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Is it advisable to borrow, in the form of a fixed loan, for the purchase of securities?

Please note that I am not talking about a margin balance; a simple, 5 year loan at a fixed rate of interest (not backed by real estate), in order to obtain a sizable position in either a basket of mutual funds or a group of non-correlated Exchange Traded Funds (ETFs). Presumably, the overall return (capital gains, plus dividends and interest) can exceed the total cost of the loan (the sum total of all principal and interest payments).
Once the loan is fully amortized, the assets remain in the account in order to generate gains, dividends and interest.

Oct 21, 2013 by Peter from Brooklyn, NY in  |  Flag
7 Answers  |  8 Followers
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4 votes

Hi Peter. In my opinion it is always a risky proposition to borrow in order to invest in a market where returns are never guaranteed. In theory it works, assuming returns average 7-8%. But returns are never average and the market can go through cycles where the returns aren't there. The US stock market is 4.5 years off the lows seen in early '09 and bull markets don't last forever. Save/invest prudently, limit your debt and control unnecessary costs. It's boring but it works over the long-term.

Regards, Glen Hahlen

1 Comment   |  Flag   |  Oct 21, 2013 from Uniontown, OH
Peter

Excellent point - the market climbs a wall of worry even if you finance purchases via 100% cash

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Flag |  Oct 21, 2013 near Brooklyn, NY

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1 vote

Hi Peter. I wouldn't do this, because I am risk averse. But lots of other folks do, which is basically why margin is offered by brokerage firms. I'm intrigued by your comment that you are "not talking about margin balance" and not backing the loan with real estate. Both of these loan types could presumably offer lower interest rates than, say, borrowing against a line of credit. I don't know what interest rate you would expect to pay on your loan, but clearly you would want the lowest rate possible if you are going to pursue such a strategy. (Apologies if this is just restating the obvious).

1 Comment   |  Flag   |  Oct 21, 2013 from Morristown, NJ
Peter

Assuming you can pay 6.25% (totally arbitrary) on a loan, that would likely be better on a margin balance (about 8.5% recently, if memory serves). If the loan is NOT backed by real estate, you avoid the risk of losing your home if the market tanks (always a risk).

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Flag |  Oct 21, 2013 near Brooklyn, NY

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Carlos P. Sava Level 13

Peter - I concur with Glen, that the variability of stock, commodity, mixed fixed income portfolios, etc. makes the proposition of borrowing to gain leverage exceedingly risky. Furthermore, I would question how an un-collateralized loan would compare rate wise versus margin borrowing where collateral is involved. Using a fixed loan versus margin could make matching your cost of borrowing difficult. In other words, let's say you borrowed these funds under a fixed rate for 5 years, and this bull market begins to correct in 2014 and you want to dramatically shift your asset allocation. And let's say that your borrowing costs are higher than expected yields at that time. If you used margin, your borrowing could immediately be scaled down, but under the fixed rate, you could find yourself experiencing negative returns that are compounded by negative asset returns, and a cost of borrowing that you can't get eliminate the same way you could if done through margin. Regards, Carlos

1 Comment   |  Flag   |  Oct 21, 2013 from Arlington, VA
Peter

You can never avoid the cost of capital, and any time I make a purchase I cross my fingers the next day won't be a "Black Swan" day or some such disaster.

Flag |  Oct 21, 2013 near Brooklyn, NY

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1 vote

NO! Just look to the real estate sector '06-'08 and you'll have your answer.

Comment   |  Flag   |  Oct 21, 2013 from Fallbrook, CA

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1 vote

The first question you have to ask yourself is: What would you do if the market went down by 50% or more like it did from November of 2007 to February of 2009?

If you are comfortable with your answer to this question and the fact that it very much could be a real possibility, then maybe it's a good move for you personally. It all depends on your tolerance for risk.

I would never advise one of my clients to do this though!

View all 14 Comments   |  Flag   |  Oct 21, 2013 from St. Louis, MO
Alan David Johnson

Peter: The video seems to be working now. Here is the link again - http://www.youtube.com/watch?v=MC6Jo88YNtw

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Flag |  Oct 21, 2013 near Morristown, NJ
Peter

The Barracuda Networks ad had music that was reminiscent of 1992's "Terminator 2" theme music - and I am watching the video now. Thanks,

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Flag |  Oct 21, 2013 near Brooklyn, NY

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1 vote

Peter the only thing I will add, it is risky but it can be done. I would look for a Tactical money Manager that has a good process in place to protect your portfolio in case of a "Black Swan Event". Of course there are NO guarantees and you are taking a risk, just like every one here pointed out to you. However, if you were our client, we would have to look at your loan to equity ratio and make sure you are not digging your self in to a big of debt doing this as well as analyse your risk tolerance and how your other assets are allocated as well. I do believe if you have a right approach you can certainly utilize this strategy. I would not, however advise that you do that yourself and buy bunch of ETF's or Funds and hold them. I hope this helps Let me know if you have any questions Sincerely Michael Mezheritskiy Founding Partner, Visionary P.W.M.G. www.VisionaryWealthMgmt.com

1 Comment   |  Flag   |  Oct 21, 2013 from Farmington, CT
Christopher B. Milton, CFP®

Give it a break guys. The answer is simply NO!

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Flag |  Oct 21, 2013 near Fallbrook, CA

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0 votes

Peter, in terms of investment advice, it is never a good idea to create debt in order to raise capital for a financial investment.

1 Comment   |  Flag   |  Oct 21, 2013 from Delray Beach, FL
Peter

Tough to dispute that notion, but once the loan is amortized, you still have the assets. The yield on original cost would (theoretically and hopefully) improve year-over-year.

Flag |  Oct 21, 2013 near Brooklyn, NY

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