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Invest using credit cards? It's both unavailable and unwise

By Alan Klayman

Maturing Loans
Maturing Loans, Alan Klayman
Alan Klayman is CEO of Klayman Financial LLC. He served as a vice president at Fidelity Investments, worked as a financial planner for American Express, and built fixed income strategies on Wall Street at The First Boston Corporation. At CreditCards.com, he writes Maturing Loans, a weekly feature in which he answers readers' questions about retirement and debt issues.

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Question for the CreditCards.com expert

Dear Maturing Loans,
Can credit cards be used when engaging in investment activities such as buying funds? Are there limitations on credit cards as a payment option? Who regulates these matters? -- Hyan

Answer for the CreditCards.com expert

Dear Hyan,
You have asked an interesting question. According to the mutual fund firms T. Rowe Price and Vanguard, they do not allow their mutual funds to be purchased with credit cards. Speaking with a representative at Vanguard, he said that Vanguard is a low-cost provider and that using a credit card would add to their costs. Vanguard is owned by their shareholders and they try to keep their costs to a minimum. They do accept electronic fund transfers from banks, however. So, if you wanted to move money from a bank to purchase a Vanguard mutual fund, you would be able to do that. At T. Rowe Price, the company also said that it does not accept credit cards for payment.  

Let's look at the matter from another standpoint, that of risk and reward. There is risk and possible reward in the purchase and long-term holding of a mutual fund. There is also a definite risk involved if you choose to purchase investments with credit. In essence, if you use a credit card to buy an investment (through a cash advance or other means), you are actually increasing the potential for greater loss should the investment lose value. Imagine the investment tanking and losing that money, but still owing your credit card company (for the outstanding balance plus interest, of course). Personally, I would advise against it. 

Plus, there are rules in place that regulate just how much you can borrow funds from other investments to protect against such scenarios. While most investment firms allow you to borrow money to invest, called "margin accounts," they have parameters that you must follow, called "margin requirements." Margin requirements are set up by the government, and brokerage firms have house requirements that are more stringent than the federal requirements. Fidelity Investments, a mutual fund provider, lists its house requirements right on its website.

Different securities at different times over the years have had different investment requirements. A margin requirement of about 50 percent is not uncommon, and is more the standard today than not. With a 50 percent margin requirement, that means that you cannot borrow more than 50 percent from a security to make a purchase of another security. For example, if you have an account with $50,000 and a 50 percent margin requirement, you can't borrow more than $25,000 from that account. If mutual fund companies were to allow credit card purchases, they would be allowing, by extension of this idea via the use of credit, 100 percent borrowing power for the purchase of a fund. Since this is higher than the federal margin and house requirements, it is not permitted.

From a regulatory standpoint, there are many aspects of investing and the markets that are regulated. Firms and individuals are regulated by the Financial Industry Regulatory Authority (FINRA) and its member exchanges (NYSE, NASDAQ, and others).  Laws regarding securities are regulated by the federal government's Securities and Exchange Commission (SEC). Mutual fund companies can trace their regulatory roots to the Investment Company Act of 1940. These regulatory organizations all started back in the Great Depression in 1929, when there was little oversight of the markets. Many of today's Depression-era regulatory origins are federal and self-regulatory. These regulatory bodies attempt to stop speculation by unsophisticated investors, keep markets fair and orderly, give all investors (big and small) access to the same information, and regulate who can sell securities (stocks, bonds, mutual funds, others).

Thanks for the question. See you back here next week.

 

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Published: August 6, 2008


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