I have to disagree with your statement to some degree. I agree that the average investor who plays the market on his own should not utilize margin as it can cause the problems that you have mentioned but lets keep one thing in mind...margin is a tool and as with any tool you need to know how to use that tool to benefit from it.

Sophisticated investors/fund managers etc. who understand how to use margin can use this tool to their advanatage. You need to 'follow the rules' when you use margin and if you intend to use margin and apply it to investment strategies which are completely outdated and do not work to begin with you do set yourself up for failure.

Like I said you need to know how to use margin (the majority does not use margin the 'smart way' and may be forced to cover margin calls) otherwise it can be a fianancial burden. Compare it to someone who uses a hammer to screw in a screw...won't really work since you did not use the hammer the way it was intended for...same is true with margin.

The majority may be better off not to use it since they lack the knowledge on how to use it but it is among the best tools available in todays markets.

__________________
It is not smart to play it safe but it is safe to play it smart.

Brian wrote:
Brian, the awful flaw is the 15% return per year.

One of the companies I do business with had their actuaries run the numbers based on the Standard & Poors 500 composite index (excluding dividends)from 1950 through 2005. Their Long Term Summary table shows statistics on returns for all possible one-year indexing periods since 1/3/1950. For example, the one year periods include 1/3/1950 to 1/3/1951, and 1/4/1950 to 1/4/1951, and 1/5/1950 to 1/5/1951 and so on.

The calculation had 20,075 rolling periods. 365 start days x 55 years.

The "best" year returned 59%.
The worst year was a 43% loss.
The average return was 9.21%.

But guess what? The probability of a 0% return was 30% or about 3 out of every ten years. Which means an average rate of return of about 6.4% per year.

A 25% loss in one year will require a 47% gain the following year just to keep even with a safe investment that was just limping along at 5% per year.

__________________
Gary Spicuzza, *SAFE
Copyright 1956
No Rights Reserved
*Self Appointed Financial Expert

S&P is focused on "very-safe" investments though, and I think has made some awful loss-developing decisions - such as buying into GOOG when it looked about to flop. Only by joining the S&P did it delay the inevitable fall.

I honestly think the S&P index is one of the worst to follow and easiest to beat.

As for borrowing to invest - I think we've seen it's an integral part of the investment process. Heck, there are plenty of people looking to borrow in order to invest in property, despite the fact that property markets have been suffering across the US and Europe.

Why invest in something that may deliver a flat 4% over the next 5 years
(UK) when you could put it in equities etc, and grow your fund through general growth plus dividends?

I think I could easily beat the interest rate on stocks - and additionally, I think my business can cover the borrowing costs as well, so rather than put a couple of grand per month into stocks, and see this slowly accrue, instead borrow an amount that requires the equivalent repayment rate, then you have a massive head start.

Brian wrote:
The illustration below shows what type of IMPOSSIBLE market returns one would have to earn after suffering a 40% loss.

Retirement savings should NEVER be exposed to that type of risk.

Borrowed money used to invest would magnify the problem because the debt still has to be repaid with interest.

I'm just saying.

__________________
Gary Spicuzza, *SAFE
Copyright 1956
No Rights Reserved
*Self Appointed Financial Expert

Gary,

impossible is something that not a single person can ever achieve. An annual return of 78.5% is by no means the norm but it is possible as demonstrated by several fund managers on the leading business news channel. If it would be impossible to achieve what do you say to those fund managers that were on TV whose funds did tripple digit returns?

It is not the average but neither is a 40% loss so if you like to make comparisons at least compare apples with apples. The extremes may go both ways...

__________________
It is not smart to play it safe but it is safe to play it smart.

Hermes, you have a great perspective and to the big boyz who play the high risk game and win more power to them.

The illustration above highlights the value of NOT losing money.

It's that simple.

This thread is about borrowing money to invest.

Well, had someone borrowed $125,320 in August 1999 and invested the same way, by August 2003 they would have only had $89,602.

They still would have an outstanding loan balance of $125,320 PLUS interest.

And even IF they get a 78.5% return August 2004 they haven't made one red cent because that would simply represent enough money to pay back the original loan with interest.

I'm just saying....

__________________
Gary Spicuzza, *SAFE
Copyright 1956
No Rights Reserved
*Self Appointed Financial Expert

Only if they were stupid enough to hold - the warning signs were clear for a very long time that there was a huge bubble about to burst - heck, every market commentator was saying so before the pop. As a layman then, I would have sold up and moved to safer investments (ie, gold), then bought into shares after a good rise on gold and then cleaned up on cheap shares.

And if anyone had done that, and then bought into shares after the crash, they would have made a big profit.

By the way, as I'm in the UK, I've found the big flaw in my plan - Capital Gains. So all money gained would be taxed at 18%. And if invested in my company as originally planned, after paying that tax, I then get hit by corporation tax at 28%.

I strongly believe I could still do and still turn a health profit, though. Still thinking.

Yes Brian, you are correct.

Of course the conventional broker wisdom in the USA in the standard, "don't worry about it, it will come back."

Regarding 18% capital gains tax in the UK. That's a good point that illustrates how if one employed the borrow to invest strategy the gains wouldn't be worth the risk.

Let's use your numbers of 5% interest on the loan and 15% gain on the investment.

Simple interest says on a $100,000 loan you'd owe $5,000 interest per year.

You made $15,000 on your investment but 18% or $2,700 went for capital gains tax. So $7,700 was spent on taxes and interest leaving you with $7,300 or 7.3%

Okay, not bad.....and if you can do that each and every year and never have a bad year...or 2...or 3,....well then you'll be way ahead of the game.

Kind of...but not really... there is one more pesky thing out there...the $100,000 loan itself. When do you pay that back and with what money?

And how long will it take to keep rolling over the gain invested with the original $100,000 of borrowed money before you can pay back the loan and finally ACTUALLY realize any profit?

__________________
Gary Spicuzza, *SAFE
Copyright 1956
No Rights Reserved
*Self Appointed Financial Expert

Gary,

you amuse me when you refer to a 'higher than normal' return as playing a game and winning. It is not a game that is played and has nothing to do with winning.

Like you said, this thread is about borrowing to invest and those people who borrow to invest do not, as you may call it 'play by the same set of rules'. There are plenty of sophisticaed investors out there and they do not risk their money they just know how to invest their money.

In your example, IF you really would have held on to your loosers to accumulate a 40% loss you probably should not be in the market to start with (just like if you have lost money this year...change the industry).

Is it a bad idea to borrow money to invest?

That really depends on how sophisticated you are. The majority has no buisness to borrow money to invest as they do not know how to invest to start with (a 'mutual fund approach' and borrowed money is set-up to fail) and than there is a small minority who does a great job at it.

In the end each individual needs to decide what the best solution is for them.

One question I always ask portolio managers is:

Why did you even loose money during a 12-month time period?

There is no reason to loose money on an annual base and those who manage that and charge their clients for it may want to change their profession as well.

Just my opinion about it.

__________________
It is not smart to play it safe but it is safe to play it smart.

No Hermes, it's not a bad idea to borrow money to invest as long as you are an accredited investor meaning:

1. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase or;
2. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

If that's the case then I say go for it!

By the way, for the sake of argument and not to be argumentive, could you mathematically answer the two (2) questions I asked above?

AND
Use Brian's numbers of 5% loan rate, 15% return and 18% capital gains tax on $100,000 and see if those numbers work out.

__________________
Gary Spicuzza, *SAFE
Copyright 1956
No Rights Reserved
*Self Appointed Financial Expert