Author Topic: Borrowing to invest in an index fund  (Read 2401 times)

JMS

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Borrowing to invest in an index fund
« on: November 08, 2019, 05:53:14 PM »
Hi there

My wife and I are thinking about whether we borrow to invest in an index fund and Iím very keen to hear thoughts on this from the community. 

Our situation is that we are mid 30s and expecting our first child.  We have a fully paid off house and are currently investing any surplus from our earnings into an index fund. 

I wonít go into too much detail but i have a business investment I can borrow around $300k against at about 4% per annum.  This would be tax deductible and able to be invested in the index fund.

Obviously this adds risk but the low cost of debt and deductibility is attractive. 

Thanks for your thoughts.     

js82

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Re: Borrowing to invest in an index fund
« Reply #1 on: November 08, 2019, 07:56:20 PM »
If this were mid-2009 when stocks were cheap, I'd consider it.

Right now, stocks are relatively expensive by historical standards, and as such the risk-reward ratio for taking out a loan to buy stocks isn't all that great (in my personal, non-professional opinion).

ChpBstrd

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Re: Borrowing to invest in an index fund
« Reply #2 on: November 08, 2019, 08:40:36 PM »
Between 40 and 10 years ago, that would be an outstanding deal. Hell, in 2006 I had an online savings account yielding 5.5%. I would have borrowed millions at 4% if I could. Those days are over. Instead of a savings account, you'd now have to buy junk bonds to earn 5.5%, and with yields so low those non-investment-grade investments could collapse at any moment.

Plus, there are cheaper ways of getting leveraged. I just refinanced my house at 3.5%. You could also buy LEAPS call options on SPY for a tenth of what you'd spend buying the actual ETF, and enjoy limited downside too.

Bottom line: not advised.

JMS

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Re: Borrowing to invest in an index fund
« Reply #3 on: November 08, 2019, 10:09:20 PM »
If this were mid-2009 when stocks were cheap, I'd consider it.

Right now, stocks are relatively expensive by historical standards, and as such the risk-reward ratio for taking out a loan to buy stocks isn't all that great (in my personal, non-professional opinion).

The business investment currently returns 11.5%.  Or 7.5% if I borrow against it.   Therefore all the index fund needs to return is in excess of 3% which is pretty tempting
« Last Edit: November 08, 2019, 10:20:17 PM by JMS »

Malcat

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Re: Borrowing to invest in an index fund
« Reply #4 on: November 09, 2019, 04:10:26 AM »
You have a paid off mortgage and you are asking about leveraged investment.

I don't get it.

Indexer

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Re: Borrowing to invest in an index fund
« Reply #5 on: November 09, 2019, 05:32:18 AM »
The rate is good, about the same as many people's mortgages, and there are plenty of people here(myself included) who choose to pay the minimum on their mortgage so that they can invest more instead of paying the mortgage down faster. Summary: many people here are already doing this to some extent.

Would I personally borrow 'more' in 2019 to invest?  For the same reasons that others have mentioned, probably not. Markets are impossible to predict in the short term with certainty. That said, we are also 10 years into a bull market, and that could last for another 10 years.... but that has never happened before. I would say the odds are higher that we are in the late stages of this business cycle than that this market will keep going for another 10 years without a recession. I'm not making a prediction that there will be a crash, just acknowledging we likely have over 50% odds of one within the next 5 years. I'll keep buying in every month because they are hard to predict, BUT I personally wouldn't add leverage unless there was a major downturn first.


The business investment, how safe is it? I'm not asking if it's a good company. I'm asking how safe your investment is if it turned out that the company wasn't solid? It happens... (Example: Wachovia, even the Fed thought it was a solid bank and asked it to bail out Lehman Brothers, only to learn Wachovia had it's own problems. You don't know what you don't know.) Is this investment protected if the company ran into problems? If no, what happens if you borrowed 300k and then the investment fell in value? Is this a situation where you would need to put the money back?  If so, you don't want to be in stocks, which can drop 50% in a recession, which is likely the exact same time any business is going to learn if they are solid or not.

Buffaloski Boris

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Re: Borrowing to invest in an index fund
« Reply #6 on: November 09, 2019, 07:19:49 AM »
Leverage kills.  This is a very long bull market powered by central banks making credit very cheap.  It's kept going on for 10 years. It could go on, sure.  I'm in the minority here in saying I think that the US based cap weighted index funds are expensive and I see a lot of FI folks setting themselves up for a facepunch by being heavily invested in them.  That's their choice.  Mine has been to mostly stay away from US equities, stick to hated industries for my "fun" portfolio, and increase international index exposure. And to not touch corporate bonds with a 10 foot pole.  Otherwise, cash isn't all that that bad a place to be.  The best "investments" I see right now for me and mine are things like putting a solar array on the house, installing insulation, taking advantage of tax advantaged investments, and making expenditures that will cut costs in the long run. As for debt, I see paying it off as more attractive than incurring it.

