Has anyone here borrowed money to i.e. buy mutual funds, stocks, mortgage etc. I know a lot of companies use debt as leveraging? I borrowed money to invest in mutual funds. I know this will be risky, but companies do it, why cant your individual investor do it. I think is all about money management, and using debt for things that will increase in value.

Anybody who has debt and investments has effectively "leveraged" their money. Sure the debt may have not been taken out specifically for the investments, but debt is debt. By putting money in the market instead of paying off debt is the same thing as borrowing to invest.

For most people it's reasonable to carry a mortgage @ 6% while making 10% in the market. On the other hand if you have a CC @ 18% or a double digit car loan, pay those off before investing in the market..

I agree- technically, DH and I borrowed to invest when we bought our house. We'd moved from a very high COL area and sold 2 houses (just married) and bought one in a much lower COL area and could have paid cash. I chose instead to put 20% down and take out a mortgage. This was 2003 and I wish I could tell you it was a brilliant piece of market timing, but it was more a conviction that over the long run, we'd make more in the market than we were paying on our under-5% fixed-rate mortgage.

Would I borrow all the equity in the house to invest if I had no other cushion, or take out an unsecured personal loan? Absolutely not. The behavior of the market over the last month ought to be enough to convince anyone that what goes up can come down.

Its done all the time. The major issue involved is you need your gains to outpace the interest rate you are paying on that money. Most brokerages are currently charging 11% or so for margin interest, and you can figure roundabout that much to loan other money as well. The S & P 500 historically doesn't gain 11% per year, its more like 8-10%. So yes it can be done, but you really have to know what you're doing to make a profit.

Hi tman!

Agree that using businesses using debt is pretty common. We do that in our rehabbing business.

We buy foreclosures and need cash to Close and rehab, but since the homes are often unmortageable when we purchase them, we use the equity built up in the rentals that we already own. We have 2 LOCs on the rentals and use the $$ to buy more homes.....Steady work.

Is it risky? Potentially, yes. Since what we buy is usually in pretty bad shape there will always be some risk. Do our banks care? Not really....they always want to extend us more $$$ once they see our Financials.

Take care,
Skipper

Hi Skipper

I've taken advantage of 0% promo rates from several credit card companies, and BTd as much as possible into my Vanguard MF account. To date I am up 16%, so it has worked so far, on paper at least. Haven't sold anything yet though, so tomorrow I could lose all my money. I became really concerned a month or two back when the market dipped, but I never went negative. It's looking good for the time being, we'll see how the market behaves...

I've been using my GI bill to pay the minimum monthly payments, so I'm also using this as kind of a savings plan. Overall I've been very happy with my results, but as everything in life, YMMV.

I actually did the same thing, and I'm doubling up on my monthly payments. I use Trowe Price, and my accounts are still looking good. I Dollar cost average every month to these accounts which helps keep it steady. You just have to make sure your mutual fund accounts return more than the interest on your cc.

One of the issues you need to look at is the return after fees and taxes. If you still think you will clear a profit over and above your finance charges then you are in business. Otherwise it is a gamble.

It is possible to do better than your low interest debt but you want to go in with your eyes wide open. Certainly not a recommended strategy for the faint of heart or those with out some investment experience. Do your homework and do your math and you will be fine.

Good luck!

Annuit,
How are you using GI Bill to pay this?

saladdin

They pay you based on the number of units you are taking. They just direct deposit into my checking account. Right now I'm getting about $1,000 a month, but I only spent $500 on tuition and books for the semester. Gotta love community colleges

If my mutual funds can't return better than the 0% promo interest on my credit cards, well that would just suck.

I'm coming up on the last few months of the promo offer on most of the cards. Once I am in the last month for each card I'm going to cash out the MFs and pay it off. I refuse to pay any interest! Except on my mortgage, but that's a different story...

http://www.forbes.com/investoreducation/20...opedia_inl.html






In the mortgage banking industry, property owners that owe more than their properties are worth are described as being underwater. If the value of a real estate asset is less than the associated mortgage debt, when owners sell their properties they are left owing money on the mortgage.

Similarly, after the Nasdaq crash, many employee stock options were referred to as being underwater because the stock price had fallen below the exercise price, leaving employees with no incentive to exercise their options.

Mortgaged real estate and employee call options are both leveraged investments, which can be a powerful tool for building wealth when asset prices rise, but in a falling market, an investor's equity can be quickly wiped out. Despite this, these investments still have some value based on the possibility that asset prices can recover from their previous losses.


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In this article, we'll follow a leveraged investment as it builds equity, loses value, goes underwater and then recovers. An understanding of this process is critical for investors who use mortgage debt, margin debt, long-term call options or other similar financial derivatives to build wealth. (For related reading, see ” Barnyard Basics Of Derivatives.”)

