Would you ever borrow money from a bank to invest in stock market?

I often write on Quora.com, where I am the most viewed writer on financial matters, with over 335.1 million views in recent years.

In the answers below I focused on the following topics and issues:

  • Would I borrow money to invest in stocks?
  • In what specific ways does money change people, or does it really change them?
  • Are Chinese stocks worth investing in?

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Source for all answers – Adam Fayed’s Quora page.

Would you ever borrow money from a bank to invest in stock market?

I have never done this before. I wouldn’t advise most people to do it, but there are some caveats, which I will speak about later.

The biggest reason why most people shouldn’t do it is risk: related to return. If you invest only money you have, then you can reduce your risk by being long-term as shown below:

Buy any broad-based index, such as the S&P500 or MSCI World, and you will be fine if you invest for decades.

In comparison, unless you can find a long-term loan that is cheap and lasts for thirty years, you can’t leverage time to reduce your risk.

If you would have taken out a 10-year loan in 2000, and invested it in the markets, you would probably have lost money or have ended up even.

That is because many markets, such as the US stock markets, were stagnant for ten years.

That isn’t a problem if you are a long-term investor. In fact, you can benefit from lower valuations.

Markets then have done well since 2009–2010. If you need to pay back a loan, the same fundamentals don’t exist.

You might be paying 2%, 3%, or even 6% per year on the loan, which also reduces your net returns, even if the markets are doing well.

The only time loans, or Lombard loans, make sense, is if:

  • Interest rates are very low- for example, you are high-net-worth. It is true that some sophisticated investors have increased their net worth with debt.
  • You are balancing the probability of risk. So, if markets have fallen by 50% and your broker offers you a Lombard loan at 3% for three years, then your chances of making good money are high.
  • You understand the risk: return ratio, or have an advisor who can help you understand that.

It only works in limited situations for certain people. It doesn’t work for the average investor who is getting greedy because markets are going up.

In what specific ways does money change people?

I am not convinced that money, or even success in a broader sense including the non-financial aspects of it, changes people as much as is often assumed.

It does change people’s behaviours and incentives. What is more, people often modify their behaviour as they age.

Therefore, if people become gradually wealthier as they age, it might appear that they have changed a lot.

Yet often money just gives people the ability to make more choices.

That person who appears materialistic after gaining money might have previously been like that. They just didn’t have the ability to act in that way.

Likewise, that generous person who gives loads of money to charity maybe wasn’t ungenerous before.

Perhaps he/she merely couldn’t afford to give as much, and needed to focus on basic material needs.

Will Smith has a great quote about this:

This is especially an accurate quote because people who have more money don’t need to compromise as much.

That wealthy 70-year-old retiree doesn’t need to be diplomatic. Their 30-year-old self might have needed to be to keep their job.

People who have made it in business like Zuckerberg can also dress as scruffy as they like – which is harder to get away with if you work in a corporate environment.

That is one of the biggest reasons why we might see dramatic changes in behaviour in people who have gotten rich fast such as sports stars and lottery winners.

Suddenly the possibilities seem endless, and the need to compromise is less.

Ask yourself this question. If you were on the breadline, would you call out somebody who racially abused?

Or, would you make controversial statements on social media, especially if the platform is open to the public, including your employer?

Maybe, but maybe not, because you might be worried about the consequences.

If you are already very comfortable or rich, you wouldn’t be worried about doing this.

So, often money just allows people to be truer to themselves and take more chances/risks.

Why do some investors say that Chinese stocks are uninvestable?

I wouldn’t say most investors think that all Chinese stocks are uninvestable. Below is a relatively updated version of MSCI World:

China is a big part of MSCI Emerging Markets as per the graph below, so it has a whole to play in MSCI World:

MSCI World is one of the most popular ETFs in the world. It is bought by institutional and retail investors.

If people were uncomfortable about the China allocation, then there would be a big growth in indexes that tracked the world but exclude China.

What is absolutely correct, however, is that most investors don’t want a high allocation to China, and many don’t want to buy individual Chinese stocks, listed in Mainland China.

This makes sense for the following reasons

1. Stock picking is risky in any market. Most people struggle long-term even in the US. In China, the political risks are super risk, so it is even riskier.

Look at what has happened recently with firms just going out of business in the education space, and some others, after one or two changes to legislation. That does bring about opportunities and volatility but in return for huge risks.

2. Many of the biggest US and international firms already make a lot of revenue in China. What is more, plenty of very successful Chinese firms IPO in the US and abroad?

So, if you buy the S&P500, you indirectly have a reasonable amount of exposure to Chinese growth.

3. The whole point about the stock markets is that if you buy and hold for decades, you should be up. That was always the case in China as well, until 2006.

Now markets have been down for 15 years. This might come and go. The US stock market had 17 years of stagnation from the mid-60s until the early 80s.

The point is though, China has performed very badly for a long period of time, and unlike the US before, there is no indication that things will change.

They might change, but the political risks have probably contributed to the situation.

Against that, some investors see Chinese stocks as cheap now, which is true.

4. Growth and stock prices aren’t usually connected.

US, UK, and many other stock markets have sometimes performed poorly during periods of low growth or even recessions.

Likewise, emerging markets, whilst great in terms of GDP growth, haven’t always outperformed developed ones, and are riskier.

So, even if you are bullish about Chinese growth, which is questionable given the numerous challenges they have, that won’t automatically translate into better returns.

The bottom line for most sensible investors is the risk: reward ratio. China might outperform again, just as the Shanghai Composite did from 2000 until 2006, but the risks are also far higher, especially considering the indirect exposure you can get elsewhere.

Pained by financial indecision? Want to invest with Adam?

Financial Planner - Adam Fayed

Adam is an internationally recognised author on financial matters, with over 335.1 million answers views on Quora.com and a widely sold book on Amazon

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