JMS

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Re: Borrowing to invest in an index fund
« Reply #7 on: November 09, 2019, 10:59:35 AM »
I appreciate all of the responses thank you.   This effectively confirms what we were thinking and what we have been doing.  It was just sitting in the back of my mind the question "should be take advance of cheap debt and try and accelerate our FIRE" but as everyone has rightly pointed out perhaps this isn't the right time in the business cycle.

Cheers
JMS

dandarc

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Re: Borrowing to invest in an index fund
« Reply #8 on: November 09, 2019, 11:11:44 AM »
Are you in the US? If so, leverage the house first - under 4% for 30 years at a fixed rate is a great deal. Just made this move myself.

Borrowing against the business - what are the terms of the loan? Business debt can be callable, shorter term, have adjustable rates. Terms of the loan could make it a much riskier move than borrowing against the house.

If you're not in the US, then I can't provide advice as I don't know the typical mortgage terms.

chasesfish

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Re: Borrowing to invest in an index fund
« Reply #9 on: November 10, 2019, 05:01:05 AM »
What is the collateral for the loan?  Who is the borrower and do you have to guarantee the loan if the business is the borrower?

How much of your wealth is tied up in this business asset?

My answer would usually be no, but I'm a bit curious what your diversification looks like.

Leisured

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Re: Borrowing to invest in an index fund
« Reply #10 on: November 10, 2019, 05:13:07 AM »
Of course you should borrow to invest in productive assets! The only question is how much should you borrow.

When I was 14, I learned that a local dentist had paid off the family home, and had then borrowed to buy a rental property. The interest was tax deductible, and the tenant's rent helped pay off the mortgage on the rental property, so he then borrowed again to buy another rental property. He now had two tenants paying off the mortgage on the second rental property. Repeat the process.

That was my introduction to investment. I thought 'just like that'.

In Australia we had, and maybe still have, a managed fund that is leveraged. The rules are that the higher the interest rate, the less the fund borrows to buy stock, and the higher the dividend yield, the more the fund borrows to buy stock. I do not remember the name of the fund.

You can copy this strategy. Other posters have suggested that this is not a good time to buy an ETF, because P/E are high and dividend yields low. But interest rates are low, so I suggest modest borrowings. I suggest a loan that you can readily afford to service. It might be $50K or even $100K. The ETF will pay dividends, which will offset your loan servicing, and the interest is tax deductible. Once you have paid down the loan on the ETF, borrow and buy another ETF. You now have dividends from two ETFs helping pay down the loan on the second ETF.

If there is a large fall on the stock market the value of your ETF will fall, but what will be the effect on dividends? My experience is that companies still pay dividends even if market sentiment turns against them. The question is, can you continue to service the loan? You do not benefit from high stock prices: you benefit from a dividend stream.

My teenage years dentist apparently did not understand the stock market. Otherwise, his strategy was sound.
As Warren Buffett has said, it is hard to go broke betting on the American economy.


shinn497

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Re: Borrowing to invest in an index fund
« Reply #11 on: November 10, 2019, 10:24:56 AM »
This may seem like a good idea on paper. But, in practice, behing highly leveraged sucks to go through. You can easily find yourself in a situation with guaranteed leverage payments and non guaranteed investment returns.

It should also be stated that there is no proof that borrowing to invest increases your expected returns. But there is a ton of evidence that it increases the dispersion in possible returns. Think about that for a second. Investment already has rick. Even if you are properly diversifeid, there is a small risk that over the long term you do not make a higher return in the market vs T-Bills. Leveraging increases and worsens the negative possibility, without increases your expected possibility.
« Last Edit: November 10, 2019, 10:27:10 AM by shinn497 »

MaaS

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Re: Borrowing to invest in an index fund
« Reply #12 on: November 10, 2019, 09:57:03 PM »
Taking leverage to invest in the longest bull market of all time is absolutely insane.

Don't do this.

Please don't do this.

Going off your age, I assume you didn't have significant amounts invested before the GFC. You have no idea (neither do I, for that matter) how you'll react if you lose half on leverage.

shinn497

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Re: Borrowing to invest in an index fund
« Reply #13 on: November 10, 2019, 11:55:02 PM »
I would not look at current valuations in order to avoid a market timing mindset. It is just a bad idea to borrow to invest ever, even when you have collateral. The issue is that there is no evidence that borrowing increases your expected returns. It just increases the dispersion in possible returns (which is why there are so many stories of it creating rich people).  In a sense, it achieves the opposite of diversification.

vand

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Re: Borrowing to invest in an index fund
« Reply #14 on: November 11, 2019, 03:08:00 AM »
Do It.
Nothing can possibly go wrong.

