Borrowed funds or debt is an integral part of capital that determines the growth of a business enterprise and often comes with a certain amount of risk. This risk is looked upon from an extremely critical viewpoint when it comes to stock market investments using borrowed funds. The social stigma surrounding this investment strategy is considered similar to gambling, whereas reality suggests against the same on a vastly different truth.
Let us consider two commonplace investment scenarios that require borrowed funds. For instance, the society will not look differently at a businessman taking a loan to invest in upgrades to increase their production capacity, despite not having a rooted guarantee of the investment generating returns as planned. The returns on their investment production upgrades rely heavily on the ever-changing dynamics of their market’s demand and supply status. Hence, even though their investment may be well-planned, accumulation of borrowed funds or debt may either book into growth and profits or end in tragic failure for any businessman or entrepreneur.
In a similar scenario, investment made in the real estate sector through borrowed funds is quite common. You will never encounter a shortage of financial institutions willing to lend for this investment category. Lending organizations such as banks, NBFCs and private money lenders are quick to offer financial assistance in the case of real-estate investments, be it residential or commercial space. Real estate investments generate returns over the long term, where interest and the principle are primary payoffs for the lenders, and investors usually have the capacity to repay the same.
The same does not apply to stock market investors, who are not given loans easily by banks, NBFCs or unorganized lenders, keeping the aforementioned social stigma in mind. These lenders are most-likely to stay away from the situation, deeming it too risky. This is where the stockbrokers come into the picture. They not only agree to provide short term loan to stock market investors, but also have a system in place for it. The most common means of acquiring borrowed funds to invest in the stock market are Margin Funding and Loan Against Shares (LAS). The catch here is that you may use the borrowed funds to invest in the stock market, but if you fail to return the investment or encounter market losses, then the brokerage is liable to liquidate your holdings to make up for it. Intraday and Futures investors prefer margin funding where you can buy twice the number of shares with your capital, i.e. your total capital contribution is 50% and the other 50% will be funded by your brokerage. The time duration on borrowed funds through margin funding is flexible and varies from brokerage to brokerage. Whereas, Loan Against Shares (LAS) are borrowed funds that are based on holdings available in your demat account, after deducting the perceived risk haircut ranging between 20-40%.
Stock market investment is subject to market movement risks and must be planned carefully. You can avail financial advice on using borrowed funds to invest in the market from expert financial advisors at our website: PL India