Investing 101: Borrowing to Invest in Stocks

In a previous post, we discussed investing and how it is very useful for future planning. I heard of someone who decided to invest in the stock market by borrowing money from a bank to fund the share purchase.

Well, my head spun to say the least because that is a very risky thing to do. Many investors (I know at least) including myself, will not go down that road because:

  1. The stock market can be quite volatile. A stock tip may tell you about the potential returns you may get but it is full of risk because the stock price can just …crash. It may take a long time for you to see your “potential returns” and by that time, you may be in serious debt!
  2. The bank is interested in receiving interest and the loan (capital lent to you) repayments! That something went bad is of no consequence, as they will pursue you until you repay the money.

In my opinion, prior to accepting a loan agreement and signing the dotted lines:

  1. You should assess the potential total return(s) that the asset will produce – is it higher than the total cost of interest and capital?
  2. If it is an interest only repayment loan, do you think that the potential cash flow (or money that you will receive) from the stock will cover the interest repayment and at the end of the “term”, do you think that the stock’s price will cover the capital you need to repay?
  3. Finally, is it an interest plus capital repayment loan? Do you have the cash flow (or money) you need to service the interest & initial loan you must pay to the bank periodically?

If all your answers are not yes and based on all your outgoings, you don’t have money to cover the bank charges, please don’t go for the loan. Instead try to save some funds so that at another time, you can buy it or another one. The stock market is there and will not disappear anytime soon – I believe.

Lastly, yes we know that banks worth their salt know their customers, so they will probe them as to why they are borrowing the money and how they plan to repay, however, the onus is on you to ensure that you are telling yourself the truth about your “financial health”.

Finally, remember to only invest money that you are willing to lose in the stock market (especially if you are going for growth stocks).

Keep investing,