Leverage kills portfolios. Even a cursory glance back at the financial crisis highlights the dangers of leverage for professional and amateur investors alike. In my book I called leverage a “non-starter” for individual investors.
That is why so many people took umbrage with a post over at Benzinga suggesting individuals borrow from their home equity lines to invest in the stock market. Some took this as a sign of exuberance in light of 30%+ gains we saw last year. Robert Seawright at Above the Market noted:
Maybe this article is signalling a market top. Or maybe it’s just silly and dangerous. But it surely shows that we have been in a very good market cycle for a long time now. And that makes me nervous.
Herb Greenberg at TheStreet.com was downright “scared” of the idea of levering up to buy stocks:
If you have to get a loan to buy shares that you believe will yield a greater than the rate on your mortgage — you have no business buying stocks. You’re out of your league. You’re nothing but a gambler and you have no idea what you’re doing. You’re the classic individual chasing a dream, or putting in just one more quarter for just one more push on the slot machine button. You’ll be the last to get in and the last to get out.
In responding to a different advocate Felix Salmon at Reuters had this to say on the idea:
For me, the choice in all cases is clear: it’s pretty much always a bad idea to borrow money and invest it in the stock market — and it’s an even worse idea to borrow money against your house and invest it in the stock market. Because that way you not only risk losing money in the market, you also risk losing your house.
Can you make the math work where borrowing money against your house to invest in the stock market works out? Sure. Of course it can work in theory. The bigger problem is that the we investors have a raft of behavioral biases that make sticking to any sort of leveraged equity strategy problematic at best. As I wrote in my book:
The biggest challenge facing most investors is not the market itself, but their reaction to the market. When leverage is employed, it creates higher psychological highs when times are good and greater feelings of panic when times are bad. These mood swings tend to push investors to make precisely the wrong move at the wrong time.
There is a reason brokerage firms are required to provide investors with a disclosure statement before they can open up a margin account.* The same should be required for anyone looking to bypass broker-provided margin by borrowing against their home to “invest” in stocks.
Update: Joe at Upside Trader is a little more blunt:
Savvy my ass. Maybe at 666, not here. They advocate buying dividend paying stocks. I guess they don’t go down when shit goes bad.
Mark Gongloff at Huffington Post also thinks this advice is appropriate for people who “hate their money.”