does “investing with borrowed funds” mean?

We call this approach leverage. Essentially you take out a personal loan to offset a large sum of money, which you then invest with the expectation that your return will outpace the interest charged on your personal loan. Put simply, even if it does offer increased exposure it inherently increases financial risk.

Advantages of borrowing for investment purposes

• Greater purchasing power: Taking out a loan allows you to acquire larger items than your savings might permit.
• Possible greater returns: Trade some of the lower returns of traditional loans for the potentially higher returns stock or real estate can offer.
• No collateral is required: Personal loans are usually not backed by collateral such as your home.

Disadvantages of borrowing for investment purposes

• High interest costs: Loan rates may be higher than the returns on safe investments, such as bonds or FDs.
• Market risk: If you fail to perform, you may have very little money left over after your debts are called for repayment. In the worst of cases, you are paying interest and losing money.
• Debt race situation: Just because you miss out on a potential investment doesn't stop you from being on time with your debt repayments.

What does an expert say?

“Taking a personal loan to invest is generally not advisable. Personal loans come with fixed EMIs and repayment timelines, while investment returns are often unpredictable and may not follow the same schedule. If the investment underperforms or the payout is delayed, it can impact your ability to repay the loan and lead to unnecessary financial stress. It’s more prudent to grow your wealth gradually through regular savings and investments that match your financial goals and risk appetite,” says Bhavin Patel, Founder and CEO, LenDenClub.

When could it work?

1. Low-interest loans: It can be a good strategy if you are looking to get into bonds, property, or mutual funds, and you have access to loans with lower interest rates.
2. High-conviction assets: A type of investment that you believe will provide consistent future returns.
3. Career: Indirectly, debt can be an investment in your future or career, when discussing loans that have value from your education/work which can in future provide great income levels.

Should you borrow to invest?

If you are considering investing with a personal loan:

• Use a calculator to get a sense of whether your expected returns will offset interest and fees.
• Understand that the markets can be unpredictable and be willing for downturns.
• Have a repayment cushion to cover monthly EMIs, even if your investments under-perform.

In conclusion, when you invest with a personal loan, you can increase your gains, but also your losses. Your disposable income is what you should be investing, or borrowing against collateral, unless you are lucky enough to have other low-cost personal credit, a clear repayment plan, and high conviction in the yield on your investment.

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