At Sarwa, we’re always answering questions about our customers’ finances. One question we often get is whether it is a good idea to use a credit card to invest in stocks?
This is called credit card arbitrage and the answer we give is no, it’s not a good idea. Here’s why.
Sounds simple in theory…
Most investment platforms won’t accept credit cards for cash deposits. But anyone with a bit of financial savvy can work out a way to deposit credit card cash and buy stocks.
The theory goes that if you can borrow money on a credit card for a zero or low interest rate, you can invest it into stocks that offer a higher rate of return. Here’s an example:
You borrow $1,000 on a credit card at zero percent for the first month. You invest that $1,000 and the stock market goes up 10%. At the end of the month, you repay the $1,000 (with zero interest charge) and you pocket $100 profit.
In this example, your credit card arbitrage paid off.
Sounds simple , right? But this is only an example and, in the real world, the theory can land you in hot water.
… but it’s not good in practise
As we know, all investing involves risk. And using a credit card to invest in stocks ramps up the risk of investing in stocks even higher. Let’s look at our example above:
You borrow $1,000 on a credit card to invest in stocks. At the end of your zero-interest month, the stock market is down 10%. Now you have to pay back $1,000 to avoid paying any interest, but you only have $900.
You could cut your losses and pay the money back. But you might think that the stock market is going up. So you don’t pay back the money. Now your interest charge kicks in and you’re paying (conservatively, let’s say) an APR of 2% per month.
But the stock market falls another 10%, leaving you with $810 in the stock market and an interest charge of $20 ($1,000 x 0.02). You’re now down $210.
If we consider that the average annual rate of return of the S&P 500 is 9.7% per year, and the average APR of a credit card is between 15-20%, you see that, over the long term, there is only going to be one winner: the credit card company.
And the losers? You, your bank balance and your credit score.
Nice in theory. Bad in practise
As the example shows, borrowing money to invest in the stock market is almost always a bad idea. That’s because the stock market is volatile, and so investing borrowed money that you have to pay interest on is getting yourself into financial trouble.
You should only invest money that is yours and yours alone. You should invest your savings, not your borrowings. Credit cards can also negatively impact your credit score, so they’re best avoided whenever possible.
The bottom line is that borrowing cash to invest in stocks is always too risky, as the stock market is volatile. Given that the stock market is unpredictable, you don’t want to have credit card debt and interest to pay when markets fall.
Any questions? We can help
Here at Sarwa, we get a heap of questions from our customers about a range of topics. We’d love to hear from you if you have anything that you’re unsure about.
We’re here to help our customers build a secure financial future by allowing them to accumulate wealth through investing. Investing can be intimidating and this can mean that new investors make mistakes. So we’re here to assist you and answer any tricky questions you may have.
So if you have you have questions about any aspect of investing money, be it in stocks or other securities, get in touch for a chat. We’d love to hear from you.
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