Author: Geoffrey Ejiga
Are you wondering if you could take out a loan to buy stocks? Then chances are you are among the millions of people looking to invest in stocks but don’t have enough money to do so.
Should I Take Out A Loan To Buy Stocks?
Taking a loan to buy stocks can be referred to as “investing a loan”, and many people do it despite reasonable warnings from financial experts.
For example, Warren Buffet previously warned investors about the risk of leverage, yet the billionaire invested in stocks with borrowed money.
However, it’s essential to know that buying stock with a loan will be different for a hedge fund with a professional level of risk assessment compared to an individual investor.
In general, investing borrowed money may be a good option if the loan terms are fair and your stock picks move accurately.
Additionally, it makes sense to only “invest a loan” when the return on investment is high and the risk is low. So experts usually advise investors not to invest loans in risky ventures such as the stock market.
How To Invest In Stocks With Borrowed Money
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Margin Accounts
A broker can allow you to take out a loan to buy stocks, which is known as “buying on a margin”, and requires a margin account to do so. Margin accounts differ from basic cash accounts, which can only be used to purchase securities.
With margin accounts, you can buy stocks and have the broker lend you up to 50% of the total purchase, making it possible to purchase more stocks at once.
The securities or money in your account acts as collateral for what you borrowed. The collateral is what is called the margin.
When opening a margin account, you should watch out for the fees, restrictions, interest, maintenance margin, margin calls, and other terms of the agreement.
A significant issue with margin accounts is the margin call, which allows brokers to sell whatever they choose if you fail to deposit cash or sell your stocks.
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Get Loans From Family and Friends
Borrowing money from family and friends is a form of a loan with the least financial risk and regulation. Close friends and relatives wouldn’t report your missed payment to the credit bureau.
However, defaulting to repay the loan can damage trust in your relationship with family and friends.
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Indirect Loans
People often use borrowed money to invest in stocks without knowing it. For example, if you can afford to purchase a car with cash but choose to use a loan, then you’re effectively borrowing money to buy stocks.
This method has its risks, which depend on the type of investment and loan you choose.
What are the Risks of Investing in Stocks With Borrowed Money?
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Systemic Debt Risk
Systemic debt risk can occur when stocks turn down, causing people to sell the stocks they bought with the loan. Additionally, these people need to sell off other stocks to repay a loan or cover a margin call.
As investors sell more stocks, prices continue to drop, which pushes more investors into this same situation.
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Loan Default Caused by Investment Loss
If your choice of investment performs poorly, then there’s a higher chance that you will default on the loan, which can damage your credit, cause you to liquidate other investments, or lead to bankruptcy.
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Risk of Leverage Addiction
You can be at risk of leverage addiction after succeeding in stock investing with borrowed money. As your success increases, you’re likely going to invest more, therefore increasing the risk you’ll take.
At some point, the market can underperform and make times hard for investors.
A Final Word
So if you’re wondering if you should take out a loan to buy stocks, then consider the returns on investment and the amount of risk involved.
