Amplifying gains — and losses

Q:

I occasionally see references to people amplifying gains using debt. How does that work? — A.L., Lima, Ohio

A:

This 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 percent, 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.

Q:

Which websites are good for researching and comparing mutual funds? — T.P., Lubbock, Texas

A:

Morningstar.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 pre-fee returns, so include fees in your comparison.) Both those websites can help you learn more about mutual funds in general, too.