Whether you are a first time investor or seasoned one, knowing all your options on funding is a good place to start. The interest rates on loans are low, really low. The rates are so low; some people might think that with these low interest rates that they could create a long term arbitrage between a personal loan and the stock market. You might think that knowing the average return on the stock market over time and with a fixed loan term you might be able to play the system and come out ahead. Well, that is ‘possible’ but highly advised against.
What You Do Know
If you are borrowing funds, you know what the lender will charge you for the funds. According to CNBC.com the average rate of return of the S & P 500 is 9.8%. Loan rates for a personal home loan with Wells Fargo today are 4.49% with good credit and other needed requirements by the lender.
Loan Term Breakdown
If the stock market yields an average of 9.8% return, you’d think that you would earn the variance between the interest incurred on the loan and the interest earned on the investment, however the math isn’t that simple. You also need to deduct the monthly payments that need to be made to the financial institution for the loan during the investment / loan term. Using a calculator at BankRate.com for an investment with monthly withdraws.
Using the initial investment of $100,000 and varying terms of 10, 20 and 30 years for the loan and length of the investment we have calculated these figures for you. While they look promising these numbers are only indicative of the actual interest earned, this variable can make or break these predictions. Borrowing funds to invest is tricky but some believe with enough knowledge the gap between the interest earned and interest owed it is worth the gamble.
|Loan Interest Rate||Earned Interest Rate||Initial Loan / Investment Amount||Term Mos.||Monthly Payments||Loan Interest Paid Over Term||Investment Interest Earned Over Term||Potential Gain on Loan & Investment|
What You Don’t Know
According to CreditMonkey.com the average return for the last 10 years starting in 2008-2018 the average return is only 6.88% which would change the investment interest earned over the 10 year period to only $16, 713 which doesn’t allow for the investment and loan to yield a return. You actually end up paying $7,595 in the interest on the loan than you would have earned on the investment after the $24,308 paid in interest on the loan.
TheBalance.com compiled a list of the best and worst returns on the stock market during a one-year period. During 2009 the worst return was during the crash of the mortgage industry the market lost 43%. The best return was in 1983 where there was a return of 61%. So not being able to predict the market when big wins will come and big hits will happen it is strongly advised to not invest with funds you cannot afford to lose. Just like in gambling you shouldn’t use money that isn’t yours to lose. If you lose every penny you borrowed, you still owe the money. If you lose funds you already had, you are at least at zero, no gains but nothing owed either. While that is not an ideal situation it is much better than borrowing funds and losing them and then still owing them to a lender.
The rate of return decides if your investment turns a profit or a loss. If you earn 9.8% on a 20-year investment you can earn $150,149 in interest. However if the average interest earned is only 6.4% you pay more in interest on the loan ($51,706) than you earn on the investment ($44,524) a net of -$7,182. The worst rate of return on the market for a 20 year period being that of 6.4%, this would not lead to a profitable investment. These rates are only for periods that TheBalance used for research, so there might be worse periods of investments but they were not tracked for the reporting article.
While the return on the investment can be enticing, the uncertainty of the stock market should be a deterrent that keeps people from investing with borrowed funds. The market can be affected by great many external factors that you have no control over. The stock market it intertwined nationally and globally. If there is a hurricane that hits the parts of the US that impact oil prices it can easily affect the stock market on all goods domestic and imported. This can lower expected returns on stocks and depending on the period of time of your investment it may hinder your ability to turn a profit.