Amplifying gains — and losses
QI occasionally see references to people amplifying gains using debt. How does that work? — A.L., Lima, Ohio
AThis is referred to as investing “on margin” when you do so through your brokerage.
Here's a simplified (and somewhat extreme) example: Imagine that you invest $100,000 in stocks and they double in value, to $200,000. You gained $100,000!
But what if you had $100,000, borrowed $100,000, and invested $200,000 in stocks that doubled? You'd gain $200,000, ending up with $400,000. After paying back the $100,000, you'd have $300,000 left. See how that gain was amplified?
Using debt sounds marvelous — unless you lose money. In the example above, if the stocks fell by 50%, you'd have $50,000 left if you hadn't borrowed money. But if you'd borrowed that $100,000 in order to invest $200,000, it would have shrunk to $100,000 — which you'd owe to your lender, leaving you with $0. Debt amplifies both gains and losses, which is why it's arguably best to steer clear of investing on margin.
QWhich websites are good for researching and comparing mutual funds?
— T.P., Lubbock, Texas
AMorningstar.com is a terrific mutual fund resource, where you can learn about the performance, fees, taxes, holdings and much more of thousands of funds. And the Financial Industry Regulatory Authority (FINRA) has a handy fund analyzer tool at FINRA.org/fundanalyzer, letting you compare fees and performances of various funds. (Inexpensive index funds often outperform managed funds, even if the managed funds sport higher prefee returns, so include fees in your comparison.) Both those websites can help you learn more about mutual funds in general, too. you have a solid thesis for the sector and its potential. — Ken, online
THE FOOL RESPONDS >> Those lessons can apply to any stocks you buy. Be sure to always research a company before investing, so that you have good reasons to expect it to grow in value over time. And aim to hang on to the stocks you buy for at least a few years, to give the companies time to perform and to recover from any short-term drops.
Your investments sound like they were too speculative. It's risky to put money into investments in which you don't have a lot of confidence.