Don’t Take Out Personal Loans To Invest

A recent survey by MagnifyMoney found that a significant portion of investors, particularly younger investors, have taken on debt to invest. Out of about 1000 investors surveyed, 40% took on debt to invest. Here’s how that broke down by age group:

Generation	Percent who took on debt to invest
Z	80%
Millennials	60%
X	28%
Baby boomers	9%

Of those who took on debt, 38% took out a personal loan and 14% went into credit card debt. In terms of debt amount, that varied as shown:

Amount of debt	Percent of those who took on debt
< $1,000	22%
$1,000 – $4,999	32%
$5,000 – $9,999	26%
$10,000 +	20%

As you can see, many people have taken on debt to invest, particularly younger individuals. And almost half of them have taken on $5,000 or more in debt, with 20% taking on more than $10,000!

While it might seem like a great idea to kickstart your investing by taking out a personal loan, this is actually a terrible idea. Don’t take out personal loans to invest. It’s quite likely to be a mistake, even for those with high credit scores. Here’s why.

Personal loans often have high interest rates

If you’re planning to take out a loan to jumpstart your investing, you would need to find a loan with a lower interest rate than you expect to earn in the stock market. While mortgage rates and car loan interest rates are currently very low (an average of 2.96% for a 30-year fixed mortgage and 4.12% for a new car loan), the interest rates on personal loans are still quite high, even for individuals with credit scores over 780.

Interest rates vary based on credit scores. For those with a credit score of 780 and above, the average interest rate is 9.3% for a 3-year personal loan and 11.1% for a 5-year loan. 9-11% is already about the same as average stock market returns, but of course, not all people have a credit score of 780 or above. Only about a fourth of Americans have credit scores in that range, as you can see here:

Credit score range	Percent of the population
< 600	18.9%
600 – 649	9.3%
650 – 699	12.5%
700 – 749	16.2%
750 – 800	20.7%
800 – 850	22.3%

Interest rates increase significantly as credit scores decrease. For those with a credit score below 600 (about a fifth of Americans), the average interest rate is 31.7% for a 3-year personal loan and 29.2% for a 5-year loan. With interest rates that high, you should not even think about taking out a personal loan to put money into the stock market. Honestly, even those in the 780+ group are pushing their luck. Below them, those in the 720-779 range are already facing average interest rates that are just too high to realistically consider it (12.8% and 14.5% for a 3-year and 5-year loan, respectively). More likely than not, you would lose money at those rates.

The lowest personal loan interest rate I could find is about 6%, which technically may be low enough to provide a chance of making money in an average performing stock market but still has about a 36-38% chance of losing money based on historical data.

Personal loan interest rates are often higher for longer term loans

The best way to keep your chances of losing money low is to invest over a long time frame. That way a bad year or couple of years will not affect your overall return. In fact, there has been no period of 15 years or longer where the S&P 500 with dividends reinvested has lost money, which you can see in this article.

Unfortunately, personal loans generally have shorter durations, usually 1-5 years, with some extending to about 8. And the longer the loan term, the higher the interest rate usually is. For instance here’s the rates offered by SoFi for a $30,000 loan:

As you can see, the lowest rate on a 2-year loan is 5.99%, but this rate increases for every additional year of the loan up to 11.09% by 7 years.

Similarly, here are the lowest rates for a $50,000 personal loan through LightStream (category – other):

Again, the rate increases from 7.49% for a 2-year loan up to 10.24% for a 6-year loan. The website (and rate comparison sites) actually advertises a lowest rate of 2.49%, which would be significantly better for investing purposes, but this does not seem to be available for most loans. The lowest I could find on the site was 2.99% for a car loan.

Since the interest rate goes up for longer term loans, you’d be better off with just a 2-year loan, but that leaves you open to short-term volatility in the stock market. Now, you could theoretically keep getting new loans every 2 years to try to play the long game, but it is quite possible that rates will rise going forward, making this less viable.

I should note that if the loan interest rate you receive is higher than expected market returns, a shorter loan term is actually better. There is a much higher chance that the market will outperform over the short term than over the long term (and also a higher chance that you could beat the market over the short term). That said, even for just a 1-year period, your chance of losing money is very high (about 50% with just an 11% interest rate). This is also assuming that you don’t keep taking out successive short-term loans, in which case your odds of success over the long term decrease substantially.

Potential returns are minimal

Even if you’re okay with the risk of losing money and going into debt, you’re still not looking at much in the way of potential returns even if you do qualify for the best available rate. To maximize your potential earnings, you would need to take out the largest possible loan, which is generally $50,000 but in some cases can be as much as $100,000.

Assuming a 2-year loan of $50,000 with an interest rate of 6%, on average you would make $2,083. That’s with a median return of 9.9% per year in the stock market. Best case scenario with a 75th percentile return of 19.2% per year, you’re looking at a return of $7,786. On the other hand, with a 25th percentile return of 1.9% per year, you’d lose $2,238.

Almost $8,000 over 2 years sounds pretty good, but the chances of that happening are low. Is it really worth taking out $50,000 in debt for a likely $2,000? You also have to consider that returns typically fluctuate each year. If the first year happened to be a bad year, that could really hurt your return even if the next year was amazing, since your loan payments would reduce the value of the account during the bad year and leave less to take advantage of the subsequent good year. For instance, if the stock market was flat the first year but went up 20% the next, you’d actually end up losing $861 even though the annualized market return was about 9.5% per year. This problem can be avoided if you pay the loan payments out of your income rather than out of the loan amount, but if you can afford to do that, you might as well just invest your income rather than taking out a loan in the first place.

Conclusion

In summary, don’t take out personal loans to invest. Even in the best case scenario, you’ll end up losing money 1/3 of the time. And if you do end up making money, chances are you won’t make much. Unless personal loan interest rates decrease significantly in the future, it’s not worth taking one out to invest even for those with the best credit scores. And for those who don’t have a 780+ credit score, don’t even think about it.