Taking out a student loan to invest
Question: I totally agree, paying 6% to receive 4% is lost money…but perhaps I havn’t clarified what I am proposing. Assuming this loan allows me to invest money I have already saved. So taking the loan and putting it into a savings account yields me 4% on this money and allows me to invest the money I have already saved up. So in reality, this loan is only costing me 2% yet gives me the ability to invest whatever money I had previously saved because it is no longer needed for expenses. I am very confident I can meet the break even return of 2% and anything over that is pure profit.
Answer: You say you are a finance major.
So you can see, therefore, that it is irrelevant whether you borrow and invest the money, or borrow, and invest other money? (only difference, in the former case, you *may* be able to deduct the interest from taxable income).
The outcome is entirely dependent on the gap between your after tax borrowing rate and your after tax investment return.
Since you are a finance major, you know that to get inv return borrowing rate, it is almost certain you will have to take on more risk.
There really is no free lunch. The first thing they teach you in finance101. Here’s something I know: Over the last 100 years, the long term annualized growth rate of the U.S. stock market (as measured by popular averages like S&P and DJIA) has been about 10-12% annualized. (closer to 10% for large-caps, closer to 12% for small caps). Which reflects the long-term growth of the U.S. Gross National Product.
Now you say you are getting a 20% annualized return, but you’re having to pay 5% (at least) annualized for that money in loans. That means you’re really getting a 15% annualized return *at most*.
Well, that’s a few percentage points more than the 10-12% figure for the market as a whole. But if you’re getting a few percentage points more, somebody else must be getting less in order to keep the average at 10-12%. It’s impossible for everyone to make more than 10-12% in the market–because they *are* the market! Somebody has to be out there to purchase the stocks you sell at a big profit, and sell the stocks you purchase at bargain prices.
So if you’re a skilled investor in the class of Warren Buffett, congratulations and best wishes. But the logic of the situation is that everyone in the stock market can’t hope to do that well. There is no way that the U.S. stock market can create tens of millions of Warren Buffetts, because the U.S. economy is not big enough for that.
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