Many people dream of achieving financial success through investing in shares, but the idea of taking out leverage(loan) to do so can be both exciting and daunting. While it can potentially increase an investor's returns due to leverage, it also carries significant risks and challenges that must be carefully weighed and managed as it is said “leverage is a double-edged sword” If wielded properly can increase your return exponentially
Sure, there are advantages and disadvantages of investing in shares using loans, here are some Advantages & Disadvantages;
Risk of losses
Stress and anxiety
Let's claw a little deeper into each point:
Maximizing Returns: Taking out a loan to invest in shares can provide an investor with the necessary funds to purchase more shares. This can potentially increase the potential for higher returns if the shares perform well.
Let us illustrate this with an example
We will take two different cases:
Case 1: Let’s say John has invested 1 lakh in X Ltd. shares and earned 20% on his investment. His gain will be 100000*20% = 20,000.
Case 2. In this case, John has taken another 1 lakh as a loan from the bank @12% Pa. and invested the sum of those 200,000 in X ltd. and gained 20% return.
His total gain will be: (200,000*20%) = 40,000 – (100,000*12%) = 28,000
Let’s see John’s overall return over his capital of 1,00,000
(28,000/100,000)*100 = 28%
Due to his exposure to leverage his overall return jumped from 20% to 28%.
However, it is important to note that borrowing to invest in shares carries risks and could lead to significant losses.
Tax benefits: Depending on the investor's country of residence and personal circumstances, there may be tax benefits associated with borrowing money to invest in shares. For instance, in some countries, the interest paid on investment loans may be tax-deductible. This can potentially reduce an investor's tax liability and increase their overall return on investment.
Diversification: By using a loan to invest in shares, investors can diversify their portfolios, spreading their investments across different companies and industries. This can help to mitigate risk and potentially increase returns. Diversification is an important strategy for reducing the overall risk of an investment portfolio.
Risk of losses: Investing in shares using loans carries a high level of risk, as there is always the potential for loss. If the share price falls, the investor could lose both their own money and the money borrowed.
Interest payments: Loans come with interest payments, which can cut into the profits made from investing in shares. If the interest rate on the loan is high, the investor may end up losing money even if the shares perform well.
Debt burden: Taking on debt to invest in shares can increase an investor's debt burden, making it harder to qualify for loans in the future and potentially limiting their financial options.
Portfolio Destruction: The stock market can be volatile, and sudden drops in share prices can wipe out the value of an investment. If the investor has taken out a loan to invest in shares, they may be forced to sell at a loss to cover their debt.
Stress and anxiety: Investing in shares using loans can be stressful, as the investor must manage both their investments and their loan payments. This can lead to anxiety and sleepless nights.
To sum up, investing in shares using loans may seem like a tempting shortcut to financial success, but the potential pitfalls can quickly turn it into a risky game of chance. Careful evaluation of the pros and cons, as well as seeking the guidance of a financial advisor, are essential steps to make an informed decision that will avoid future financial regrets. Remember, it's not about taking a leap of faith, but rather taking a calculated step towards your financial goals.
Until Next Time
The Humane Opportunist