Ask Money

Borrow to buy?

Chris Farrell Oct 28, 2008

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.

We’re here to help you navigate this changed world and economy.

Our mission at Marketplace is to raise the economic intelligence of the country. It’s a tough task, but it’s never been more important.

In the past year, we’ve seen record unemployment, stimulus bills, and reddit users influencing the stock market. Marketplace helps you understand it all, will fact-based, approachable, and unbiased reporting.

Generous support from listeners and readers is what powers our nonprofit news—and your donation today will help provide this essential service. For just $5/month, you can sustain independent journalism that keeps you and thousands of others informed.