"Commentary"-Beg, Borrow & Invest
Tuesday, May 22, 2007SUSIE GHARIB: In tonight's commentary, a few thoughts on playing with borrowed money. Here's Allan Sloan, Wall Street editor at "Newsweek."
ALLAN SLOAN, WALL STREET EDITOR, NEWSWEEK: There are those of us who borrow a lot of money and worry about paying it back. Then there's Wall Street, where you borrow money to make money. One of the reasons private equity and hedge funds can make huge profits for investors is using lots of borrowed money, make that lots of cheap borrowed money. Blackstone, the private equity firm trying to go public, even offers us an example. Buried deep in one of its filings, it shows how a 6 percent increase in the value of an acquired company can make 15 percent a year for its investors.
The secret, borrowing 70 percent of the purchase price. And you can do this at home, although I sure wouldn't. Say you had put $3,000 into an S&P 500 index fund for the year ended in April. It's boring, but you'd be up 15 percent which is pretty nice. Now let's say you'd gone the borrowed money route, borrowed $7,000 at 6 percent and put that in there too. Know how much you'd have made on your $3,000? Try 36 percent. But if the S&P had fallen 15 percent, you'd be out 64 percent. That downside risk as we call it is why you should leave the borrowed-money game to the pros. Watching big hitters win or lose big is a great spectator sport. But it's a whole other thing trying to play that game yourself. I'm Allan Sloan.
