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Can I take a loan from a bank and invest it in mutual funds?

If you ever talk to your parents or grandparents about their investments, they will most likely talk about fixed deposits, post office saving schemes, or real estate. For the more adventurous ones, they might have invested in some shares of a couple of well-known companies. And funding for these investments either came from their savings or borrowings from friends or family. But if you talk to your peer group you might hear MLD, Crypto Currency, REIT, Peer Peer Lending, NFT, SGB, and ETF thrown into the conversation. The new-age investor doesn’t shy away from taking risks in his investments or investment funding. So, how did the idea of investing and growing your money move from FDs to Crypto? The answer to this is- financial literacy.

With the Indian economy opening up and flourishing, many new avenues for building tangible and non-tangible assets are available. Investors today are more likely to do detailed research to search for the best mutual fund options or the most suitable loan. Increased financial literacy means higher confidence and a higher risk appetite. They are no longer satisfied with the bare minimum return on their money. The financial attitude has shifted from saving to investing. Intelligent investors often have a separate budget to fund their investments. They are disciplined in their approach to saving and investment. Don’t be just an investor, be a smart one.

Saving vs Investing

Although the basic purpose of both saving and investing is to have better financial security; the main difference between the two is the associated risk.

Saving: It is the process of putting money aside for a future expense or need by parking it in a bank account. The saved money is readily available when you need it, for expenses and emergencies, and it is extremely low-risk and highly liquid.

Investing: It is the act of using your money to build assets (mutual funds, real estate, etc) with the expectation of achieving capital appreciation. Investments are typically volatile and illiquid and have higher risks than savings accounts.

Let us understand some other differences between saving and investing.

  Savings Investments
Objective Mainly for purchases and emergencies. Mainly for creating assets for capital appreciation.
Tenure For short-term financial objectives and goals. Eg: Buying a car For long term financial goals. Eg: Building a retirement corpus
Risk, Volatility and Liquidity Low risk, low volatility, high liquidity. Typically high risk, high volatility, low liquidity.
Return Low savings bank interest rates. Have the potential for higher returns than savings account.

Think of your savings as a diving board for funding your investments.

Should I risk My Savings on Investments?

Investments have the potential to generate better returns than savings accounts. However, the risks associated with such financial tools are higher than with a savings account. If you’re investing your savings, you should be willing to take the risk for earning a return that’s better than inflation. Investments are made with an eye on long-term financial goals such as children’s education or retirement. There are various asset classes where you can put your money – stocks, mutual funds, real estate, gold etc. The main difference among all these is the associated risk. Stocks and mutual funds have a higher risk than gold or real estate. Say, your investment of choice is mutual funds. So, is it a wise idea to invest your entire hard-earned money in mutual funds?

The answer to this depends on your risk appetite. If you are someone who gets easily frazzled when your investments go down in a bear market, maybe high-risk investments aren’t for you. You should pick your investments wisely and according to your capacity to handle risks. As an intelligent investor, you should put away some amount every month after fulfilling your other financial obligations. And out of these savings, you should create an investment fund to take care of the investments.

Can I take a personal loan to invest in Mutual Funds?

The answer to this is YES. Unsecured loans like personal loans and secured loans like gold loans do not have any end-use restrictions. This means that you are free to use the loan amount for any purpose barring, of course, illegal activities. And there is a term for borrowing to invest; it is called leveraging or gearing. Some investors strongly believe that leveraging is beneficial to earn higher interest in a short duration, whereas others believe that it is a highly risky affair.

Should I take a Personal Loan to invest in Mutual Funds?

Technically, you can take a loan with no end-use restriction to finance your investments. However, this route is not advisable. Taking a loan is recommended only when you are building an asset such as buying a house. It is always better to utilize your savings investment fund to pay for your investments.

A personal loan is an unsecured loan that has the highest rate of interest. Most banks charge personal loan interest rates between 10.50% to 24% p.a. So, is it a good idea to finance your investments with such a high maintenance loan? The answer to this again comes down to your risk appetite.

As an investor and depending upon your financial condition, are you comfortable with servicing your personal loan EMIs with the possibility of losing your capital in a volatile market? Even for the most optimistic investor, it would be unwise to expect extraordinary returns, year after year.

Disadvantages of taking a Personal Loan to invest in Mutual Funds

Now, let us break down the flipside of taking a personal loan to invest.

  • Risk of Losing the Capital: Money invested in stocks, mutual funds, or other equity-linked schemes does not offer guaranteed returns. In worst market conditions, you may lose some or all of your capital.

  • High Rate of Interest: Say, your Personal Loan interest rate is 18%. This means that your investments should generate a return of 18% or more to make any returns. Even when you make a loss on your investments, you still have to pay the 18% on your loan. Furthermore, as personal loans are generally offered with a floating rate of interest, there is a chance that the interest rate can increase at any time after availing of the loan.

  • Short Tenure of Personal Loans: The personal loan tenure is typically one year to five years. If you intend to repay your loan from your investment profits, the short tenure of the loan might make that very difficult.

  • Potential of Creating a Large Debt: If for any reason, your investments don’t generate expected returns, you still have to service the PL EMIs. Paying EMIs without sufficient investment return puts added pressure on your finances every month. In addition to the partial or complete loss of capital, the EMI situation could spiral into a large debt.

  • Additional Costs Associated with a PL: Apart from the high-interest rates, other charges like processing fees get barely covered by a decent return on your investment, let alone by a loss on the investment.

Conclusion

Before deciding to take a personal loan to make investments, please note that the costs of unsecured borrowings are high and fixed, irrespective of market conditions. Thus, you need to understand your risk appetite, financial capacity, and return objectives well before deciding on borrowing money for investments.

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