Is it worth taking a consumer loan from a bank to invest in stocks or bonds? Buying securities with borrowed funds may seem like a good idea. A quick look at the stock market shows that assets such as stocks can easily generate returns that are higher than inflation and the bank’s interest rate on loans.
Why, in this case, almost no one takes advantage of this opportunity? Well, it’s actually been used for decades. Only with some important nuances.
Firstly, borrowed funds are not used by investors, but by traders who carry out many daily speculative transactions. Secondly, they do not use personal bank loans, but the leverage provided by the broker.
Leverage
Leverage has a vague resemblance to a regular bank loan, but is provided for a specific purpose: the purchase of securities in the hope of increasing their value. In addition to cash, you can also borrow shares from a broker if you use a short selling strategy, in the expectation that these assets will soon fall in price, but this is not about that now.
To obtain leverage, a trader must have assets (money and securities) in his brokerage account for a certain amount, which will act as collateral. Both those securities that have already been purchased and those that are planned to be purchased using leverage are taken into account. This collateral is called margin, so such lending is called margin lending.
Leverage is used in aggressive trading and makes it possible to multiply the profit from transactions. However, where sometimes there is a big and fast profit, there is usually always an equally big risk nearby. Thanks to the so-called effect of financial leverage, not only profit, but also loss can increase significantly if the forecast does not materialize and stocks start to fall in price.
Lending from a broker is not intended for the purchase of securities for the purpose of conservative long-term investment. Interest-free leverage is provided for one day only. Further, a commission will be charged for the transfer of open positions to the next day in the amount of 10–20% per annum. Professional traders most often use credit as part of a speculative strategy within one trading day, less often for several days.
Why margin trading is not suitable for investors?
- The classic long-term investor needs complete control over his assets, and margin lending does not provide this.
- The broker can force close positions if they are too risky and could create losses. The more leverage, the less flexibility the broker provides.
- The commission will eat up part of the profit or all the profit.
- Leverage is addictive and makes it difficult to learn how to manage money.
Bank loan for investment
In the case of a bank loan, the main thing to remember is that a retrospective review of the market does not say anything about how it will behave in the near future. Even buying seemingly stable ETFs does not give you any guarantee of their further growth in the time period during which the loan must be repaid.
The stock market is, by definition, a risky instrument. A bank loan further increases this risk. In addition, if an investor takes out a loan, it makes no sense to invest in securities that will mature after the loan is repaid. As for bonds, it is simply not profitable and, although less, it is still risky.
Fortunately, all these methods have been tried thousands of times before us, so we can now learn from the mistakes of others. It is important to always remember that the key to building wealth is consistently investing money, not trying to guess the markets.