Q: Stocks generally return 9%-10% per year over the long run, and I can get a home equity line of credit (HELOC) with 5% interest. Doesn't this make it a good idea to borrow money to invest in stocks?
It is generally not a smart idea to borrow money to invest in the stock market, even if you can get a low interest rate.
If the stocks you invest in go up by 9% per year forever, and you're paying 5% interest on your debt, this would certainly be a money-making idea. The problem is that stocks don't go straight up forever.
If stocks perform poorly, your strategy can fall apart. You're stuck making payments on your HELOC no matter what the stocks you buy do. If you borrow $20,000 to invest in a S&P 500 index fund and the market plunges by 50%, your investment will only be worth $10,000. Meanwhile, you still owe your bank $20,000 and the interest keeps running -- and it can take years for the market to come back, as anyone who invested before the market meltdown of 2008 knows firsthand.
The other problem with this is that home equity lines of credit are generally variable-rate loans with interest rates tied to the prime rate. If rates increase by 2%-3% over the next few years, as they are widely expected to do, it could increase your borrowing cost to 8% or more, meaning that the returns you would need to generate just to break even would need to exceed this.
In short, the possibility of increasing your investment returns is simply not worth putting your house at risk.
