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Why This is No Time to Borrow “On Margin”

Stock-Markets / Financial Markets 2012 Oct 28, 2012 - 01:23 PM GMT

By: Investment_U

Stock-Markets

Alexander Green writes: With stocks near a three-and-a-half-year high and interest rates dirt cheap, this might seem like a good time to borrow against your stock portfolio.

Then again… perhaps not.


“Margin loans” allow you to borrow against the value of your brokerage account at rates often below those you could get on other debt secured by your own assets, like a home-equity loan. Current rates range from approximately 6% to less than 1%. And many investors are taking advantage. According to the Federal Reserve, margin loans at brokerage houses rose 9% to $161.8 billion earlier this year. That’s the biggest jump in four years.

But for most folks, this isn’t a good idea.

One reason is that if you have suddenly decided that stocks will only go higher, you are falling into the classic trap of chasing performance. The stock market is up sharply over the last year and last three years. But that doesn’t necessarily mean its torrid pace will continue.

If there is a time to buy stocks on margin, it’s when they’re lying on the bargain basement table as they were a few years ago. Yes, stocks are still fairly cheap in some ways now. For instance, the S&P 500 has sold for an average of 16 times earnings over the past half century. Today it sells for just 14 times earnings. But that doesn’t mean the market will appreciate from here in the near term. And no one wants to borrow to buy near the top.

Also, if you are borrowing from your portfolio to spend it on a fancy trip or “more stuff,” you should really think again. Most long-term investors realize it’s unwise to spend capital. But borrowing against capital seems like a lesser sin. Even though you are borrowing against your own assets, however, these loans aren’t free… and there is another substantial risk.

You will be borrowing from one of the most unstable and unreliable lenders imaginable: Mr. Market. If the stock market suddenly drops, your margin debts may be called, forcing you to sell some of your assets to sustain the minimum account values you committed to under the terms of the loan. And margin calls only come when you don’t want to receive them: Just as the price of the securities you borrowed against are in a free-fall.

However, if you are in a pinch and need cash, consider two other alternatives. The first is using the money you have sitting in cash. After all, it’s earning next to nothing anyway. According to Bankrate.com, the average money market fund in theU.S.currently yields less than one half of one percent. Margin rates may be low, but they’re not that low.

Another alternative is to borrow against your home instead of your brokerage account. You don’t want to go whole hog, of course. That’s what got so many consumers in trouble during the real estate bubble.

But second mortgage and home equity rates are historically low. And a second mortgage may actually benefit you a few years from now. When interest rates go up – as they will eventually – a prospective buyer may be able to assume your low-rate mortgage. If not, you could still work out seller financing – like a contract for deed – that might make your property more attractive than another.

In short, if you don’t absolutely need to borrow against your brokerage account, don’t do it. It’s always better to err on the side of conservatism.

You may be sorry if the stocks you’re considering go up. But you will be doubly sorry if the stocks you’re considering go down.

So let the borrower beware.

Good Investing,

Source : http://www.investmentu.com/2012/October/no-time-to-borrow-on-margin.html

by Alexander Green , Oxford Club Investment Director Chairman, Investment

http://www.investmentu.com

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