Are you thinking of taking a loan to invest in the market? Here’s what Warren Buffett thinks of the idea

There are as many strategies to invest and create wealth as there are the number of people. Some like to build their portfolios by systematically investing every month. There are others who would prefer to invest larger amounts in one go. However, there also exists another set of investors who would not shy away from taking a bank loan to invest in the market. Is this a good idea?

Legendary investment guru Warren Buffett does not approve of it. In his this year’s annual letter to the investors, he made the strongest argument he can muster against ever using borrowed money to own stocks.

It may not be wise enough to actually pick up a loan to invest in the market. Here is why:

Markets are fundamentally volatile in nature and taking a loan to invest may seem a wise decision if the going is good. But what happens if the market crashes? In such a situation, not only will your capital erode, you will also be left with a monthly installments to repay on your loan. Remember, markets can dip sharply on account of any event or a sentiment that occurs in any part of the globe.

A personal loan which does not restrict the end-use is considerably high priced and the return earned on investment could be far lower than the interest paid. On the other hand, the loan against a collateral is generally offered on floating rates. In the event of a rate hike by a few percentage points, the chances of the investment covering the increased rates may diminish considerably.

One can never time the investment. That is why investment pundits suggest that a staggered and systematic plan works better for retail investors. Since the right time to enter the market is almost impossible to predict, the mismatch in the loan repayment and investment growth can be a big dampener for those who borrow and invest. 

The money earned on the investment would also attract tax, depending on the duration of the investment. This would in fact further reduce the gap between the interest obligation and the return on investment. While the rate of tax would be different for short term and long term gains, but the fact is that this obligation cannot be ignored.

Stock market investments carry high risks which are in proportion to the returns they potentially offer. Debt payments, on the other hand, are a fixed obligation. A fall in the stock market could be an outcome which is beyond the control of the even the most rational investor. However, debt obligations, if left unpaid, could wreak havoc on the investor’s finances apart from leading to a rather sharp fall in the credit profile and credit scores. A fall in the credit score could hurt the person’s ability to borrow for less speculative needs such a house or a child’s education.

While the people who are professional stock traders may find it worthwhile to leverage and grow their portfolio, it may not be the right decision for the retail investor. Given that the traders are in business and keep a close watch on the global developments and the market movement, apart from maintaining a balance sheet, it may not be feasible for the individual to have the time and expertise to do the same.

Hence, it might be prudent to desist from taking a loan to invest in the stock market.