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ThatMedGyal

Market crash - time to invest LOC?

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It's a gamble, and you will be subtracting guaranteed interest compounded monthly from any potential market gains (or losses).

Let's create a few scenarios, all of which are "buy and hold" for 6 years. We'll take very small amount from our LOC to simplify the math, let's say $10k. The cost of doing so is easy to calculate:

$10,000 after 6 years at 2.95%* compounded monthly = $11,933.72, for a cost of borrowing equal to $1,933.72. Note, this assumes it will be paid off in full at the end of the 6-year period.

So how much can we make from the stock market? An impossible question to answer, but let's create a few hypotheticals. For the sake of simplicity, I'm not including any transaction costs (which should be fairly low, since this is a fixed-term buy-and-hold situation).

Scenario 1: 2020 is the bottom of the crash, and the market only goes up from here (modeled after the recovery following 2008):
Year 1: +23.45%
Year 2: +12.78%
Year 3: 0.00%
Year 4: +13.41%
Year 5: +29.60%
Year 6: +11.39
Total value at end of year 6: $23,307.90, for a gain of $13,307.90
$13,307.90 - cost of borrowing = net return of $11,374.18

Scenario 2: 2021 is actually the bottom, recovery identical to 2008:
Year 1: -38.49%
Year 2: +23.45%
Year 3: +12.78%
Year 4: 0.00%
Year 5: +13.41%
Year 6: +29.60%
Total value at end of year 6: $12,587.08, for a gain of $2,587.08
$2,587.08 - cost of borrowing = net return of $653.36

Scenario 3: 2020 is more like 1973:
Year 1: -17.37%
Year 2: -29.72%
Year 3: +31.55%
Year 4: +19.15%
Year 5: -11.50%
Year 6: +1.06%
Total value at end of year 6: $8,140.98, for a loss of $1,859.02
$1,859.02 + cost of borrowing = net LOSS of $3,792.74

Scenario 4: 2020 is actually more like 1930 (just after the crash of 1929):
Year 1: -28.48% 0.7152
Year 2: -47.07% 0.5293
Year 3: -15.15% 0.8485
Year 4: +46.59% (woohoo! the largest gain ever recorded before or since!)
Year 5: -5.94% 0.9406
Year 6: +41.37% (holy cow! woohoo!)
Total value at end of year 6: $6,261.05, for a loss of $3,738.95
$3,738.95 + cost of borrowing = net LOSS of $5,672.67 (would've been even worse if we started in 1929)

So, basically, there's no way to predict the outcome. Borrowing money to invest is a dangerous game to play (more properly called "speculating" than "investing"). If you were using your own money (i.e., didn't have to repay it at some point), and your strategy was to buy and hold for 30+ years, then yeah, the next few years will probably be great for investing (just like every other year). I would rather take advantage of current low interest rates by paying off as much of the LOC as I can, because this is a true investment in future wealth.

All numbers modeled on historical S&P 500 rates https://www.macrotrends.net/2324/sp-500-historical-chart-data which do NOT in any way predict future rates. There is absolutely no way to predict the market, do not believe anyone who tells you they can. I am not an financial professional.

 

*cost of borrowing is based on current canadian bank prime rates, which despite significant movement of the overnight rates by the Bank of Canada, has yet to move. Based on this, I think we can safely assume that 2.95% is as low as the banks are willing to go at this point. A lot of LOCs have rates that are prime -0.25%, but I just left it at the full prime rate because there is equal possibility of the rates rising alongside any market increases. In fact, it is worth considering that the cost of borrowing may increase significantly before these scenarios complete, especially in the cases with more dramatic market gains.

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It comes down to a personal assessment of your level of risk tolerance.  When I was a PGY5 I borrowed $30,000 from my LOC to invest in my TFSA.  At the time I decided I was going to take a couple of weeks and focus my learning on investing, wanted to do this before I ever started to make staff $$$.  I made $3,000 over a few months but ultimately had to cash out the TFSA to buy a larger family vehicle. I have a higher tolerance for risk that others may not have and I knew that my prospects for employment were exceedingly good.  While the stock market is lower at this time, we are also in a period of time which has given some unpredictability for the future (i.e. will you get sick and need to take time off? will your exams be delayed? will you be readily employable after you finish?) 

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3 hours ago, dh. said:

It's a gamble, and you will be subtracting guaranteed interest compounded monthly from any potential market gains (or losses).

Let's create a few scenarios, all of which are "buy and hold" for 6 years. We'll take very small amount from our LOC to simplify the math, let's say $10k. The cost of doing so is easy to calculate:

$10,000 after 6 years at 2.95%* compounded monthly = $11,933.72, for a cost of borrowing equal to $1,933.72. Note, this assumes it will be paid off in full at the end of the 6-year period.

