The Nerve-Racking Way to Clobber the Market

Investing has been a scary proposition for quite a while now. But given how successful true contrarians have been with their investing, you might want to consider becoming more aggressive with your investments.

There's been no shortage of bad news to worry about lately. Oil spill-related news has largely overshadowed European problems in recent days, but many still expect another shoe to drop in the EU's sovereign debt crisis. Here at home, all the same arguments about budget deficits, higher taxes, and the eventual end of government stimulus and its impact on the economy still hold true as well.

But at some point, expectations can't get any lower. When sentiment hits rock bottom, even if bad news keeps coming, no one's surprised; but if the unexpected happens, and things turn out better than the worst-case scenario, investors can reap amazing results.

If you're inclined to get more aggressive with your investing, think about leveraging up your portfolio.

Boost your borrowing?
Taking on debt to invest is definitely not the right move for every investor. For instance, some investors borrow on margin against their portfolios to boost their leverage. When a stock moves against you, borrowing on margin can force you to liquidate your shares at exactly the worst time. In fact, that's what major executives at Chesapeake Energy (NYSE: CHK  ) , General Growth Properties (NYSE: GGP  ) , and Boston Scientific (NYSE: BSX  ) all learned the hard way during the market meltdown in 2008, as they all suffered margin calls after heavily investing in their own company's shares.

But right now, the interest rate environment is tailor-made for those who want to take on some leverage in their investments. Consider:

  • Margin loans are available at ridiculously low rates. Interactive Brokers (Nasdaq: IBKR  ) , for instance, offers margin loans at as little as 0.5%. Even small loans cost only 1.68%. Most brokers have tiered rates that vary depending on how much you borrow.
  • If you have any home equity, accessing it has never been cheaper. Some banks are offering home equity lines of credit at rates below 3%. Even conventional mortgage rates have been less than 5% for nearly a month. And for many borrowers, the interest on those loans is tax-deductible.

Conversely, those who avoid leverage aren't getting any reward at all for their prudence. Interest rates near 0% in some cases have savers looking at extraordinary measures to boost their yields.

If you can't beat 'em, join 'em
Borrowing to invest may be risky, but it's also the foundation of the business model for the entire financial industry. Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , and Wells Fargo (NYSE: WFC  ) are just among the biggest examples of what banks around the country are seeing. Borrowing money at low rates (in this case, from depositors) and investing it in higher-rate opportunities (making higher-interest loans to customers) has created hundreds of billions in net interest income for the aforementioned institutions.

By borrowing at relatively low rates, and buying higher-return investments, you, too, can try to profit from the same strategies that have made Wall Street rich over the years. For instance, even if their share prices go nowhere in the future, a host of dividend-paying stocks like AT&T and Philip Morris International currently pay higher dividend yields than you're likely to pay in interest on a low-rate home loan.

The risk, and how to deal
There are two problems with this strategy, though. The most obvious is on the investing side: If the investments you buy don't do well, you'll be stuck covering the losses from future earnings or other funds.

The other concern is that many currently low loan interest rates apply to variable-rate loans, meaning that they could rise if rates go up in the near future. Borrowing against a home equity line of credit at 2.75% now is fine, but if a higher future prime rate raises that to 6% or 7%, it won't work nearly as well. For the time being, though, it seems that interest rate hikes aren't imminent. Thus, you may have more time than you'd otherwise have to take advantage of this unusual situation.

Borrowing to invest isn't the most conventional financial planning advice. But when interest rates are as far out of whack as they are right now, it might actually be a smart move -- as long as you make sure you can repay the debt, no matter what happens.

What should you invest in right now? Morgan Housel points you toward five dividend stocks to buy after the crash.

Fool contributor Dan Caplinger has never been one to leverage himself to the hilt. He owns shares of Philip Morris International and Interactive Brokers. Interactive Brokers is a Motley Fool Stock Advisor pick. Philip Morris International is a Motley Fool Global Gains recommendation. The Fool owns shares of Chesapeake Energy, which is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy clobbers the competition with a smile.


Read/Post Comments (4) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 16, 2010, at 10:36 AM, lotontech wrote:

    Good article, but I have one comment...

    You say: "If the investments you buy don't do well, you'll be stuck covering the losses from future earnings or other funds."

    I say: Not if you cut your losses using well-placed Stop Orders, before they get out of hand.

  • Report this Comment On June 16, 2010, at 2:38 PM, weslindsey wrote:

    this article is probably one of the most irresponsible pieces of investing advice i've ever read on TMF

  • Report this Comment On June 16, 2010, at 2:59 PM, brewersfan81 wrote:

    Wow, I'm shocked that TMF would really publish an article that even hints using leverage.

  • Report this Comment On June 25, 2010, at 11:50 AM, goblinmason wrote:

    LOL. Thanks for the chuckle.

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