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Don’t Borrow Money To Invest

{ 39 comments }
borrow to invest

Bad idea

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? 

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{ 39 comments… add one }
  • investlike1percent May 28, 2012, 1:04 am

    i think it depends on what you invest in. if its to invest in things which you have no control over like the stock market, then better to go to vegas and double down.

    i got to financial independence by investing in things i can control. our real estate flips have been earning 20-25% and take about 6 months max. that annualizes to a 40-50% return. should i borrow at 10% to make 40-50%… the answer is yes.

    now i dont borrow, because i dont need to get greedy. i am happy sleeping at night, but a good investor would say go for it.

  • Cherleen @ Barbara Friedberg Personal Finance May 28, 2012, 3:53 am

    I definitely agree. It is not advisable to borrow money and invest in stock market. I hope nobody in his right mind will do this. This move is not only risky but also the earnings that you will get from the investment may only go to the interest of your loan.

  • Daisy @ Add Vodka May 28, 2012, 6:55 am

    I’ve never borrowed money to do this, and I probably never will. It’s risky and almost pointless.

    • retirebyforty May 29, 2012, 5:19 pm

      I know I’m not a genius investor and probably can’t beat the interest rate so I agree with you. 🙂

  • I never have borrowed to invest in the stock market and never will. It screams greed and can get way out of control. It sounds sexy and it sounds like how the big guys make money but what most don’t realize is the extreme risk you have highlighted and that a lot of people have the potential to lose the shirts off their backs if things go bad (and when that happens it happens quick).

    • retirebyforty May 29, 2012, 5:20 pm

      The big guys are making a lot of money because they make money from the % fee right? When they lose money, it’s the investor’s money so they don’t have the same risk as the individual investors.

  • David May 28, 2012, 8:50 am

    I don’t completely agree with this. I do agree that you should look at the cost of borrowing and the risk involved when borrowing to invest. In my case, I recently refinanced my house at a 3.25% interest rate. I refinanced without taking any cash out, so my payments dropped. I am taking that extra money along with the extra money that I had been putting towards the mortgage before the refinance and throwing that into an investment account. In my case, I don’t think the risk is extremely high since my loan balance is only about 30% of my home value and the monthly payments are less than 10% of my monthly income. Over the next 10 years or more, I expect the rate of return to be greater than the 3.25% of the home loan interest rate. Since I could be paying the loan off instead of investing, I consider that the same thing as borrowing money to invest.

    • investlike1percent May 28, 2012, 10:19 am

      concur. i think it is easy to earn 10-15% on investments. my whole point, its about the returns on investmens!!!

      • retirebyforty May 29, 2012, 5:27 pm

        If you can earn 10-15% easily from the stock market, you should really consider opening a hedge fund!
        You’ll have a huge line of investors lined up to give you money. 😉

    • retirebyforty May 29, 2012, 5:22 pm

      In your case, I don’t think the risk is extremely high either. From my research, it seems if you are young it might be advantages to borrow to invest as long as you are discipline. Let us know in 10 years if this works out. 🙂
      3.25% is very low though. Great job with that.

      • TM @ Young and Thrifty May 30, 2012, 9:01 pm

        This is exactly the situation I am in RB40. I am a big fan of passive investing, and I don’t think leveraging and passive investing are mutually exclusive. As a young investor I’m looking at a huge time horizon. If basic Index ETFs don’t gain me more than 3.25% on average over the next couple of decades it just wasn’t meant to be I guess (it will also have been the worse 20 year stretch on record).

        • retirebyforty May 31, 2012, 8:58 pm

          Good luck! The basic index funds haven’t been doing very well over the past decade. Hopefully we’ll see more growth soon.

  • Calgary_Girl May 28, 2012, 9:52 am

    I don’t necessarily agree with this. We used our HELOC to invest in dividend paying stocks years ago because 1) We had paid off our mortgage; 2) in Canada, the interest on the HELOC is deductible if used for investment purposes; and 3) the dividends that we’re earning on our stocks is 3x more than the interest payment on the HELOC.

    • retirebyforty May 29, 2012, 5:26 pm

      I know it’s a bit different in Canada, but I think it’s still very risky. Are you still doing this?

  • Forest May 28, 2012, 1:59 pm

    Completely agree, getting into more debt for almost any reason is not worth it. I operate a policy these days that if I can’t afford it I don’t get it.

    • retirebyforty May 29, 2012, 5:28 pm

      That’s a great policy!

  • The Passive Income Earner May 28, 2012, 6:17 pm

    It’s all about where you are in life and the ROI you get. Most rich people made money by leveraging assets. It’s usually the stepping stone to the next one. With respect to borrowing to buy stocks, you really need to understand the cost and the income from your investments. Is it a dividend stock? Is it a penny stock? It all depends. If you do, have a plan to pay it back.

    • retirebyforty May 29, 2012, 5:31 pm

      You also have to understand the risk of a bear market and work out a scenario. What happens if you lose your job and the stocks tanked? Is it worth losing your home? I don’t know…
      I wonder if the rick people are risking their own money though.

  • Charlotte @Dining Out Challenge May 28, 2012, 6:31 pm

    This just sounds dumb to me. The market is way too volatile to borrow money to invest in it. I also agree with not using a credit card to invest.

