What were they thinking, using their investments to pay off bills?

Staying Ahead

September 08, 1998|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

HAVE you been borrowing to invest? Or borrowing against your brokerage account to pay your bills? Are you crazy or what?

In this past week, I've spoken to:

A TV technician who's been using his brokerage account as a piggy bank. He has borrowed against one-third of it, to buy a car and help pay his bills.

A wealthy investor who keeps an aggressive stock account and "forgot" to tell his financial adviser that he'd used it as collateral for a $400,000 loan. He put the money into two Russian funds (diversification!), bought through another adviser.

A computer programmer who borrowed against her house to invest in brokerage-house mutual funds.

The TV technician is sweating out this market drop. If his stocks fall too far, he'll get a margin call -- meaning that his broker will ask him to cover part of his loan with cash. He doesn't have the cash. In that case, his broker would sell some of his securities, at a loss, and use the proceeds to lower the debt.

The wealthy investor has gotten a margin call. His aggressive stock portfolio was bombed this year, so he's losing his Russian funds and a lot of his stock positions. His original (sane and sober) adviser was planning to sell some of his underwater stocks, book the tax loss and use the proceeds to buy more promising securities.

Too bad. This investor is taking the loss, all right, but losing out on the potential gain.

The computer programmer is underwater, too. She's paying 9.5 percent on her home equity loan (6.8 percent after tax) and paid her broker a commission of 4.5 percent. So she needed a gain of 11.3 percent this year just to break even. She needed a super gain of 16.36 percent just to net the 5.06 percent she could have gotten from a U.S. Savings Bond.

In the second year (with no further sales commission to pay), she'll need a gain of 11.86 percent to beat U.S. Savings Bonds, if interest rates remain the same.

What were these investors thinking?

When you're young and trying to build up savings for the future, you shouldn't pillage your investments to pay your bills. It's tempting, when your stocks soar. You can take out some money and still feel rich.

Your monthly statement might show you how much you can borrow -- just for the asking -- at an interest rate of maybe 9.25 percent.

The TV technician's stockbroker saved him some grief. You're generally allowed to borrow up to 50 percent of the value of your better-quality equities (stocks listed on an exchange, well-diversified mutual funds and some over-the-counter stocks). Left alone, the technician told me, he would have done it.

But his broker strongly advised against it. You usually don't get a margin call unless your securities, minus the debt, are worth 30 percent or less of their nominal market value. In a plunging FTC market, accounts with big loans are more vulnerable than accounts with small ones. So far, the broker has kept the account afloat.

The wealthy trader was going for broke -- and almost made it. He knew Russian stocks and bonds carried phenomenal risk, but he saw the huge returns in the market early in the year and figured he'd get out in time. Dream on.

On a smaller scale, ordinary investors play the same kinds of fantasy games -- with options, small stocks culled from Internet tipsters or foreign-currency bets. If you want to swing for the fences, that's your lookout. But do it with "hobby" money, not money you're really going to need.

The computer programmer said she never stopped to think what she'd have to net to cover her borrowing and investment costs. She was lured by the pretty picture: Tax-deduct your loan interest while making sure-fire money on stocks. Gains of 20-plus percent have come to seem so commonplace that she assumed she'd easily come out ahead.

Luckily, she isn't risking a margin call. But she faces years of payments on her home-equity loan and needs a blazing stock market to cover her costs. When she'll start making some money is anybody's guess.

Borrowing against your securities isn't always wrong. But here's what it takes to make a success of it: a smart investor, using the proceeds to reinvest, who has calculated the cost of the loan against the potential gain and has the stomach to cut losses before they compound. If that's not you, leave your securities account alone.

Pub Date: 9/08/98

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