A big thanks to Rebecca Kennedy for writing this guest post.
The old adage, it takes money to make money, runs throughout the business world, but it has become a guiding force for those trying to boost their personal financial circumstances in recent years. For instance, paying a broker or advisor to place stock trades, or doling out a subscription for the latest and greatest market news adds up to a pretty penny over time.
The overarching theory is that these fees and charges are investments in and of themselves, but they are worth it as they lay the groundwork for generating even more money down the road. For some, that ideology extends to borrowing for the purpose of investing. Here’s what you need to know if you’ve thought about using a personal loan for investment.
Minimal Restrictions at a Cost
Loans offered through traditional bank lenders and other alternative, short-term loan providers are helpful when the need for financing a major expense arises. Most lenders do not place stipulations on how the funds can be used, so long as the repayment terms are met each month.
But just because loans do not limit the possibilities doesn’t mean you shouldn’t. All loans come with a cost that must be considered when using the proceeds for investment. The interest rate applied to a loan can be high, based on your credit history and score, making it near impossible to generate a return on an investment that outweighs the cost of borrowing.
For instance, paying 15% on a personal loan of which the proceeds are used to put into an investment only pans out if that investment generates more than a 15% return – and that’s rare. Make sure to think through all the costs involved with taking out a personal loan, and the requirement to repay over time before you invest those funds.
No Guarantee of Returns
Speaking of investment returns, every investment carries some degree of risk. The allure of investing is strongly seeded in the hope that the risk involved will be bypassed by the overall return, making the gamble worth it in the end. However, if an investment does generate a return, there is no guarantee that it will be there when the investor is ready to sell.
High-risk investments fluctuate in value constantly, and these fluctuations make it difficult to time and sale of an investment to take advantage of the gains. Taking out a loan to pay for an investment that has no guarantee of a return adds even more risk to the mix, given that the borrower is on the hook for repayment of the loan, no matter what.
If you do not have the cash available to make a sizeable investment, taking out a loan is most likely not the most sound solution given the loan costs and the risk involved. An alternative many investors utilize is a systematic investment plan which allows for monthly or bi-weekly contributions to an investment fund over time.
Instead of taking out a lump sum through a loan and then being beholden to monthly payments back to the lender, consider using the monthly payment amount to kick off an investment. You’ll save yourself the long-term commitment of a loan obligation while you build an investment portfolio over time.
Establishing a systematic investment plan that is in line with your budget is a far better way to join the excitement and potential of investing than adding to your debt.
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