  • Julie @ Freedom 48 May 28, 2012, 7:25 pm

    I wouldn’t be able to sleep at night if I’d borrowed to invest. If it’s not MY money invested… it’s not my money to lose (if it should happen)

    • retirebyforty May 29, 2012, 5:34 pm

      Thanks for your input. You probably can’t be hedge fund manager then. 🙂

  • Kathleen @ Frugal Portland May 29, 2012, 9:03 am

    This makes perfect sense to me but I know lots of people who think I’m being stupid by paying off low interest loans before investing. To each their own.

    • retirebyforty May 29, 2012, 5:35 pm

      Do what works for you! 🙂

  • Jeff @ Sustainable Life Blog May 29, 2012, 9:55 am

    I’ve never borrowed to invest – it’s incredibly risky. When I was watching one of the financial guys on tv he was talking to an MBA student who had like 100k+ in credit card debt because he got a low interest card and thought he could beat the interest rate in the market and he’d keep the arbitrage himself. The market tanked on him, and he lost his shirt.

    • retirebyforty May 29, 2012, 5:36 pm

      Wow, that’s nuts. I think short term investing involve a lot of luck and if you got it wrong, you are screwed. That’s why I don’t borrow to invest.

  • Shawn @ Managing The Money Wars May 29, 2012, 10:08 am

    I agree with investlike1percent. I don’t belive it is wise to borrow to invest in the stock market however; we do borrow to invest in real estate because it makes sense for us. Although we do not flip houses, we do purchase rentals and on a 6% loan we make roughly 1.5% per MONTH on our cash investment.

    • retirebyforty May 29, 2012, 5:38 pm

      1.5% per month on a rental property is really good. What kind of property did you invest in? Single home or apartment housing?

    • cs May 29, 2012, 7:18 pm

      yup, was gonna add that RE is where most people do borrow to invest. This mostly works in places outside of large east and west coast cities. Where I live now, you can buy a 2-3 unit rental property (finances as a 1-4 unit – best if you can live and rent) for about $70-100K and rent out each unit from $500-1000/mo. Taxes kinda cut into profit but can have a quite profitable spread. Shabbier areas are actually more profitable and SFH are hard to turn much profit on IMHE…

  • SavvyFinancialLatina May 30, 2012, 10:52 pm

    I would not borrow money to invest. I am currently looking for a car, and don’t even want to borrow money to pay for the car. It’s tempting to go buy myself a new car, but then I think about the loan…yikes.

    • retirebyforty May 31, 2012, 8:59 pm

      It’s best to pay cash for a car. That way, you won’t overspend. Hope you find a nice car for your budget.

  • MoneySmartGuides June 4, 2012, 4:23 am

    A 12% loan to invest in the market? That is just plain crazy!! That person will be lucky if they can cover that rate of interest.

    I agree about not borrowing to invest in the market. Any money borrowed just means that you need to earn that much higher of a return. Save your money, then invest.

  • Brother of Steve June 4, 2012, 6:26 pm

    In the market depths of March, 2009, I borrowed @ 3.25% on my home equity line of credit and bought high-quality Canadian bank stocks. E.g., Bank of Montreal (BMO) — the longest-running dividend paying company in Canada — was paying a 10.7% dividend.
    Do the math. You didn’t even need for the stock to go up to make 7.45%, after interest.
    Obviously, that opportunity didn’t last long. But to say that you should NEVER borrow to invest is silly.

    • retirebyforty June 6, 2012, 5:21 pm

      It’s great that you did well, but I’m sure many more people borrowed to invest in 2007 and I’m sure those people regret it. It’s not easy for a regular investor to time the market, right?

  • Gerard June 23, 2012, 6:13 am

    re credit cards: Not sure this qualifies as “investing”, but when I bought my condo, I put $10K on my credit card to get a big enough down payment to avoid mortgage insurance. I’ve been revolving low interest credit card offers while paying it off. Looks like it’s going to cost me about $600 in increased interest costs (relative to my mortgage), and save me about $2000 in premiums and fees.
    That said, I don’t expect many situations like that to arise in my life…

    • retirebyforty June 26, 2012, 7:34 am

      That’s great! I would have done the same thing in that situation.

  • Sanchi May 25, 2016, 11:49 am

    Disagree. Continiuosly make nice returns by investing cash taken out from my multiple credit cars not to mention the quarterly dividends that are earned. This is so easy, why more people won’t do it. Easy cash from credit cards, then buy stocks, sit back collect dividends. Nice.

  • tom November 7, 2016, 11:24 am

    just spread the risk, i dont invest in the stocks, peer to peer is where it is at. im looking to get up to 100k in next 6 months with 50 invested at 4-6% and 50 at 12%. we dont owe much on the morgage and dont borrow just drip feed earnings into the platforms. been on the p2p for 3 years and always had payments on time everytime.

    im 34 and have a ten year plan to retire and im 1 and 1/2 years into the plan. as the portfolio develops i will look for other platforms to spread the risk and also as it goes along be more risky as i invest in the next platform when im happy the rpevious ones are working.

    perhaps one day i will look to borrow to invest but the borrowing would never be more than 20% of the portfolio, and as im adding a 1k a week the portfolio is growing ok!

    savings are borring over one or two years but become really exciting over5/10/15 years so get every penny you can into savings as early as you can!

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