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  #1  
Old 02-16-2008, 01:05 PM
brian brian is offline
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Default Borrowing to invest

So it occurred to me...

If I invest in stocks via monthly payments, it's going to take a very long time to grow a portfolio.

However, if I were to take a loan out at an annual rate of 5%, invest this, and generate an average annual return of 15%, not only would I be able to cover the loan payments, I would also grow my investment super fast.

I'm using the international banking model for this, where the borrowings are used to pay off the interest plus receive income on the different. A form of arbitrage I guess.

Of course, this presumes that my investments would grow at a higher rate than the interest charges, but frankly, after playing on paper, not for real, my investments over the past 12 months would have grown in the region of 40%.

I probably wouldn't borrow a large amount on a personal level, both because I'm over paying my mortgage and also because I wouldn't want to embrace the personal risk.

However, someone was speaking to me about the value of my business, and reckons that banks would love to lend to it because of it's business model (guaranteed subscription income 3 months in advance).

I could then use normal business income to cover the loan repayments, allowing the portfolio to grow.

Of course, investing via my business means a range of tax liabilities I need to watch for.

And the current state of the stock market means we could be looking at a general downturn - or else general stagnation - over the next 18-24 months - then a movement into a new economic cycle.

In which case, I should maybe start looking really hard at my potential investment strategy, and then consider taking out a business loan of maybe $1 million, reinvest, and then ensure I keep the portfolio growth well above the interest repayments, plus typical reinvestment of dividends.

Because of the size of the investment, a difference of 10% on the investment interest vs loan interest would mean $100,000 profit each year, which could either be used to see the fund grow further, or else pay the loan off faster to reduce liability.

I'm presuming that investment in mutual funds is going to provide a good 15% return per year at current rates, but that the actual return could be much higher.

Surely there has to be an awful flaw in this plan, though?
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  #2  
Old 02-17-2008, 03:07 PM
Hermes Hermes is offline
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Default Re: Borrowing to invest

The only flaw that you have in your plan, at least in my opinion, is that you want to rely on mutual funds.

Your plan is definately not something the average person should follow and if you lack the 'ingredients' to do your own investments than I think you take on a lot of risks that you don't need to and your plan may not work as planned.

I personally think this plan is for the well sophisticated investor and if you fall into that category I don't see nothing wrong with that but if you plan this with the 'help' of mutual funds than I would recommend that you just leave it as a plan and not pursue this any further.

Should you move forward and execute it with mutual funds than you 'hope' that the worst professional investors will be able to deliver and that is a risk not worth taking.

This is just my personal opinion and not meant to discourage you from executing your plan. In the end if it comes down to it and you can be comfortable with it and don't have a problem to rely on mutual funds...go for it. You never know, it may or may not work I just think the risk is not worth it.
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Old 02-18-2008, 04:22 AM
brian brian is offline
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Default Re: Borrowing to invest

I used mutual funds as an example, simply because they are generally regarded as lesser risk for the ordinary investor, plus any half-decent fund should out perform a borrowing rate. Hence I used them to provide a conservative comparison.
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Old 02-18-2008, 06:09 AM
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Default Re: Borrowing to invest

Ok, thanks for setting the record straight....

Yes, the majority of ordinary investors looks at mutual funds as less risky but personally I think the opposite is true.

I agree with you that any half-decent mutual fund (but I think half-decent is as good as it gets in the mutual fund space) shuld outperform a borrowing rate but that would not help in your example....

The investment, as you mentioned, needs to outperform the borrowing rate on a constant base.

Are you going to execute this plan or did you just want to point out one option that investors can choose from?
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  #5  
Old 02-19-2008, 03:10 PM
Mynion Mynion is offline
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Default Re: Borrowing to invest

The key is managing the risk, and keeping costs low. Using high-quality low-cost mutual funds, index funds, and ETF's can yield results, but I'm thinking 15% may be a challenge going forward. Today's economic environment is entering new waters, and I just don't see much land on the horizon.

Also, I'm assuming your 5% loan is interest-only, otherwise it would encompass a greater than 5% annual payment of interest and principal.

The thing about making assumptions isn't when they are right, it's when they are wrong. If the portfolio dropped 25%, for example, your payments will exceed 5% that year, so your portfolio would take a bigger hit. This is why withdrawals alongside a value drop can do tremendous damage.

Many day-traders have been run out of business doing this exact technique.

Every day a dollar loses value and becomes less efficient. Therefore, any time you can strategize to get more dollars invested sooner, the more efficient those dollars are over time. $1 million invested today will do better than $2 million invested 10 years from now, assuming the same retirement date.
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  #6  
Old 02-26-2008, 04:47 PM
brian brian is offline
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Default Re: Borrowing to invest

I've been dabbling with some imaginary trades and my return over 12 months would have been 30%.

In June I would have pulled most of my stocks for gold because of the Morgan Stanley warning, and would have made an absolute killing.

I'm playing about with this as a viable strategy for the future - at present I don;t see much movement on the stock market for another 18 months, except for a slow downward trend.

In the meantime, time to really put together an investment strategy, and then watch how it unfolds in real time - even before the next economic cycle begins.
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  #7  
Old 02-27-2008, 11:48 AM
Hermes Hermes is offline
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Default Re: Borrowing to invest

Brian, the marktet hand out opportunities every single day. Old ideas will not work in a new market.

Trading on paper is a nice exercise but once you put real money into the markets it will get a bit more difficult (at first).