ChpBstrd

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Re: Borrowing to invest in an index fund
« Reply #15 on: November 11, 2019, 09:09:12 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

frugalnacho

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Re: Borrowing to invest in an index fund
« Reply #16 on: November 11, 2019, 11:26:40 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

What a fucking ride!

RWD

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Re: Borrowing to invest in an index fund
« Reply #17 on: November 11, 2019, 12:08:02 PM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

Haha, you beat me to it.

JMS

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Re: Borrowing to invest in an index fund
« Reply #18 on: November 12, 2019, 03:09:04 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

Crazy.  Thanks for posting.  Reading that made me feel somewhat sick. 

vand

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Re: Borrowing to invest in an index fund
« Reply #19 on: November 12, 2019, 03:23:42 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

Classic. Everyone has an "uncle" point. Even if they say they don't.

Buffaloski Boris

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Re: Borrowing to invest in an index fund
« Reply #20 on: November 12, 2019, 09:54:11 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

OMG. I read what I could stand. That was like watching a horror movie unfold. ďA Nightmare on Wall Street.ď All it needed was a screaming girl for effect. 😱

Malcat

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Re: Borrowing to invest in an index fund
« Reply #21 on: November 12, 2019, 10:28:45 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

Fucking hell...

Well, that ate up my whole morning

vand

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Re: Borrowing to invest in an index fund
« Reply #22 on: November 12, 2019, 11:53:20 AM »
The guy was clearly smart, but that counts for nothing when he has zero respect for managing risk.

This is very well written blog by Morgan Housel along the same lines - numbers on paper until a stress test scenario don't tell you how it feel when you are sitting on losses that are equivilent to a decade's work. Only having lived through it and experienced it for yourself can you know in your bones what you should and should not be doing:

https://www.collaborativefund.com/blog/you-have-to-live-it-to-believe-it/


talltexan

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Re: Borrowing to invest in an index fund
« Reply #23 on: November 12, 2019, 12:18:08 PM »
You can be right about the average return, but get the tolerance for risk wrong and lose money.

You can be right about the price five years from now, but not be able to handle the path it takes to get there from today.

powskier

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Re: Borrowing to invest in an index fund
« Reply #24 on: November 12, 2019, 10:43:09 PM »
Keep the option available for the next time all the talking heads are yammering about the crash/recession and everyone is crying in the street.

ROF Expat

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Re: Borrowing to invest in an index fund
« Reply #25 on: November 13, 2019, 02:46:44 AM »
If this were mid-2009 when stocks were cheap, I'd consider it.

Right now, stocks are relatively expensive by historical standards, and as such the risk-reward ratio for taking out a loan to buy stocks isn't all that great (in my personal, non-professional opinion).

The business investment currently returns 11.5%.  Or 7.5% if I borrow against it.   Therefore all the index fund needs to return is in excess of 3% which is pretty tempting

Is that 11.5% return likely to be stable?  Is it at substantial risk?  Is it a major part of your portfolio?  Can the loan on the business investment be called?  In some circumstances, I could see taking the loan to hedge your positions.  Otherwise, I'd probably just enjoy my 11.5% return.  Could you find yourself in a position where you borrow the money, invest in index funds, the market drops by 30% and your loan gets called?  I wouldn't take much risk for the potential return over a 4% loan cost when the US markets are at an all-time high.  Would you buy an index fund with a 4% annual fee? 

talltexan

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Re: Borrowing to invest in an index fund
« Reply #26 on: November 13, 2019, 07:02:21 AM »
Read as much of the following as you can stand, noting the dates:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

I make myself read that discussion once per year. It's amazing how my tolerance for risk has decreased since I started that exercise.

Unfortunately, the market has done well over the last 1,000 days, so I would have done quite well if I'd levered in October 2016. But I've slept easily.

vand

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Re: Borrowing to invest in an index fund
« Reply #27 on: November 13, 2019, 09:34:01 AM »
Here is the thing when employing leverage... everyone assumes that even if the trade goes their way, they will be able to remove all emotion from the trade and sit tight as the market marches higher and they watch their millions roll in.

Emotionally, it doesn't work like that.

The old advice "cut your losses, let your winner run" arises because people are WAY too quick to take their profits when a trade goes in their favour. Conversely, when the trade goes against them, instead of quickly cutting their losses they sit on them and let them grow and grow, hoping that the market reverses back in their favour. Letting your winners run is the simplest advice in the world, but it is also the most difficult thing to do in practice.  Trading (for that is what we are talking about) is not a mathematical problem to solve, it psychological and emotional war with whoever is taking the other side of your trade.