Two Yale Professors Recommend Borrowing Money to Invest. Should YOU??

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Two Yale professors say young people should borrow money to invest in the stock market.

Sounds crazy, I know. Here’s their rationale:

Borrow Money to Invest

Traditional retirement advice says you should invest 10 to 15 percent of your income.

That money should be divided between stock funds and bond funds according to your age. A 25-year-old might want to be 90 percent in stocks, 10 percent in bonds, for example. A 60-year-old might decide to be 50/50 in stock and bond funds.

The problem with this advice, say Yale business and law professors Ian Ayres and Barry Nalebuff, is that 20-year-olds haven’t saved much yet. Fifty- and 60-year-olds have a higher net worth.

So what?

Although a 60-year-old has reduced the percentage of his portfolio exposed to stocks, he has more money exposed to risk – exactly when he’s least able to recover from a wipe-out.

Conversely, the 25-year-old may have 90 or 100 percent of her portfolio in stock funds. But that’s only a couple thousand bucks.

Jill is 25. She has $2,500 saved for retirement. Ninety percent of that, or $2,250, is invested in stock funds.

Wendy is 60. During the past 40 years, she’s amassed a retirement portfolio of $680,000. Half of that, or $340,000, is invested in stock funds.

When the market drops 3 percent, Jill loses $67. Wendy loses $10,200.

The solution? According to Ayres and Nalebuff, twentysomethings should borrow money to invest in their retirement account.

“It is obvious that you’re not well diversified if you invest $100 in one stock, $200 in another and $300 in a third. You’d have less risk investing $200 in each of the three stocks,” they co-wrote in a column in Forbes Magazine. (They’re assuming each stock is equally desirable).

“The same idea of equal investments applies to investments across time,” they say. “If you have $100 invested in year one, $200 invested in year two, and $300 invested in year three, you have too much exposure to year three and not enough to year one …”

They argue that people borrow money to buy houses, so why not stocks? (Of course, they neglect to mention that you can LIVE in a house, regardless of its market value. You can’t live in a stock portfolio.)

Regardless, the two professors offer an interesting theory. What do you think? Could twentysomethings – counter-intuitively – reduce their risk by borrowing money to invest for retirement?


  1. says

    I’ve seen this study before. The math and logic are compelling, but I think it fails mostly on behavioral grounds. Paradoxically, older people with much more to lose tend to have a much higher risk tolerance than young investors just starting out, probably having something to do with having lots of experience with the ups and downs of the market. The vast majority of 20-somethings can barely managed to stomach keeping 80% in stocks. If they had to borrow to increase their exposure to, say, 120%, most would almost certainly panic and sell out. I have one of the highest risk tolerances of anybody I know, but even I would balk at this. Good idea, not particularly useful in the real world.

    • says

      @Kyle – I’ve heard the argument that this idea makes sense if and only if an investor has the discipline and fortitude to stick with it.

      I hesitate to make blanket statements about any group of people by assuming that they will or will not stick with an investing program. Some people will. Others won’t. Statistically speaking, the majority won’t, but I don’t want to dissuade the outliers who are disciplined enough to stick with it.

      That said, I don’t know if the math/logic make sense (for those people who possess the discipline). It makes a compelling case, yes. But I’m not fully sold on the idea.

  2. says

    It sounds good on paper but risky in real life. I’m trying to stay debt free to borrowing money for stocks doesn’t fit with my end goal however retiring early would be awesome. I’m going to have to give this some thought!

    • says

      @Kathleen – You can borrow money from the brokerage companies that buy/sell stocks, like E-Trade. It’s called “margin investing.” The brokerage companies will typically loan you a percentage of your overall portfolio. The amount they loan you depends on your creditworthiness and your equity.

      For example: Let’s say Joe has a fantastic credit score, and $20,000 in stock equity. His brokerage firm will allow him to borrow at an “initial margin” of 50%. That means they’ll loan him $10,000, which he can use to buy other stocks.

      After that, Joe’s account is subject to a “maintenance margin” of 25%. That means that — as the value of his portfolio rises and falls everyday — he needs to maintain a minimum of 25 percent. If the market tanks, and his portfolio drops below 25 percent, his broker will put out a “margin call,” demanding that he sell his stocks to pay back his loan. This is the worst-case scenario, since Joe then realizes the loss.

      • says

        The rate is currently 8.44% at Etrade for accounts worth $25,000 or less, and 7.94% for accounts between $25K and $50K.

        I don’t see how borrowing money to invest in the stock market is essentially much different than borrowing to invest in real estate or in a small business or any other potentially profit-generating venture. In all cases, they need to be managed – possibly intensively – and competently, for a positive outcome, of course – but they’re all methods of capital gain and people take out loans for real estate and business startups all the time.

        • says

          @444 — In my mind, the primary difference is that you control your own business and real estate activities. You absorb the risk but you also have the control to make decisions and respond to stimuli. You’re also more intimately familiar with your own company’s strengths, weaknesses, threats and opportunities.

