Borrow to buy?
Question: The stock market meltdown that we're facing today looks like one of the best stock buying opportunities that I am likely to face in my lifetime. I don't have a lot of spare cash, so I'm considering borrowing some money to buy some mutual funds. I'm 34, have a stable job in a good company. I have a 30-year fixed mortgage and a HELOC that currently offers an interest rate of 5.25%. I don't have much debt other than a car loan that I'm paying down. I am going to school part time on a student loan. I'm thinking about taking $4,000 or $5,000 out of the HELOC and buying an index fund or a financial sector fund. What do you think? Patrick, Atlanta GA
Answer: Big mistake. Yes, stocks may offer a high potential return, but only by taking on a considerable amount of risk. Remember, stock market returns are not guaranteed, but you will have to meet the interest payments on your loan no matter what--or put your house at risk. Borrowing on your home to invest in the stock market is always a bad bet. And in the current environment people need to be paying down debt, not adding to it.
That said, you could be right about the stock market. I don't know when or where the stock market will hit bottom, but there is value in the market. And there was a spectacular raly today of some 11%.
Warren Buffet, the famous stock picker, is buying. So is Marty Whitman, another well-known value investor of Third Avenue Management. Jeremy Grantham, the legendary investor at Boston-based GMO told Business Week that stocks are now cheaper than they've been since 1987. "You are looking at the best prices in 20 years, and you should be making 7% to 8% to 9% real [inflation-adjusted] returns," he said. "The last time I was this optimistic was in the summer of 1982."
These three long-time investors have built sterling money making reputations over a long period of time. Here's what Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, told me in a recent interview: "We can, however, look ahead and make reasonable predictions. In the bond market, we know with 90% probability that return in the next 10 years will be 4.5% to 5%. That's the historical number. If we have huge inflation and a Great Depression, and lots of bonds default--this is why I like Treasuries--then that's something else again. In stocks, we know the sources of stock returns. Dividend yield is almost 2.5%, and earnings growth from these levels ought to be 6% over the next decade. That's an 8.5% return."
Grantham notes that when bubbles burst markets historically overcorrect by a lot. Your idea is a reasonable bet. But don't borrow the money. Use cash.