Equity Formation
Leverage aims to use borrowed money to build equity by investing it at a higher rate. For example, if we can borrow $10,000 at 5% and invest it at 10%, we can make the difference between the investment gains and the interest, or $500, as long as the opportunity lasts.

Einstein once quipped that the most powerful force in the universe is compound interest. Large profits are made when the assets in a leveraged investment compound at a higher rate than the debt over a long period of time. The above investment compounded for 10 years will generate $9,648.

Assets
$10,000 x (1+10%)^10 = $10,000 x 2.5937 = $25,937

Debt
$10,000 x (1+5%)^10 = $10,000 x 1.6289 = $16,289

Equity
$25,937 - $16,289 = $9,648




The compounding investment gains provide an extra $5,937 ($25, 937 - $20,000) during the 10-year life of the investment and compound interest adds an additional $1,289 (16,289 - $15,000) of debt.



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Note that if the investor is able to pay the interest out of pocket over the life of the investment, he or she can prevent the interest from compounding and save money. For example, this might mean regularly paying the interest on a margin balance.

The Leverage Ratio and Volatility
Leveraged investments have a starting equity and a specific leverage ratio based on the amount of equity compared to assets. For example, $1,000 of an investor's equity could be supplemented with $2,000 of borrowed capital to create an investment with three times the leverage.

The leverage ratio is useful shorthand for calculating percentage changes in equity based on a percentage change in assets. For example, if our underlying investment gains 10%, the equity in our three-times leveraged investment should increase by 30%. However, the leverage ratio doesn't factor in the cost of debt and isn't necessarily accurate for long time periods.

The volatility of the underlying assets can be multiplied by the leverage ratio to find the volatility of the equity. For example, a three-times leveraged investment will have three times the volatility of the same unleveraged investment. (For related reading, see ”Price Volatility Vs. Leverage.”)

Increased volatility is what pushes leveraged investments underwater. Every volatile investment has a chance to lose value, and when the volatility increases, scenarios that reduce or wipe out an investor's equity become much more likely.




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Example: Negative Compounding
Suppose that we make a three-times leveraged $1,000 investment in an index fund with roughly 10% annual returns and 15% annual volatility. The interest rate on borrowed money is 5%.

On average, we would gain $200 in the first year (($3,000 x 10%) - ($2,000 x 5%)), based on $300 worth of capital gains minus $100 in interest. However, an extremely wide range of returns is possible for our investment. We can predict possible scenarios using a standard distribution of returns based on statistical probabilities.

For example, 68% of the time we would expect our asset returns to be within one standard deviation of 10%, or between -5% and +25%. That leads to a range of equity returns of -25% to +65%. That's a lot of unpredictability. Also, 34% of the time the return on our investment would be outside that range, potentially returning +110% or –70% in the first year.

--
% Asset Returns
% Equity Returns

Expected Result
+10%
+20%

68% of results (1 std dev)
-5% to +25%
-25% to +65%

95% of results (2 std dev)
-20% to +40%
-70% to +110%

99.7% of results (3 std dev)
-35% to +55%
-115% to +155%




While it is still unlikely that all of our equity could be wiped out in the first year, it is easy to see how it could happen after a few years of poor investment returns. Given the above probabilities and using Monte Carlo methods, we can calculate that our investment would be underwater about 4% of the time after five years, and 3% of the time after 20 years. (For more on this method, see ”Introduction To Monte Carlo Simulation.”)

Let's say that our fund loses 20% in the first year, which results in a 70% loss of equity. Of this loss, 60% is due to the 20% fall multiplied by three-times leverage, and 10% is a result of interest payments, although in this example we'll accumulate our interest.

--
Starting Point
After 20% Drop

Assets
$3,000
$2,400 (fell $600)

Debt
$2,000
$2,100 (rose $100)

Equity
$1,000
$300

Leverage Ratio
$3,000/$1,000 = 3x
$2,400/$300 = 8x

Expected Asset Gains
$3,000 x 10% = $300
$2,400 x 10% = $240

Interest Due
$2,000 x 5% = $100
$2,100 x 5% = $105

Expected Profit
$300 - $100 = $200
$240 - $105 = $135

Expected ROE
$200/$1000 = +20%
$135/$300 = +45%

Volatility of Equity
15% x 3 = 45%
15% x 8 = 120%




After the 20% loss, our leverage ratio increases from three-times to eight-times because we now have less equity in the investment compared to total assets. This sharply increases our expected return on equity and our expected volatility. (For more insight, see ”Keep Your Eyes On The ROE.”)

