A while back I wrote about the idea of investing your student loans. I was pretty negative on the idea because I’m not a fan of investing money that isn’t yours.
The other day a Studenomics’ reader opened up an interesting point by bringing up the opposite side of the spectrum. Daniel is more positive on the idea of investing your student loans. I’ll always support a logical and well explained point. Daniel wrote on investing student loans:
Well….. using student loans to invest would indeed be quite risky, though not nearly as risky as many other options that exist today.
By doing this, you are doing the same thing as margin trading, except the bank is unknowingly taking over the financing from the broker. To look at this on the good side, using student loans is actually LESS risky that using a margin account.
With a margin account, if the equity in your account falls below a specified level (30 – 50%) then the broker has the right to sell stocks to equalize that equity at their discretion. This could lead to even higher losses (on your part). You are also required to meet many restrictions (to protect the broker no less, though it does offer you some protection from yourself!), which can reduce your buying power.
On the other hand, if you are using a student loan, you need not worry about the broker selling your stocks haphazardly to equalize equity. You also do not need to maintain a minimum cash investment (lets face it, you could open the account without any cash of your own, using only borrowed money). Also… and the biggest advantage obviously, is the interest rate… a margin account, right now, is going to charge you between in the ball park of 8 to 9 percent interest on the money you borrow…. the student loan could be a low as 2 to 3 %.
Another advantage of a student loan is the repayment schedule…. if you do happen to go bust, and lose your entire investment….. you are not dead in the water. You will be in the same situation as many other college students, owing a bunch of money to student loans. Granted, you would have willingly put yourself into that situation, but it would not be a situation that was life threatening (as a major default on a margin account could be).
Overall….. is it risky…. YES! But then again, basic math will tell you that the following formula holds true:
stocks = risk
Anyone that should try something like using borrowed money to invest with is probably a little crazy to begin with (yes, you too traders!)
What do you guys think about this comment? Do your agree or disagree?