The success of your investment strategy should have nothing to do with the state of the markets. It doesn't matter if there is a bull or a bear market...your portfolio should always deliver.

Just out of curiosity:

Do you plan to wait for 18 months before you participate in the markets?
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Old 03-02-2008, 08:13 AM
brian brian is offline
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Default Re: Borrowing to invest

I need to get a few things organised first - planning and organisation issues - then once ready, will examine my position and see if ready.
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  #9  
Old 03-02-2008, 05:20 PM
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Default Re: Borrowing to invest

Sounds like a plan to me...
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  #10  
Old 03-03-2008, 08:08 AM
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GarySpicuzza GarySpicuzza is offline
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Default Re: Borrowing to invest

Borrowing to invest is the fast track to financial ruin.

Source LINK.

The 1920’s were a time of peace and great prosperity. After World War I, the “Roaring Twenties” was fueled by increased industrialization and new technologies, such as the radio and the automobile. Air flight was also becoming widespread, as well. The economy benefited greatly from the new life changing technologies.


As the Dow Jones Industrial Average soared, many investors quickly snapped up shares. Stocks were seen as extremely safe by most economists, due to the powerful economic boom. Investors soon purchased stock on margin.

Margin is the borrowing of stock for the purpose of getting more leverage. For every dollar invested, a margin user would borrow 9 dollars worth of stock. Because of this leverage, if a stock went up 1%, the investor would make 10%! This also works the other way around, exaggerating even minor losses. If a stock drops too much, a margin holder could lose all of their money AND owe their broker money as well.

From 1921 to 1929, the Dow Jones rocketed from 60 to 400! Millionaires were created instantly. Soon stock market trading became America’s favorite pastime as investors jockeyed to make a quick killing. Investors mortgaged their homes, and foolishly invested their life savings in hot stocks, such as Ford and RCA. To the average investor, stocks were a sure thing. Few people actually studied the fundamentals of the companies they invested in. Thousands of fraudulent companies were formed to hoodwink unsavvy investors. Most investors never even thought a crash was possible. To them, the stock market “always went up”.

By 1929, the Fed raised interest rates several times to cool the overheated stock market. By October, the bear market had commenced. On Thursday, October 24 1929, panic selling occurred as investors realized the stock boom had been an over inflated bubble. Margin investors were being decimated as every stock holder tried to liquidate, to no avail. Millionaire margin investors became bankrupt instantly, as the stock market crashed on October 28 th and 29 th. By November of 1929, the Dow sank from 400 to 145. In three days, the New York Stock Exchange erased over 5 billion dollars worth of share values! By the end of the 1929 stock market crash, 16 billion dollars had been shaved off stock capitalization.

To make matters worse, banks had invested their deposits in the stock market. Now that stocks were obliterated, the banks had lost their depositors money! Bank runs started, where bank patrons tried to withdraw their savings all at once. Major banks and brokerage houses became insolvent, adding more fuel to the bear market. The financial system was in shambles.

Many bankrupt speculators, who were once aristocracy, commit suicide by jumping out of buildings. Even bank patrons who had not invested in shares became broke as $140 billion of depositor money disappeared and 10,000 banks failed.

The 1929 stock market crash was beneficial for some, however. Jesse Livermore correctly forecasted the economic crisis and shorted. He made over 100 million dollars! Joseph Kennedy, John F. Kennedy’s father, sold before the 1929 stock market crash and kept millions in profit. Kennedy decided to sell because he overheard shoeshine boys and other novices speculating on stocks. Livermore and Kennedy were individuals are known as the “smart money”, who profit regardless if the market is skyrocketing or plummeting.

The stock market crash of 1929 launched the Great Depression. The Depression was the time from October 1929 to the mid 1930’s. Mass poverty occurred then, as many workers lost their jobs and were forced to live in shanty towns. Former millionaire businessmen were reduced to selling apples and pencils on street corners. One third of Americans were below the poverty line in the Great Depression. The Dow Jones finally surpassed its 1929 high, a full 26 years later in 1955.

The stock market crash of 1929 was identical to any other financial bubble.

The classic pattern of extreme euphoria and irrational expectations will always lead to devastating financial crashes. Learning how to identify these timeless patterns will allow you to profit whether the market is rising or falling.
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  #11  
Old 03-04-2008, 05:49 AM
Hermes Hermes is offline
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Default Re: Borrowing to invest

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.
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Old 03-04-2008, 08:27 AM
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GarySpicuzza GarySpicuzza is offline
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Default Re: Borrowing to invest

Brian wrote:
Quote:
However, if I were to take a loan out at an annual rate of 5%, invest this, and generate an average annual return of 15%, not only would I be able to cover the loan payments, I would also grow my investment super fast.

I'm presuming that investment in mutual funds is going to provide a good 15% return per year at current rates, but that the actual return could be much higher.

Surely there has to be an awful flaw in this plan, though?
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.
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  #13  
Old 03-04-2008, 09:28 AM
brian brian is offline
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Default Re: Borrowing to invest

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.
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  #14  
Old 03-10-2008, 07:18 AM
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GarySpicuzza GarySpicuzza is offline
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Default Re: Borrowing to invest

Brian wrote:
Quote:
Why invest in something that may deliver a flat 4% over the next 5 years
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.

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  #15  
Old 03-11-2008, 07:36 PM
Hermes Hermes is offline
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Default Re: Borrowing to invest

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...
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