Why Buying Stocks On Credit Is A Bad Idea?
Nowadays, some investors choose to buy stocks by taking out a loan or credit cards, is buying stocks on credit a bad idea?
With a good mix, a stock investment brings at least 6% in value over the long term. Again and again, stock exchanges provide opportunities that require immediate access, such as in the run-up to corporate takeovers.
Jumps of 20% or more are hard to miss. Even more exciting are investment products with a lever in which the profits multiply accordingly.
Borrow and buy stocks?
However, equities cost money and leverage products require a margin to the provider. So what if your own cash reserves are tight or otherwise fixed? Of course you could borrow and buy stocks. After all, the interest rates are so low that they fade completely before the development of some stock market racers.
For example, over a five-year period, the price of Amazon rose over 700% and Facebook 500%. Other examples, 5G is extremely hot right now, AAOI rises over 1000% since its IPO in 2013. Acacia even managed almost 600% in 5 months alone. This turned $2,000 into $12,000 – in just five months. Taking out a loan and buying stock of it seems only logical in view of these proportions.
But who can predict the future when he gets in? Often it is too late for more top profits. In the examples mentioned: Acacia dropped more than 500% from the top. Nor can the trees grow endlessly in the sky at Amazon. And who knows how Facebook continues after the data scandal?
High added value required
Stocks are always a risk. If their value drops unexpectedly, the full loan amount plus interest must still be repaid. For leveraged paper threatens even total loss. Nevertheless, it is not absurd to speculate with borrowed capital. It depends entirely on the individual case. A installment loan, with the house and yard are at stake, is definitely not a solution.
At most, experienced investors with sufficient financial support would be subject to a security loan. Here, the own deposit serves as a security deposit, but with discounts. Even solid stocks of large corporations are being loaned between 50% and a maximum of 80%. However, the loan interest can not be deducted for tax purposes. In addition, one must deduct from the appreciation of the shares the taxes due on sale.
Star investor Buffett also strongly advised against
Overall, the risk is very high that a loan leads to a downward spiral. Especially when losses in the loaned depot in value loses, more and more money is borrowed and the debt grow.
“With the pressure no one makes a right decision,” says even star investor Warren Buffett . With the rise in US securities lending, he recalled in the annual shareholder letter earlier massive falls in share prices at his otherwise successful investment firm Berkshire Hathaway . The past can be repeated at any time.
What many people are unaware of is that stock losses are not as easy to catch up as it seems. After each setback, a stock must work its way up from the lower level. If it falls by about 50%, it will of course be listed at 50% of its previous value. If you increase it from there by 50%, but compensated only 75%.
Because 50% of 50 are 25. For a complete compensation but the paper would have to catch up 100%. The lower the price falls, the more he has to grow disproportionately. Anyone who realizes this effect is unlikely to buying stocks on credit.