Skip to main content

INVESTING : Can You Borrow Money to Buy Stocks?

 With margin debt soaring and many investors actively taking on consumer debt to buy stocks, we can conclude that there’s a lot of borrowed money in the market today. If so many others are doing it, does that mean you should also borrow to invest?

Consider the Risks

You can borrow money to buy stocks, but you’ll be taking significant risks, and some of the risks may not be obvious. Let’s take a look at some of those risks.

Systemic Debt Risk

This risk is not specific to you. It applies to anyone using borrowed money to invest in a highly leveraged market. High debt levels mean high risk levels: if you look at the margin debt chart above, you’ll see that margin debt peaked before both the 2001 and 2008 recessions.

If stock values turn down, people who are borrowing to buy stocks don’t just have to sell the stock they borrowed to buy. They may have to sell other stocks to cover a margin call or pay back a loan. That selling pushes prices down further and pushes other investors into the same situation. That makes a highly leveraged market vulnerable to rapid price drops.

You should assess the impact of leverage on the market before making any investment, but it’s particularly critical when you’re investing borrowed money.

Risk of Loan Default Due to Investment Loss

This is the most obvious risk of using borrowed money to buy stock. If your selected investments don’t perform as expected you may lose money. You may then be unable to pay your loans. That could force you to liquidate other investments.

Your credit may suffer and you could be forced into default and even bankruptcy, depending on the amount and type of loans you’ve used to buy stock.

Risk of Leverage Addiction

This is perhaps the most insidious risk of borrowing money to buy stock. If you succeed and make money you’ll get a huge emotional high. You’ll feel smart and accomplished like you beat the system. There’s a very good chance that you’ll do it again. The more you succeed, the more likely you are to borrow more and take more risks. That can leave you in an extremely risky situation, and sooner or later markets do turn down.

When leverage works, it magnifies your gains… but leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices.

Warren Buffet

The Experts Advise Against It… But Aren’t They Doing it Too?

Very few investment professionals would advise using borrowed money to buy stocks. Most would advise against it, and those who would approve would probably qualify their approval heavily.

That reluctance to endorse buying stock with borrowed money is often seen as hypocritical. Many of the fund managers and investment professionals that discourage individual investors from buying stock with borrowed money are managing highly leveraged portfolios. Warren Buffet, who has warned about the risks of leverage, used borrowed money to invest early in his career.

The difference, of course, is that individual investors simply can’t borrow on the same terms as large investment institutions. That may not be fair, but it’s still true. If you could borrow on the same terms as Berkshire Hathaway or a major hedge fund, and if you have professional-level risk assessment expertise, borrowing to buy stocks might be a good idea. Very few individual investors are in that position.

Investing with borrowed money could be a reasonable move if the loan terms are good and you’re very sure that you’ve predicted the stock’s movement accurately.

It’s very tempting to use low-interest loans to invest in a rapidly expanding market. It’s also very risky. You may choose to take that risk, but you’ll want to assess it very carefully and avoid getting carried away if you do succeed. Leverage has made some investors rich. It has also made some rich investors poor.

                                                   ______    XXXX    ________

Comments

Post a Comment

Popular posts from this blog

"This, too, shall pass,"

Dr. Martin Seligman of the University of Pennsylvania did an intensive research on what creates learned helplessness. In his book Learned Optimism he reports on three specific patterns of beliefs that cause us to feel helpless and can destroy virtually every aspect of our lives. He calls these three categories permanence, pervasiveness, and personal. Many of our country's greatest achievers have succeeded in spite of running into huge problems and barriers. The difference between them and those who give up revolves around their beliefs about the permanence, or lack thereof, of their problems.  Achievers rarely, if ever, see a  problem as permanent, while those who fail, see even the smallest problems as permanent. Once you adopt the belief that there's nothing you can do to change something, simply because nothing you've  done up until now has changed it, you start to take a pernicious poison into your system. No matter what happens in your life, you've got ...
Post a Comment
Read more

Problem Solving Questions ...............Continued

Every morning when we wake up, we ask ourselves questions. When the alarm goes off, what question do you ask yourself? Is it, How come I have to get up right now?," "Why aren't there more hours in the day?, "What if I hit the snooze alarm just one more time?" And as you get in the shower, what are you asking yourself? "Why do I have to go to work?," "How bad is the traffic going to be  today?," "What kind of stuff is going to be dumped on my desk today?" What if every day you consciously started asking a pattern of questions that would put you in the right frame of mind and that caused you to remember how grateful, happy, and excited you are? What kind of day do you think you'd have, with those positive emotional states as your filter?  Obviously it would affect how you feel about virtually everything. Realizing this, I decided I needed a "success ritual" and I created a series of questions that I ask myself ever...
Post a Comment
Read more

The Magnificent Obsession - Creating A Compelling Future....

GIANT GOALS PRODUCE GIANT MOTIVATION So often, people ask me, "Where do I get my energy? With all that intensity, no wonder you're so successful. I just don't have your drive; I guess  I'm not motivated. I guess I'm lazy." My usual response is, "You're not lazy! You just have impotent goals!" Frequently I get a confused look to this response, at which point I explain that my level of excitement and drive comes from my goals. Every morning when I wake up, even if I feel physically exhausted from a lack of sleep, I'll still find the drive I need because my goals are so exciting to me. They get me up early, keep me up late, and inspire me to marshal my resources and use everything I can possibly find within the sphere of my influence to bring them to fruition. The same energy and sense of mission is available to you now, but it will never be awakened  by puny goals. The first step is to develop bigger, more inspiring, more challenging ...
Post a Comment
Read more