Should you take out a personal loan to invest?

Investing is a great way to grow your net worth and meet financial goals. You can often earn much more with your money by putting it in the stock market instead of keeping it in a savings account. Over the long term, the stock market offers a roughly 10% annual rate of return, compared with 1% or less in a high-yield savings account.

If you’re looking to increase the amount you’re investing, you may consider taking out a personal loan to add to your investment account. But this is rarely a good idea.

Here’s why you generally shouldn’t take out a personal loan to invest, as well as a few instances when it might make sense.

• Why you shouldn’t take out a personal loan to invest
• When taking out a personal loan to invest might make sense
• Other (safer) options for building your investments

Why you shouldn’t take out a personal loan to invest

A personal loan is a relatively small, unsecured installment loan that you pay back at a fixed rate over a period of three to seven years (sometimes longer). You usually don’t need to put up collateral, but you’re required to make a monthly payment until you’ve fully repaid the loan — plus interest. If you don’t, you risk damaging your credit score. Personal loan amounts often range between $10,000 and $100,000, though some lenders also offer smaller loan amounts.

With investing, there’s very little guaranteed. The money you put into the market could go up in value, or it could go down. You could even lose it all.

That difference makes using a personal loan for investing inherently risky, and usually a bad idea. In fact, some personal loan lenders even specifically prohibit you from using the money for investing. Here are a few other reasons why you might shy away from using a personal loan to invest:

• The investment you’re considering may lose value. When you invest, you may lose money. Markets can crash, stocks can tank, and businesses can go under. But when you take out a loan, you’re required to pay back the money and interest, no matter what happens. Losing money on your investment can make it more difficult to pay back your loan, leaving you open to the severe financial consequences of missing payments.
• You have poor credit. When lenders set the interest rate you’ll pay on a personal loan, they take your credit score into account. People with excellent credit pay lower rates, while people with fair or poor credit will pay higher rates. If you fall into the latter category, your personal loan may be expensive. People with bad credit may struggle to find any personal loans available to them at all. This can make it difficult to earn enough return on an investment to cover the interest you must pay on the loan, even in ideal circumstances.
• Your finances may change. With a personal loan, you’ll know from the beginning how much you’ll need to pay each month. It won’t change for the life of your loan. While this payment may be affordable when you take out the loan, your finances may change. You could lose your job, or face an unexpected expense or financial emergency. A significant drop in your income or rise in your expenses could make it more difficult to make your monthly personal loan payments. If this is a possibility in your situation, it might not make sense to take out a personal loan for investing.

When taking out a personal loan to invest might make sense

Using a personal loan to invest is almost always a bad idea. However, in rare cases, it can make sense. Here are a few scenarios when you might consider investing the funds of a personal loan:

• You could get a higher rate of return on your investment than you’re paying in interest. Using a personal loan for investing theoretically makes sense when you’re able to safely earn a higher rate on your investment than you pay in interest, earning you money over the course of the loan. However, few investments are safe, especially over the relatively short term of your loan. If you find a safe investment — like a certificate of deposit or savings bond — with a higher rate than the interest you’re quoted, it may make sense to try.
• You’ll be able to pay off the loan early. If you’re due a large amount of money, such as through an inheritance or home sale, you may be able to use a personal loan to jump-start your investing and then quickly pay back the loan. Be careful, though: Some personal loans require you to pay a prepayment penalty if you pay off your loan early.
• You can use the investment to generate income. Investments don’t always mean stocks. You may be considering using a personal loan to start a new business, creating a means for you to make money for years to come. This approach isn’t without risks, but they may be risks you’re willing to take.

Other (safer) options for building your investments

Although borrowing money to invest is fraught with peril, investing is still a good idea — it’s an excellent way to build long-term wealth and save for retirement.

Instead of taking out a personal loan and using the money to invest, consider these investing options:

• Pay off high-interest debt and invest the savings. Personal loans can be a good way to reduce interest costs, especially if you have high-interest debt like credit cards. You could take out a personal loan to pay off those other debts, and put the interest savings toward investments.
• Increase your 401(k) or IRA contributions. Work-sponsored retirement plans are a great way to get started investing. If you have a 401(k), consider increasing your monthly contribution. If you don’t have access to a work-sponsored retirement plan, you can open your own IRA to start saving for retirement.
• Learn about mutual funds. A mutual fund can be another good entry-level investment. Money you put into a mutual fund will be pooled with money from other investors and used to buy stocks, bonds, and other types of securities. The investors in the pool will share in any dividends or interest the investments pay.