Borrowing to invest
George Kamel, co-host of The Ramsey Show, recently asked Hammer why he’s managed to keep the debt around for roughly a decade even though he can presumably pay it off. Hammer explained that the money was more productive in the stock market.
"The money that I’ve put in, versus paying it off, is up like 30%, 40%, 50%,” he said. “Whereas if I paid off the student loans instead I would have made progress of 2.5%.”
The annual interest rate on federal student loans can be in the low single digits, according to the Education Data Initiative. Depending on when he graduated, it is possible that Hammer's student loan is just 2.5%.
Meanwhile, the S&P 500 has delivered a 13.33% compounded annual growth rate over the past 10 years, according to Vanguard. So it’s likely that this strategy has paid off for him.
However, there are reasons why this strategy might not be appropriate for everyone.
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Get StartedThe risks of leverage
Investors looking to use borrowed capital to invest must consider all the risks before deploying this bold strategy.
The first consideration is interest rates. Hammer’s 2.5% interest rate is no longer common, given that a federal student loan in 2024 could range from 5.5% to 8%.
Meanwhile, the S&P 500’s double-digit return isn’t guaranteed. Past performance is not an indication of future returns and there’s no way to predict if the stock market will have a terrible decade ahead.
Debt amplifies losses just like it amplifies gains, so investors need to consider it a double-edged sword.
The second consideration is duration. A student loan doesn’t have to be paid back when the lender requests but is instead fixed for 10-year to 30-year terms. However, other forms of borrowed capital, such as lines of credit or margin debt, can be recalled when the market crashes or circumstances change.
According to data gathered by FINRA, investors had $797 billion in aggregate margin debt as of August 2024. During the pandemic-era stock boom, a Yahoo Finance-Harris poll found that roughly 43% of retail investors were using options or margin or both.
This means most retail investors are borrowing in a more risky way than Hammer is.
Finally, investors must also consider their risk appetite. Borrowing money, regardless of the interest rate or term, is more risky than simply investing in cash. For some investors, that risk isn’t worth the trouble.
“You really don't need leverage in this world much,” Warren Buffett, one of the most successful investors of our generation, once said. “If you're smart, you're going to make a lot of money without borrowing.”
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