Someone posted this question to us and we thought it would make an interesting topic to write about.
What if you could buy shares using your credit card, at least in the short term? You will actually be in a position to use your 45-50 day grace period to get interest free money to invest in securities.
Credit Card Billing Cycle
Credit card billing cycle is 45-50 days. If your billing cycle runs from the 1st of every month, i.e. you receive your credit card bill on the 1st of every month, which is to be paid before the 20th day of the month; you actually get 50 days of interest free credit, i.e. for a purchase made on the 1st of a month, you have time until the 20th of the next month to make the payment.
Now imagine if you could use your credit card to buy shares.
Example: Rajat spends Rs. 1, 00,000/- on his credit card to buy shares of Company A at Rs. 10 per share on the 2nd of July. He gets his Credit card bill on the 1st of August and must pay back the Rs. 1, 00,000 before the 20th of August. In effect, he has secured interest free Rs. 1, 00,000 for almost 50 days. So if he could bet on where Company A share trades on 20th August, he could make some money so long as shares of Company A trade higher than Rs. 10 on or before the 20th of August.
Sounds like fun!
Of course this is not possible, at least in a regulated market. I am not sure if this happens anywhere. May well be that it does, there are more enterprising businessmen in this country than we know of.
If someone was really disciplined then here is a way to actually use your credit limit to invest in shares. For most part this will qualify as how not to do your financial planning.
Using credit card to buy shares – How not use credit limits
You get your salary paid on the 1st of every month. The same day on which your credit card’s billing cycle starts.
Now – use your salary to buy shares and on the 1st of the month. At the same time, do all your big purchases on the credit card, on the same day (i.e. grocery, shopping, that big purchase that you have been planning to make etc).
Effect – You need to pay back your purchase bills in 50 days from now. All you need is that the shares you purchased are trading higher than the price you paid for them, within these 50 days. To explain with some numbers – in the above example, where you purchased 10,000 shares of Rs. 10/- each (i.e. for Rs. 1,00,000), the other thing you would do is to make purchases for an equivalent amount, i.e. Rs. 1,00,000 on the same day. Now if you can manage to sell the shares at a price above Rs. 10 at any point of time before 50 days, you are in profit.
Why you should never do this?
Simply because you are using loaned money to speculate by buying shares in the short term. Just in case the price of the share falls by 10-20% in the short term, you will be using your next month’s salary to finance your previous share purchase decision. Next month, when you need money, you will be selling your shares at a loss.
WHAT DOES WORK
Using Credit Card Limit to Earn Money – The Fixed Income Way
That said, if you could invest for 50 days in a fixed income product like a bank fixed deposit, then the interest element you make on that, is definite risk free profit. Most banks pay 7-8% interest rate on short term deposits (i.e. 45- 60 days). So what you can do is deposit Rs. 1,00,000 in a bank FD for 45 days. This way you will earn a risk free profit of Rs. 1,027/- (calculated @ 7.5% interest on a 45 day fixed deposit). Higher your credit limit, higher is the amount you can make.
Why do People not do this?
Actually a lot of people do this. Mostly with drastically negative results. The very reason that credit card companies give a 50 day grace period is in the hope that people will try such things, in the process missing their payment cycle and consequently paying a hefty penalty to the bank. It is absolutely shocking how many credit card holders default in timely payment at least once in a year. I think the stat would be close to 100%.
So long as you are missing one timely payment in 1-2 years, the banks are making profits, depending of course on the amount outstanding.
Also, the banks have actually covered this really well. They extend the interest free credit period only on your small purchases. That means that if you try to make a large purchase like – buying a car, you will find that the auto company will ask you for a 2 – 2.5% surcharge if you want to finance it with a credit card payment. In any event, in the ultimate analysis, do not even think of using any form of credit to finance your share purchases.
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