Last Updated on 21 September, 2020 by Samuelsson
Investing in stocks is arguably the easiest way an average person can make money. When you spot a good stock, but you’re low on cash, you may begin to wonder if you can buy stocks with a credit card.
No, generally speaking, no stockbrokers will allow you to buy stocks with your credit card. The reason is that stocks are risky assets and can fall in value very fast, so a genuine broker won’t allow you to invest the money you can’t afford to lose.
While the majority of stockbrokers won’t accept a credit card as a payment option, there may be a few ways to use the money in your credit card to buy stocks. But should you do it? Read on to find out and also learn better ways to invest with borrowed money.
Buying Stocks With a Credit Card: a Few Workarounds
For you to buy or sell stocks, you must open a brokerage account and fund it. There are several ways you can fund your account, but brokers won’t accept funds from your credit card — whether for initial deposit or account top-up.
Some of the ways you can fund your account include electronic fund transfer from your bank account, personal check, certified check, and sometimes, PayPal. So if you must buy stocks with the money in your credit card, you have to figure out ways to get the money into any of those acceptable funding options. Here are some of the ways you can do that:
If your credit card allows cash advances, it is the easiest way to transfer funds into any of the payment options accepted by your broker, but because of the fees and interest rates involved, it is not a financially wise choice.
However, if you really want to use that money, take out a cash advance and move the cash into your bank account. From there, you can make a transfer to your brokerage account, or issue a personal or certified check. You can even deposit directly to your trading account with a cash advance check.
The second option is to create two PayPal accounts and link one to your credit card and the other to your bank account. Then, send money from the card-link PayPal account to the bank-linked PayPal account. From the bank-linked account, you can fund your brokerage account if your broker accepts PayPal as a funding option.
Why You Should Avoid Buying Stocks With a Credit Card
There’s a reason stockbrokers don’t allow investors to invest in stocks with their credit card, and it’s actually for your own good. Even though you can bypass the brokers’ no credit card policy with the above methods, it is not advisable you do so, and here is why.
You Pay a Fee for Cash Advances
You don’t take out cash advances for free; there are fees attached to them. The fee may either be a flat rate, (say $30 or $50), or it may be a percentage of the amount you wish to take out. In addition, if you’re going to get the cash via an ATM, it’s possible you will pay another $3 usage fee.
Even if you use the PayPal option, you’re still liable to PayPal charges which may be up to 4% of the amount.
The Interest is High
Cash advances usually carry a high interest rate, which may even be higher than the rate on online purchases with the credit card, and there may not be a grace period — the interest begins to accrue immediately. Some credit cards charge up to 24% interest rate in addition to the cash advance fee.
PayPal option may be better because the interest rate is the usual APR rate, but at 16-18%, that is still high compared to the rate on margin accounts.
Stocks are Risky Assets
Unlike fixed-income securities with known returns, stocks can increase or decline in value at any time. What happens if the stocks go south after purchasing them? You don’t want to be in a situation where the stocks lose value, and you have to pay the borrowed amount and interest.
But even if the market is all good and stocks keep getting a normal return, the average return in the stock market is around 10% Using a loan with a 24% interest rate to make an investment with a 20% return is financially hemorrhagic.
Alternative Ways to Buy Stocks With Borrowed Money
You don’t have to use your credit card if you want to buy stocks on credit. There are better ways to invest in stocks with borrowed money. The following are some of the options for you:
Some brokers allow certain investors to trade on margin. A margin account is a brokerage account that qualifies an investor to borrow money from the broker to buy stocks. For most brokers, the interest rate is around 9%. Not all investors qualify for a margin account though. To be able to buy stocks on margin, you must meet the standard required by the broker.
The broker may try to ascertain your experience in investing by asking you certain questions. Also, the broker may check your credit status. If you are fine on these ones, they will tell you about their deposit policy. In the US, federal regulations require a $2,000 minimum balance on the account, but some brokers may require more than that.
There’s a limit to how much you can borrow; the rule is different for different brokers. But, generally, most brokers may allow you to borrow up to 50% of the total cost of the stock you want to buy. For example, if you want to buy 200 shares of an $8 stock, they will cost $1,600, so you can get up to $800 from the broker and add to your own $800 to buy the stock.
Another way you can invest in stocks on credit is through stock-based derivatives that have inbuilt leverage. One common example is single-stock futures contracts. These are standard futures contracts with a particular stock as its underlying asset. Each contract here controls 100 shares of the stock.
The financing costs are added to the price of the futures contracts, so the transactions are similar to short-term loans. And they are leveraged contracts because you can use a small amount to control large contracts. You are required to deposit only about 20% (or less) of the cost of the contract to be able to purchase the contract. This implies leverage of about 1:5 or more. In other words, with a $5,000 deposit, you can control more than $25,000 worth of futures contract.
Apart from the high leverage, stock futures typically have low bid-ask spreads and lower interest costs. But while owning real stocks entitles you to dividends and may also carry a voting right, stock futures don’t get you all those.
The Dangers of Using Excessive Leverage
Leverage is a double-edged sword. In as much as it can multiply your profits if the investment is profitable, it can also do the same to losses if the investment is bad. If you are using a 1:5 leverage in your trade and the asset’s value declines, your losses will be multiplied by five. That can wipe out your initial deposit and even put you in debt if care is not taken. So, leveraged investments can be very risky, especially for inexperienced investors.
Although most brokers won’t allow you to buy stocks with your credit card, there are ways you can circumvent that rule. But it’s not worth the effort, because the fees and exorbitant interest rate will make it almost impossible to make any profit from the adventure.
There are other ways you can buy stocks on credit, such as margin accounts and stock futures, but leveraged investments come with higher risks. You can never be too careful when investing with borrowed money.
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