Thinking of purchasing a hot stock with a credit card? Beware that fraudsters running investment scams often trick victims into opening and maxing out cards. And even if you’re not being targeted by crooks, using your own card to invest can hurt your credit and wipe out your return.
The U.S. Securities and Exchange Commission (SEC), which regulates the investment industry, urges investors to be wary of investment brokers or advisers encouraging them to buy stocks, mutual funds, exchange-traded funds (ETFs) and other investment products with a credit card.
Ray Pellecchia, a spokesman for the nonprofit Financial Industry Regulatory Authority, says that if a broker or adviser pressures you to use a credit card when making an investment, it could be a sign of a scam.
Licensed and registered investment firms normally don’t let investors use credit cards to pay for investment products, according to the SEC. And even if they do allow it, investors should refrain from whipping out their credit cards to cover investments, the federal agency says.
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Be wary of anyone pushing you to invest with a credit card
Still thinking of purchasing that hot stock with a credit card? In October 2019, the SEC suggested proceeding carefully if someone who could be masquerading as an investment professional:
- Coaxes you to open a new credit card account or to boost the credit limit of an existing credit card.
- Asks you to divide an investment payment among several credit cards.
- Promises you’ll reap enough of an investment gain in the next 30 days to pay off your credit card bill.
“Fraudsters may try to get you to apply for additional credit so they can make more money off of you. They also may suggest splitting your investment between more than one credit card to avoid a large charge from being flagged as suspicious by credit card companies,” the SEC says on its website. “Finally, remember that there is no such thing as guaranteed high returns in a short period of time — this is a classic sign of fraud.”
Phony brokers duped disabled people, retirees out of their life savings
The consequences of credit-card-funded investments can be disastrous.
In September 2019, the SEC charged three men who owned and operated overseas call centers with defrauding investors in a multimillion-dollar scheme partly fueled by credit cards.
The SEC alleges employees of the call centers tricked investors into thinking they were brokers or financial advisers. These workers would push investors to make large deposits — often from credit cards, retirement accounts or savings accounts — to pay for purchases of dicey investments called binary options, the SEC claims in court documents. Credit card payments would wind up in bank accounts controlled by one of the alleged fraudsters.
As part of the alleged swindle, employees of the call centers would request copies of investors’ credit cards, driver’s licenses, passports and bills to supposedly comply with “know your customer” requirements. Actually, the SEC says, employees sought these documents so credit card chargebacks and fraud allegations stemming from the investment purchases could be disputed.
To make matters worse, the call center workers allegedly engaged in what’s described as a “credit card loop.” The SEC claims these workers counseled investors to borrow the maximum amount available on their credit card so they could execute short-term trades of binary options.
“Under the ‘loop,’ investors were supposed to withdraw their profits and pay off the credit card debt before the next billing cycle. Salespersons pitched the ‘loop’ as essentially an interest-free loan to fund binary options trading,” the SEC alleges in court documents. “When the time to repay the credit cards arose, however, [brokers] typically refused to permit the investor to withdraw funds.”
For some victims, the scheme wiped out their entire life savings, Melissa Hodgman, associate director of the SEC’s enforcement division, said in a news release. The victims, mostly in the U.S., included disabled people, farmers, doctors and retirees.
Federal rules regulate how investments can be paid for
Former stockbroker Matt Elliott, a certified financial planner who founded Pulse Financial Planning LLC in Rochester, Minnesota, says brokerage firms steer clear of enabling the purchase of investments by credit card because of strict federal rules about how someone can pay for investment products like stocks, mutual funds and ETFs.
The Federal Reserve’s Regulation T governs how certain investment products are paid for. Typically, an investor pays for purchases through a cash account at a brokerage. An investor also can borrow money from the brokerage through what’s known as a margin account. This is where Regulation T comes in.
“Generally, you’re allowed to borrow up to 50% of the purchase price in a margin account unless your broker has a higher requirement,” Elliott says. “Your broker will charge you interest on the amount of the purchase you borrow in your margin account.”
Elliott recommends that investors stay away from margin investing. And, even if it were widely permitted, he’d suggest that investors avoid using a credit card to cover investment purchases.
Credit card interest charges can wipe out your return
One big drawback to card-financed investments: A credit card interest rate of, say, 17% could easily erase an investment gain of, say, 10% if you fail to pay off your credit card balance before interest charges kick in.
“On top of that, you will pay interest on the amount you borrow, increasing your investment costs,” Elliott says. “Investors, in general, tend to be overly optimistic about the upside of their investment ideas and underestimate the risks. Borrowing to make your investment has the potential to make a bad decision worse by amplifying losses.”
Furthermore, the SEC warns, you might be hit with late fees if you’re unable to make the minimum monthly payments, possibly triggering a lower credit score, and you might be charged a transaction fee of roughly 1.5% to 3% for each investment purchase.
In the end, Elliott recommends investing only as much money as you can afford to invest and thoroughly weighing the risks.
“If you’re trying to get a return greater than what your credit card interest rate would be, you’re probably already treading into investments that may be too risky, particularly if you can’t afford to lose it,” he says.