Borrowing money to invest in the stock market is a terrible idea for a regular investor. If you’re a genius investor, maybe you can make some profit, but I know it’s not the right move for me. Unfortunately, there are many ways to go into debt to invest.
Peer to peer lending. A few days ago, I saw a loan on Prosper. Prosper.com was asking for $15,000 to “invest in high quality stocks.” The interest rate on this loan is 12%. Here is their strategy – This loan will be used to invest in high quality US stocks like Apple and IBM. There is no way that I will lend to this investor. It’s not easy to beat 12% interest. What happens if the market continues to perform badly over the rest of this year? Can this investor pay back the loan if the market doesn’t improve quickly?
Margin Buying. If you have some equity in a brokerage account, you can apply for a margin account. Generally, you can borrow up to 50% of the value of your account to invest. In the 90′s, I signed up for a margin account because everyone I knew was making a bunch of money from tech stocks. It was great for a couple of years and paying interest wasn’t a big deal when the stocks were doing well. Once the dot com bubble popped though, the margin call came in. If the value of your account is not enough to cover your margin position, you have to add more money to your account or else your stock position would be sold. This locks in your loss and drives the market down further. So I learned my lesson and stayed away from the margin account ever since.
Credit card. I hope nobody seriously considers using their credit card to invest. The interest rate is so high and I don’t think it’s worth putting your credit at risk. I think the rates are higher than the 12% from Prosper, right? Has anyone done this?
Borrow from 401(k). You can borrow from your 401(k), but this would put your retirement investment at risk. If you lose your job, you would have to pay back the whole amount or else you’ll have to pay taxes and penalties. The only scenario I can think of that makes sense is if you borrow from the 401(k) and then reinvest it again in the 401(k) to get employer matching. Is this an easy way to get 100% gain? Some plans disallow new contributions if you have an outstanding 401(k) loan so the company is guarding against sneaky people this way. I’ll have to check and see what my company’s policy is. Anyway, I recommend against borrowing from your 401(k) to invest. Even if you get a 100% match, it’s better to add new money from your paycheck than to borrow.
There are many other bad ways to borrow money to invest. You can get a home equity loan, borrow from friends and family, and more. I think all these are bad plans. If you do any of these, you’re thinking only about the short term gain. The stock market is much more reliable to make money over a long period of time. When you have to pay back the debt in a set amount of time, you’ll be in a rush and take more risks. When you’re in a schizophrenic stock market, it can be very difficult to make enough profit to beat the interest rate. Personally, I avoid borrowing money to invest in the stock market at all costs. I know that my risk tolerance is not high enough to do that. What about you? Have you borrowed money to invest in the stock market?