In the midst of a generally upward market, as we've seen over the past 12 months or so, it's understandable to want to borrow money to get a piece of the action. And these days, getting a loan is as easy as accepting any of the 10 "pre-approved" offers you might get in the mail during a given month.
But whether you have an offer for a home equity line of credit or a chance to increase the limit on your credit card, resist the urge to try to cash in by putting these funds in the stock market. One of the Fool School's first rules is to pay off your debtbefore you begin investing (with a mortgage payment being the exception), so naturally we don't like the idea of going into debt to invest.
Granted, the stock market has been doing pretty well over the past year. Since closing at 800 on March 11, 2003, the Standard & Poor's 500 has risen more than 40%. That rocks. In fact, it crushes the historical (since 1926) average annual S&P 500 return of between 10% and 11%. But you only have to look back to 2000, 2001, and 2002 to see that the market will underperform the long-term average (and lose investors' money) just like it can post outstanding returns.
So, knowing that the stock market shouldn't be expected to return too much more than 10% on a regular basis, does it make sense to invest the cash advance from a credit card? Since credit cards charge interest rates anywhere from 9% to 29%, using one to fund your brokerage account doesn't sound too prudent.
What about a much more reasonable rate of 7% on a home equity line of credit? If you managed to get 11% on your investments, that'd be pared down to 4% off the bat. And you'd have to sell your stocks to pay back the loan, which gives you a tax hit. But more important, what if the market tanks this year? It'll come back -- but after how many years of interest payments on your loan?
When most investors borrow money to buy stock, they use margin -- i.e., they borrow money from their brokers. The interest rate is usually much lower than the rates charged by credit card companies, but it still can be risky. See Should You Borrow to Buy Stocks?
Be smart. Invest money that you have saved and can afford to put away for at least five years. Don't be lured by the enticement of quick riches in the stock market and put yourself in double jeopardy. Don't be a speculator, especially with money that isn't yours. Investing is a life-long process of owning great companies, so take the time to do it right -- even if that means a little at a time.
Finally, if you want to invest, but think you don't have enough cash to get started, start "Dripping." Dividend reinvestment plans (Drips) and direct investment plans let you buy into companies with very little money up front. Check out our Drip area to learn more.