Now-a-days, it’s easy to avail of a personal loan from banks, non-banking financial companies (NBFCs) and peer-to-peer (P2P) lending platforms. There are some investors who take personal loans to invest in equities and subscribe to initial public offerings (IPOs) expecting to will earn healthy profits and repay the loan. With the equity market performing well and Sensex at an all-time high, several investors are keen to participate in this rally even with borrowed money.
In January 2016, Niraj Thakkar from Nagpur an avid trader in stock market took a personal loan of Rs 5 lakh to invest in mid/smallcap stocks. He also traded in the derivatives market expecting to earn short term profits through this transaction. Thakkar called this "the biggest blunder of his life” as he lost the entire borrowed amount in mid-February 2016. At that time, the Sensex fell over 3,000 points due to weak quarterly earnings and mounting non-performing assets of banks, which weighed on investor sentiment. Vijay Kuppa, chief brand officer and chief operating officer, Orowealth, said, “The market risks of trading in futures and options are much higher. Losses can quickly mount and one can be left with a gaping hole in addition to the loan burden."
Why you shouldn’t borrow and invest in equity markets?
Financial experts recommend one not to borrow and invest in equities for short term gains. Amit Kachroo, managing partner, Aaneev Wealth, explained, “It is exceedingly risky to invest in stocks and that too for the short term. Equity markets are volatile, so investments need some time to gain momentum and appreciate in value.” It doesn’t make sense to borrow money at 14% interest and expect returns higher than the borrowed money in a short span of time.
Abhinav Angirish, managing director, Abchlor Investment Advisor, said: “There is more than a 50% chance that the person borrowing will end up with a negative portfolio, if he invests for short term gain with borrowed money. The odds will never be in favour of such investors.”Gaurav Chopra, founder and chief executive officer, IndiaLends, said investors looking to borrow to invest in the market should first answer these four questions:
Is it an investment with guaranteed results? Whether the returns will be able to cover interest and processing costs of the loan application? How will you repay the loan if the returns are not as expected? Is the promise of return worth the risk? Risks of taking personal loan to invest in equity market Capital invested risk
“There is no surety that money can be made in IPOs, stocks and derivatives. Returns might be negative and can erode the value of your investment,” said Kachroo. Further, the burden of paying interest on this personal loan can be detrimental.
The interest rate on the loan you took could increase. Navin Chandani, Chief Business Development Officer, BankBazaar, said, “If interest rates rise by 2-3%, chances are that your investments may not be sufficient to cover the additional expense. You may have to rejig your budget to pay the EMIs.”
Liquidity and concentration risk
Have you invested money in some smallcap/penny stocks which turned illiquid and not traded on the exchange? Bhavin Patil, co-founder and chief executive officer, LenDenClub, said, “Concentration risk is investing only in 1 stock, which may underperform after you have invested. It may continue to underperform if the near term outlook from analysts is poor."
Mismatch between tenure of personal loan versus returns
An investor can’t time the market and enter to make quick profits. There is high probability of mismatch between tenure of this personal loan and returns expected from investment. Kuppa cautioned, “If the market crashes, an investor may not have sufficient time before which he/she can recover the losses to even pay back the principal of the personal loan.”
Interest rates of personal loan equals expected return
Interest rate on a personal loan is around 14% and above for most banks. “It is just about equal to the long term return expectations from largecap equities. Even in the longer term unless one is very lucky, you will not make any net returns even after investing well,” said Kuppa.