    • says

      You can get pretty decent rates on margin if you have a lot of money to invest (less than 4% at Fidelty), but most 20-somethings aren’t going to have half a million dollars to put up. It’s been a while since I read it, but I believe the paper specifically mentions buying deep in the money long-term call options, called LEAPS. You can typically get leverage a bit cheaper with options than you can actually borrowing money from a bank but there’s a bit more work involved since you have to roll the options over every year or so.

  3. says

    I always found that weird that you can borrow money to invest. I first heard of it as an “investment loan” on a rental property. In fact, if you google “investment loan” the first 3 results are about real estate. At the Credit Union I work at, you can get a unsecured loan at a 14.99% if you have an A rating. You’d have to expect above average returns from stocks to even match that.

    I’m not sure how legal it is, but I once considered taking out student loans to invest in something like a CD. I never researched it but if you qualified for subsidized (I think that’s the one that doesn’t accrue interest while you’re in school) you could get thousands of dollars a semester to put into a SAFE investment. I never wanted to get into debt though, and I also was ignorant to the magic of other people’s money. That would have been a 0% interest loan that would never show an accruable balance (I would’ve just timed my CD to mature at graduation). Like I said though, not sure how legal that would have been…

    So…I wouldn’t get an investment loan to invest in stocks, but I would definitely get one for real estate in these economic times.

    • says

      @Chris – I feel the same way. I’m uncomfortable with the concept of borrowing money to invest in stocks. But I’m chomping at the bit for more money to put into real estate. That might simply be because I understand the real estate market better. I can evaluate the strength/weakness of any house as a rental with a much stronger degree of accuracy than I can evaluate a stock.

      So should a person who understands stocks as firmly as I understand rental properties borrow money to invest? I’m not sure. The Yale professors make a strong case, but my “gut check” says no.

  4. says

    I agree with the concept, but most young people are saddled with college loans. Therefore there is a limitation as to how much they can reasonably borrow.

  5. says

    People do it all the time. It’s called trading on margin. I’ve done it to buy a stock I wanted immediately but wouldn’t have the cash until the next paycheck. I’m sure some other people use it to buy stocks without the intention of paying off the balance in a few days.

    Personally though, I wouldn’t borrow money to invest in the stock market. Maybe a business or precious metals even, but not the stock market.

  6. says

    I have an excellent credit score (780) and often receive 0% APR balance transfer offers on my (numerous) credit cards. On several occasions I’ve “borrowed” $5000 to $10,000 per card and invested the proceeds in stocks. I then write covered calls on these stocks and have been very fortunate to recoup my entire investment intact and paid off the 0% balance transfer offer within the promotional period (usually a year).

    I know I’m taking a big risk but with my median income (I’m fairly young, in my early 30s) and low savings rates I feel this is a risk I simply HAVE to take to get ahead financially.

  7. says

    It is a nice theory, but, maybe typically for academia, it is only that. When you are young you can either borrow for a house, paint low interest, or for something else, paying a high interest rate, but almost never for both. Most people prefer to buy a house, as it gives a great sense of pride. Investing on margin doesn’t help either if you have no money to start with, as you can only borrow a percentage of the equity you already own. And when you are young, there is no way you can already be an experienced investor. So starting investing with only a little bit of money is VERY wise indeed. Investing on margin is for very experienced investors and speculators. Not for novice investors.

  8. says

    It depends on the kind of investment you are venturing into. This might be a good idea if the investment you are planning to venture in would be guaranteed to have a return fold of more than a 100% of your loan amount, an ROI of 100% is rare but possible.

  9. says

    Sounds REALLY dangerous. I mean, no gain without taking risk, I get it, but if you borrow to invest and then companies go bankrupt or your portfolio bottoms out…how do you repay what you’ve borrowed?

  10. says

    This strikes me as idiotic. You’re courting bankruptcy if you lose, for starters. Worse, you’re borrowing money in a falling rate environment (dumb) to invest in a market that’s returned basically nothing for a decade (dumb) and which is overpriced by the highly predictive Shiller PE pricing methodology (dumber).

    I’m sure there’s a worse idea out there, but you’d probably have to be a professor at Harvard to figure out what it is.

    • says

      Like you said, it would some Harvard or Yale professor or some self serving elected or appointed official to come up with something worse.

  11. says

    Another good reason to teach college undergraduates a whole lot about American history. Whiling away their hours in business, stats, and accounting courses, these folks seem to have missed the fact that this is exactly what happened in the run-up to the Great Depression.

    During the lively years before the 1929 Crash, many people bought on margin: they borrowed to buy equities, figuring the returns would pay the interest on the loans and then some. So it went…for a while. When the market crashed, they were wiped out–and so were the lenders who stupidly gave them money to gamble in the market.

    Plus ca change, plus ca reste le meme.

  12. says

    Borrowing money for retirement is extremely risky and makes an uncertainty even more uncertain. Leverage is not the solution, forgone consumption is. Just because folks borrow money for homes and education (maybe they shouldn’t…) does not make borrowing for retirement viable.

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