So how much can we make from the stock market? An impossible question to answer, but let's create a few hypotheticals. For the sake of simplicity, I'm not including any transaction costs (which should be fairly low, since this is a fixed-term buy-and-hold situation).

Scenario 1: 2020 is the bottom of the crash, and the market only goes up from here (modeled after the recovery following 2008):
Year 1: +23.45%
Year 2: +12.78%
Year 3: 0.00%
Year 4: +13.41%
Year 5: +29.60%
Year 6: +11.39
Total value at end of year 6: $23,307.90, for a gain of $13,307.90
$13,307.90 - cost of borrowing = net return of $11,374.18

Scenario 2: 2021 is actually the bottom, recovery identical to 2008:
Year 1: -38.49%
Year 2: +23.45%
Year 3: +12.78%
Year 4: 0.00%
Year 5: +13.41%
Year 6: +29.60%
Total value at end of year 6: $12,587.08, for a gain of $2,587.08
$2,587.08 - cost of borrowing = net return of $653.36

Scenario 3: 2020 is more like 1973:
Year 1: -17.37%
Year 2: -29.72%
Year 3: +31.55%
Year 4: +19.15%
Year 5: -11.50%
Year 6: +1.06%
Total value at end of year 6: $8,140.98, for a loss of $1,859.02
$1,859.02 + cost of borrowing = net LOSS of $3,792.74

Scenario 4: 2020 is actually more like 1930 (just after the crash of 1929):
Year 1: -28.48% 0.7152
Year 2: -47.07% 0.5293
Year 3: -15.15% 0.8485
Year 4: +46.59% (woohoo! the largest gain ever recorded before or since!)
Year 5: -5.94% 0.9406
Year 6: +41.37% (holy cow! woohoo!)
Total value at end of year 6: $6,261.05, for a loss of $3,738.95
$3,738.95 + cost of borrowing = net LOSS of $5,672.67 (would've been even worse if we started in 1929)

So, basically, there's no way to predict the outcome. Borrowing money to invest is a dangerous game to play (more properly called "speculating" than "investing"). If you were using your own money (i.e., didn't have to repay it at some point), and your strategy was to buy and hold for 30+ years, then yeah, the next few years will probably be great for investing (just like every other year). I would rather take advantage of current low interest rates by paying off as much of the LOC as I can, because this is a true investment in future wealth.

All numbers modeled on historical S&P 500 rates https://www.macrotrends.net/2324/sp-500-historical-chart-data which do NOT in any way predict future rates. There is absolutely no way to predict the market, do not believe anyone who tells you they can. I am not an financial professional.

 

*cost of borrowing is based on current canadian bank prime rates, which despite significant movement of the overnight rates by the Bank of Canada, has yet to move. Based on this, I think we can safely assume that 2.95% is as low as the banks are willing to go at this point. A lot of LOCs have rates that are prime -0.25%, but I just left it at the full prime rate because there is equal possibility of the rates rising alongside any market increases. In fact, it is worth considering that the cost of borrowing may increase significantly before these scenarios complete, especially in the cases with more dramatic market gains.

Great analysis. I think however, many "investors" would consider that 10 years is the short term, 15 years is the moderate term and ≥25 years is the long term. Would love to see this analysis using a 10-15 year horizon instead.

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1 hour ago, ArchEnemy said:

Great analysis. I think however, many "investors" would consider that 10 years is the short term, 15 years is the moderate term and ≥25 years is the long term. Would love to see this analysis using a 10-15 year horizon instead.

Yes, this is definitely a short-term analysis, driven by the intention to pay off the borrowed funds ASAP.

Taking the 1930 example (investing $10k just after crash of 1929):
1930    -28.48%    7,152.00
1931    -47.07%    3,785.55
1932    -15.15%    3,212.04
1933    46.59%    4,708.53
1934    -5.94%    4,428.85
1935    41.37%    6,261.06
1936    27.92%    8,009.15
1937    -38.59%    4,918.42
1938    25.21%    6,158.35
1939    -5.45%    5,822.72
1940    -15.29%    4,932.43
1941    -17.86%    4,051.49
1942    12.43%    4,555.10
1943    19.45%    5,441.06
1944    13.80%    6,191.93
Total value of 10k investment after 15 years invested: $6,191.93, for a loss of $3,808.07
Borrowing cost of 10k at 2.95% over 15 years: $5,557.49
Total loss: $9,365.56

Let's take it further, and go for 30 years:

1096426813_ScreenShot2020-03-28at1_26_32PM.jpg.0959cf0eb46cfbed79b50fe2134fe4c3.jpg

Only after 27 years does this strategy return a profit, and remember, this is a very optimistic calculation: assuming investment after the 1929 market crash, assuming constant and near rock-bottom borrowing cost, and zero MER and transaction costs. Of course, you could pay off the money borrowed earlier, and save some of your borrowing costs, but I still think a better investment is to pay off debt before investing, and then to invest real money for the long haul. Borrowing money to "invest" does not seem to be a solid financial approach. Look at what your return in 1960 could have been had you used your own money instead of borrowed!

