Building wealth starts with making solid investments, but how do you do that when you don’t have a lot of cash? You could break into your piggy bank but another option is to take out a personal loan. Borrowing money to invest can pay off if you know what you’re doing, but it’s not risk-free. If you’re thinking of getting a personal loan to play the market, here’s what you need to consider.
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1. Check the Loan Rates
Before you start snapping up stocks, you’ll need to find out what kind of interest rate your lender is offering. Earning high returns on your investments won’t do any good if you have to hand a big chunk of it back to the bank. If the loan’s APR is more than half of the investment’s average return rate, you won’t be earning much money.
2. Weigh the Payments
Ideally, if you’re taking out a loan to invest the goal is to have returns rolling in on a regular basis that you can use to repay what you borrowed. If you’re taking a long-term buy-and-hold approach to investing, you might be waiting a bit longer to realize any gains. If that’s the case, it’s important to make sure you can afford the loan payments in the meantime.
That’s particularly important if you have other debts you’re paying down, such as student loans or a mortgage. If you fall behind on your personal loan payments, you can open yourself up to a world of financial trouble. The lender could seize your collateral or sue you and if they win, your wages could be garnished.
In the worst-case scenario, you might have to file bankruptcy to get out of the mess. So you’ll need to be sure your loan payments aren’t going to put you in a financial bind.
Check out our student loan calculator.
3. Study Investment Performance
Jumping into the stock market without doing your research isn’t a good idea, especially when you’re doing it with borrowed money. If you’ve got your eye on a particular stock or mutual fund, you’ll need to look at how it has performed since its inception date, not just over the last few months.
Just because a stock is doing well right now doesn’t mean it’ll perform well in six months. If you’re not careful, you could end up losing money. And even an investment with solid past performance isn’t guaranteed to perform in the future.
4. Assess Your Comfort With Risk
If you pay any attention to the news at all, then you probably know that the market can change in the blink of an eye. If you’re thinking of using a loan to invest, how well will you stomach the market’s ups and downs? Some people can take on more risk to have the possibility of bigger rewards but if you’re not one of them, borrowing to invest might be outside of your comfort zone.
Try out our asset allocation calculator.
5. Review the Fees
Along with charging interest, lenders might impose certain fees when you get a personal loan. Even if it’s just a few dollars a month, every nickel and dime counts in terms of eating into your investment returns.
Aside from the lender’s fees, you’ll also have to think about what the investment itself is going to cost. If you’re buying stocks through an online broker, for instance, you might have to pay a trade commission every time you complete a transaction. Mutual funds carry their own management fees that you’ll need to watch out for as well.
The Bottom Line
Using a personal loan to invest can be a big gamble and it’s definitely not for the faint of heart. Before you pull the trigger, it’s best to analyze the pros and cons from every angle to make sure you know what you stand to gain and potentially lose.
If you’re unsure of what to do, consider consulting a financial advisor, who can guide you on making the right decision for your personal financial situation. The SmartAdvisor matching tool can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and your goals. Then the program will narrow down your options to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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