A reader who borrowed to invest recently is having second thoughts.
He used his home equity line of credit (HELOC) to buy mostly dividend stocks, but also some speculative mining shares. “Is it a good move to borrow using my HELOC to buy stocks?” he wrote. “I did so and I’m not sure if it was the right move.”
I doubt anyone ever borrowed to invest and didn’t have doubts like this at some point. Leveraging, as borrowing to invest is known, is about harnessing risk to improve your returns. Using borrowed money helps magnify gains over what you’d make if you used only your own money, but also your losses.
The best time to invest with borrowed money is in a market downturn like we had in March. The worst case for a leveraging investor is to buy into the market and then have stocks fall later on. In a market crash, you can take some comfort from the fact that stocks are already down a lot in price.
The pandemic may be a unique situation for leveraging, though. Usually in stock market downturns, investors must grapple with financial and economic variables to assess the prospects for gains ahead. Today, there’s a third element in this analysis – the virus and its impact on public health.
If it takes longer to revive the economy than investors expect because the virus persists, we could see another big downturn in stocks. The trap in leveraging is losing your nerve and selling your stocks for less than you paid. Instead of building wealth, you damage your finances in a worse manner than if you were using your own money.
If you’re financially secure, comfortable with market ups and downs and can afford to be patient, then using a HELOC to buy stocks now might work out for you. Make sure you have an exit strategy – a plan to sell when your portfolio of borrowed stocks reaches a certain value. Also, you have to be fine with carrying the interest costs of the HELOC, which must be paid on a monthly basis (you can repay the principal at your discretion, provided your financial situation remains stable).
Now for the realist’s take. There will almost certainly be some nerve-wracking moments ahead for a portfolio of stocks bought on leverage, particularly speculative investments. Even dividend stocks could get hit, as some did in March. Already, a significant number of dividend payers have had to cut their cash payouts because of the economic slowdown.
We all have a lot of stress in our lives right now. Do you really want to add to it by borrowing to invest in stocks?