Of course, making a lump-sum purchase of stock at a single point in time is not an ideal investment strategy, but my goal here is to illustrate the cost of using borrowed money to speculate in the market. I'm also sure that after 1929, many people thought the market was as low as it could go. And again after 1930. And again after 1931. Etc.

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4 hours ago, dh. said:

Yes, this is definitely a short-term analysis, driven by the intention to pay off the borrowed funds ASAP.

Taking the 1930 example (investing $10k just after crash of 1929):
1930    -28.48%    7,152.00
1931    -47.07%    3,785.55
1932    -15.15%    3,212.04
1933    46.59%    4,708.53
1934    -5.94%    4,428.85
1935    41.37%    6,261.06
1936    27.92%    8,009.15
1937    -38.59%    4,918.42
1938    25.21%    6,158.35
1939    -5.45%    5,822.72
1940    -15.29%    4,932.43
1941    -17.86%    4,051.49
1942    12.43%    4,555.10
1943    19.45%    5,441.06
1944    13.80%    6,191.93
Total value of 10k investment after 15 years invested: $6,191.93, for a loss of $3,808.07
Borrowing cost of 10k at 2.95% over 15 years: $5,557.49
Total loss: $9,365.56

Let's take it further, and go for 30 years:

1096426813_ScreenShot2020-03-28at1_26_32PM.jpg.0959cf0eb46cfbed79b50fe2134fe4c3.jpg

Only after 27 years does this strategy return a profit, and remember, this is a very optimistic calculation: assuming investment after the 1929 market crash, assuming constant and near rock-bottom borrowing cost, and zero MER and transaction costs. Of course, you could pay off the money borrowed earlier, and save some of your borrowing costs, but I still think a better investment is to pay off debt before investing, and then to invest real money for the long haul. Borrowing money to "invest" does not seem to be a solid financial approach. Look at what your return in 1960 could have been had you used your own money instead of borrowed!

Of course, making a lump-sum purchase of stock at a single point in time is not an ideal investment strategy, but my goal here is to illustrate the cost of using borrowed money to speculate in the market. I'm also sure that after 1929, many people thought the market was as low as it could go. And again after 1930. And again after 1931. Etc.

Which is why it's so important to dollar cost average... You could also buy a stock while it's on it's way up (some time after it starts going up)

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1 hour ago, MDinCanada said:

Which is why it's so important to dollar cost average... You could also buy a stock while it's on it's way up (some time after it starts going up)

Exactly!

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9 hours ago, dh. said:

Exactly!

Btw, thanks for your analysis! It is also important to mention that this guy is graduating in 2021. So theoretically, he would be able to start paying off his debt within a year with his resident salary, so the cost of borrowing is less.

I would feel more comfortable using LOC money to invest as a graduating med student than as a first year med student! 

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Not relevant to investing, but note that your personal financial situation may change drastically from when you are a medical student to resident to staff.

As someone who is 3 months from the end of training (!!!), I had used only $50k in medical school of LOC. Fastforward to end of residency and I am eager to pay off a large 6 figure LOC.

Life will "happen" and you may need that immediate cash flow. Speculating on the market might sound good now, but you have no guarantees of coming out ahead. Add to that unexpected expenses in the future can make this a risk.

As a note: I am pretty risk averse and debt averse. Spending on these expenses were not decisions made lightly but made our of significant necessity.

To each their own. Stay healthy, all!

LL

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I had the same discussion with my financial advisor. The conclusion we came to was that the market is currently very unpredictable since the current tendencies are dictated by emotions (ie: the Saudis dumping oil, the reaction to COVID-19, etc.) with no logical basis on which to try to predict the future evolution of the markets. Therefore, we did decide to make some investments considering the recent crash and perspective of the stock market rising but doing so in smaller regular investments rather than a large chunk, which should mitigate the risk.

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If you like gambling, invest your LOC... Otherwise I would not invest even cold hard cash let alone capital from a loan. 

Personally, I pulled everything I had in the market out when COVID started rampaging through Iran in February... The pandemic writing was on the wall when this virus reached that country. 

The political response to the pandemic has often been not rational. The scientific response one of many unknowns. So in my opinion there is no way to truly predict what the markets will do in the immediate future. What firms will get bailed out, which regions will get hit hard, what public health policies will be implemented, what sort of second wave will occur, it’s all a black box. 

The economic hurt from this is just starting. Long after COVID is dealt with we will still be picking up the financial wreckage on a markets scale. It would not surprise me if we enter into a decade similar to the 1930s markets wise... I would hold tight until more rationality returns and all the supply chain restructuring is sorted. Over time the more reliable investments will become more clear. 

 

Edited by rogerroger

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