[DesertCat]

[ QUOTE ]

But I only need a 6% return to break even on my 12% loan. See my original post in this thread. Ok, that is not counting taxes. After taxes, I need an 8-10% return to break even on my 12% loan, depending on if I pay my 15% long-term captial gains tax or short-term ordinary income tax.

[/ QUOTE ]

Your math is very, very, wrong, and it's leading you to make a big mistake.

What you are missing here is that you aren't borrowing $25,000 at 13% for three years, you are actually borrowing about $15,000 on average during those 3 years, and supplementing it with your own savings. That's why your total interest is only $4,893 on a 12% loan.

Essentially you are foregoing any earnings on your savings to make it appear that you only need to earn 8-10% to pay off a 12% loan, but in reality the portion of the loan matched against your stock portfolio loses money unless the stock portfolio returns significantly outpace the 12% you are paying (due to taxes).

Look at it in three components. You are going to save $29,893 over the next three years )$830 per month). You are going to have a $25k portfolio that you can keep the gains on. You are going to pay your lenders $29,893 over the next three years. If your portfolio grows to $33,704.14 (10% gains), you'll owe around $1,700 in taxes (assuming 15% cap gains + 5% state taxes), netting around $32,000 total.

If instead, you had just put your savings in a money market yielding 4% after tax, you'd end up with around $31,700 total. Only $300 less for absolutely no risk and no effort.

If you invest your savings in an index fund that simply produces 6% after tax returns you'd end up with $32,605, $600 more without taking any leverage risk. And if you can really earn 10% per year by investing in your chosen stocks, just investing your savings would end up with $34,500, almost $800 more than using leverage.

The reason is that while only relying savings starts slower, it's counterbalanced by the fact starting at $25,000 isn't good if it's using negative leverage that lowers your returns. You must return 20% more than your loan rate in order to have positive leverage, 15% per year for a 12% loan rate.

This problem is made worse because your interest isn't deductible against investment earnings. If you use margin interest, your break-even can be the same as your interest rate, which should be 9% or less for a margin loan.

[ QUOTE ]
Even if my stocks stay stagnent, at a 0% return, I will have $25k in 3 years. If I don't take this loan, I cannot guarantee I will save $25k over the next 3 years. Does that change your mind at all?

[/ QUOTE ]

Earning nothing is a substantial opportunity loss ($6,500)for you compared to just forced savings to a money market. Why haven't you thought of an automated savings, i.e. just schedule a monthly transfer to vanguard or your money market?

[ QUOTE ]

I agree, but it's not like I'm buying penny stocks here. I am buying large-caps, worst case scenario i figure i lose 20%.

[/ QUOTE ]

From Oct. 2000 to Oct. 2002 (two years) the S&P 500 (all blue chip large caps) lost 40%. Of course that doesn't count dividends, so it probably only really lost 36% or so.

[ QUOTE ]
Although I know I am being extremelty optimistic, I am positive i can get at 20-30% annual return on my money by investing in individual stocks. Before you jump all over me, Warren Buffet says he could definitely get a 50% return on smaller portfolios.

[/ QUOTE ]

Warren Buffett has told his shareholders not to expect him to beat the S&p 500 by more than a couple of a percentage points from now on, and to expect only 6-8% from big stocks, so 10% for ol' Warren. The reason? His portfolio is so large he can only buy "blue chip" large cap stocks, which are the most efficiently priced and expensive stocks.

He only said he could guarantee 50% returns if he was only running a $1M portfolio, so he could invest in small cap and micro-cap stocks, where there are much greater opportunities (and risks). I've beaten the market myself for over five years running by substantial margins, but I could never do it if I was investing in blue chip stocks.

[ QUOTE ]

I feel I am the T.J. Cloutier of the stock market. I don't do much math but i have an absolutely great feel as to what companies are going to be successful and which one aren't. I'm also still young so I know what trends are hot and which ones aren't (i.e. I can read through the hype on journalists trying to act cool).

[/ QUOTE ]

And this isn't how Buffett picks stocks. Not by "feel", not based on trends that are hot (he ignored internet stocks, for example). You understand so little about investing I'd have to handicap you as extremely -EV in expectation. Investing is hard work, and requires research and good judgment. Would you expect to be a great poker player without studying and applying yourself?

[ QUOTE ]

I definitely agree this loan is "thinking outside the box" and would traditioanly be frowned upon. But please provide me with some calculations on how much I would actually be losing out on. I don't think it would be more than 2-3k over 3 years maximum on average. And that is worst case scenario.

[/ QUOTE ]

One valid worst case scenario is that your $25K turns to $15k. That's the 40% loss that 500(!) stocks averaged in only two years. Since you are picking 5 specific stocks you have a volatility risk that is much higher than that, so your real worst case scenario is much worse. Example, there were many internet stocks that lost over 95% in two years, and some suck, er, investors loaded their entire portfolios into 5 hot internet stocks.

But even if 40% is your worst case, you've turned $30k in savings into $15k, whereas a risk free investment strategy would have turned it into $32k, an opportunity loss of $17k (almost two years of savings gone).

One of the biggest problems that causes individual investors to trail the markets is they buy things after they have gone up, and sell things after they have gone down. They panic when the markets are down and pull their cash out and miss the rebound. They get afraid they'll be missing out on the party when the market hits new highs and they put everything in at the top, including borrowed money.

You seem to have a lot of those characteristics. You have no real experience investing, but tremendous confidence. The markets are setting new highs, so you want to get in now, without waiting because you seem to be afraid of missing out. I question what will happen to your 5 picks when they are down 20% and going lower every day. Someone like yourself, who has no experience to rely on, is likely to lose that extreme confidence and panic faster, locking in your losses before the market turns.

[ QUOTE ]

so does that mean my investment in nintendo (NTDOY) blows?

[/ QUOTE ]

It's interesting you've made nintendo an investment right now when it's getting tons of great press. Don't you think all those high expectations for the Wii are "baked into" the stock's price? I question whether you really would have invested a year ago. It's easy to say you would, but when you have real money at risk sometimes it's hard to pull the trigger, esp. if the rest of the world is saying nintendo sucks and PSP3/XBox are going to kill the Wii.

[ QUOTE ]

I agree, dollar-cost-averaging is great, but that is only because the market goes up over time. If you invested in a lump sum at the beginning of your investing period, you would end up with more money, on average, than your dollar-cost-averaging method (For example: Investing 12k as a lump sum every January is better long-term than investing 1k every month).

[/ QUOTE ]

Dollar cost averaging protects you from buying in at the top of a market. Something you just don't seem to fathom as possible. Anyone who dollar cost averaged at the last market peak (1999) is way ahead of anyone who bought in with a lump sum at the same time. The lump sum guys will never catch up.

Edit: I should point out I did my estimates by hand in excel, so I might be off slightly. But I'm pretty sure any minor inaccuracies don't change the thrust of my comments.