Even after this loss our investment could still recover, but given the razor-thin equity, it is also very possible that it could be pushed underwater. Although the probabilities slightly favor recovery, either scenario is likely,


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Recovery
The gradual compounding of our investment gains is the tool that creates equity in a long-term leveraged investment. However, the volatility of the risky asset also has the potential to negatively compound the investment. Situations in which the asset is compounding at a negative rate but the debt is compounding at a positive rate lead to underwater investments.

However, in every time period our assets are still more likely to compound positively than negatively. This makes it statistically likely that our leveraged investment will recover, given time. This is true even when the expected return is low or negative, because as the leveraged investment accumulates assets, the expected return will eventually turn positive and the losses will be erased.

Still, this could take a long time. In the above example, if the level of debt ever gets to the point where it is 50% higher than the level of assets, then the investment is at least 10 years away from profitability, on average, and future negative returns would make this recovery period even longer.

Rewarding Patience
Even though leverage is often seen as a "get rich quick" tool for short-term speculators, it is clear that leveraged investments reward both patience and thoughtful diversification.

There is always reason for optimism in a leveraged investment. Whenever investment returns are expected to accumulate faster than interest payments, simply holding the investment for a long period of time should, on average, create large amounts of equity. This is still true even after years of heavy losses.

And although we've shown a situation in which a string of poor investment returns pushes a leveraged investment underwater, note that the reverse is also possible. A series of above-average returns can help a leveraged investment build vast amounts of equity very quickly.

When a leveraged investment gains a lot of equity, the appreciated assets continue to compound over time, but the leverage ratio falls, which makes the investment both more valuable and less volatile. This is a very good situation for an investor to be in, and the high returns generated can make up for several underwater investments.

http://www.lendingtree.com/smartborrower/M...m-leverage.aspx

Build wealth: Profit from leverage
Borrowing to invest can be an effective way to build wealth. But it's important to understand the risks as well as the rewards.
Just because you can afford to pay cash to purchase an investment doesn’t mean you should. You may want to preserve your capital to use for other purposes, or you may want to borrow funds in order to benefit from the affects of leveraging. This can be a very effective strategy. However, it’s not for everyone.

In some ways, leveraging turns traditional investing on its head. For example, a typical investor might contribute $200 to his or her portfolio and watch it grow gradually. An investor using leverage, on the other hand, might borrow $25,000, invest all of it right away, and then pay the loan back over 15 years at $200 a month. This strategy is riskier, but it’s potentially more rewarding.

What are the benefits of leveraging?
People who borrow to invest do so for two main reasons. The first is to magnify the effect of compound interest by having the largest amount of money invested for the longest possible time. Investors who start from zero and save $200 month will have to wait several years before their portfolios really begin to snowball. By borrowing $25,000 and being “fully invested” from day one, a leveraged investor can potentially start earning considerably greater returns immediately.

Of course, this is assuming the chosen investments appreciate in value. Also, the returns will be offset by the amount of interest being paid on the loan. But over the long term, leveraging may still pay off even if the investment returns are less than the interest rate on the loan. This is due to the other benefit of leveraged investing: The possible tax savings. For example, a popular way to use leverage is to take out a home equity loan. Because this is a type of mortgage, the interest you pay may be tax deductible, which can significantly reduce the cost of borrowing.

What are the risks?
It’s critical to understand that the same characteristics that make leveraging potentially profitable also make it more risky. Just as your returns will be magnified, any losses will also be correspondingly greater.

If you invest $25,000 of your own money and your portfolio drops in value to $15,000, after 15 years, you’ve lost $10,000. But if you borrowed $25,000 to purchase that same portfolio, you’re out of pocket much more. If, for example, you paid for your investment by taking out a home equity loan with a 15-year term at 6.5 percent, you’ll also have paid $14,200 in interest. Bottom line: Your total loss is $24,200 ($10,000 + $14,200) -- almost 150 percent more.

Using an adjustable rate home equity loan to invest also means that any time interest rates rise, your cost of borrowing will increase. Sometimes your investment returns will go up to compensate, but sometimes they won’t. In addition, some loans may be subject to a “margin call.” This means the lender can require you to pay back the loan principal in full at any time, possibly forcing you to sell your investments at a loss and to find another source of funds to make up the difference. In a worst-case scenario, if you can’t afford to pay back the loan, you could even lose your home.

Who is leveraging right for?
Leveraging is a strategy best suited to affluent, experienced investors. You need to have the excellent credit necessary to qualify for a low-interest loan and the knowledge needed to make wise investment choices. You must also be able to absorb any potential losses that can come with this strategy.

You don’t have to be wealthy to use leverage, but you must have a healthy cash flow. You should be able to comfortably cover your mortgage and car payments, for example, before you even think about adding an investment loan to the mix.

Finally, you should have the stomach for leveraged investing. That means a high tolerance for risk and a long investment horizon. Leveraging is not a get-rich-quick scheme; most leveraged investors think in terms of 10, 15 or even 20 years.