Dear Mr. Know-it-All,
A friend recently introduced me to the stock market, but I don't have much money to work with. I'm thinking about getting loans to playing the stock field. Any last thoughts before I take the plunge?
Sincerely,
M.Y.
Dear M.Y.,
We can't help but object to the idea that you should invest on the stock market with borrowed money. Setting a time frame on any investment can be an amazingly risky maneuver. You might think you know a company that's going to be the next big play or have a company that you think will last forever, but one of the few things that I know for sure is that unexpected events can shift investor sentiment in an instant.
Not long ago we came across a British stock on a message board only to stumble upon it again about a week later on the “price-movers” list. Over the course of that week (rather the course of a single day) the price had fallen from $100 to $30. What was the reason? The company was the largest public internet gaming stock. Although previously rated to be a "solid investment" by many analysts, a sudden ruling in the US Congress that banned online gambling decimated the company overnight. Also fancy a quick look at the recent case of Bear Stearns, an investment company that has a 70+ year history. Wasn't it simply incredible that over the course of a "We're OK" and three days comfort that the company could drop from $60 to $2 (after falling from $130 over the year)?
When it comes down to it, investing should be about utilizing the capital that you have, not the debt that you owe.
Consider also what would happen if you decide to follow through with your idea. We are going to assume that you will be looking for a short-term solution, meaning you will likely have to sell your securities within a year, meaning you will also have to pay taxes for the short-term sales (taxed as ordinary income) which we're going to assume is about 20% for you. Right off the bat, you need to find securities that make back AT LEAST 20% just to break even. Add in your loan payments as a percentage to that number and it surely won't be comforting to face the challenge ahead of you. Yes, that's right. Within a year, under the short-term exit strategy that your debt will likely be engaged under, you would have to achieve a portfolio that can maintain that return percentage just to break even.
Those kind of returns can be awfully daunting based on the fact that the S&P500 typically reveals an average annual return of a mere 8-15%.
Sincerely,
Mr. Know-it-All
