The_Danger_Of_Buying_Stock_On_Margin
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai.
00:00:02.700 | And in this episode,
00:00:04.020 | I wanna talk about buying stocks on margin,
00:00:06.460 | why we shouldn't do so,
00:00:08.660 | and why we shouldn't confuse brains with a bull market.
00:00:13.000 | 2021 turned out to be a banner year for stocks,
00:00:18.000 | for real estate, for cryptocurrencies.
00:00:20.500 | And then 2022 turned out to be a bear market
00:00:24.620 | with the S&P 500 down about 20%, giving up all its gains.
00:00:28.840 | Cryptocurrencies down 60 to 90, 900%.
00:00:33.740 | And then real estate finally starting to fade
00:00:36.240 | in the second half of 2022.
00:00:38.720 | So obviously losing money from anything stinks,
00:00:42.400 | but it's just part of the risk we take
00:00:45.700 | when we put our money to work in risk assets.
00:00:48.280 | If we invest a long enough period of time,
00:00:51.640 | we will lose money.
00:00:52.820 | And sometimes we will lose a lot of money.
00:00:56.200 | The key is to learn from every single loss
00:00:59.520 | so you can better calibrate your risk exposure.
00:01:03.240 | Now the proper asset allocation is where you make money
00:01:07.960 | and you don't feel much emotion.
00:01:10.400 | And when you lose the money,
00:01:11.640 | you don't feel much emotion either.
00:01:14.000 | This is really important to be a long-term investor,
00:01:16.640 | a successful long-term investor.
00:01:18.280 | You don't wanna get your emotions to whipsaw you,
00:01:21.080 | to panic sell at the bottom and then panic buy at the top
00:01:25.160 | because you're suffering from intense investing FOMO.
00:01:29.200 | I have mentioned in the past that investing FOMO
00:01:31.520 | is very, very hard to break.
00:01:34.680 | It's I think harder than the lifestyle FOMO
00:01:37.600 | you see on social media, Instagram and so forth.
00:01:40.600 | That stuff, you can go visit Bali,
00:01:43.040 | you can go visit the pyramids of Egypt eventually,
00:01:45.800 | but investing FOMO is like, wow,
00:01:48.560 | that person's getting rich, I need to get rich too.
00:01:51.200 | And I can just click some buttons to get there
00:01:52.820 | without doing the proper due diligence, research
00:01:56.300 | and understanding of your true risk tolerance.
00:01:59.080 | Now in the past,
00:02:00.120 | I've talked about quantifying your risk tolerance
00:02:03.080 | by looking at how much time you can buy
00:02:05.600 | with your investment gains
00:02:07.340 | and how much time you will lose with your investment losses.
00:02:11.720 | So if you always think about money in terms of time,
00:02:14.580 | I think it helps better calibrate
00:02:16.280 | how much risk you should actually take.
00:02:18.320 | It makes you really focus on risk management
00:02:20.760 | every single quarter, every six months, every single year
00:02:23.880 | to make sure you have a proper asset allocation.
00:02:26.800 | There are really two ways to get ahead
00:02:28.760 | when it comes to money.
00:02:29.980 | One is to make more money and have greater returns
00:02:33.720 | than everybody else, or at least the average.
00:02:36.600 | And the other way during a bear market
00:02:38.920 | is to lose less than everybody else.
00:02:41.500 | Because at the end of the day, finance is relative.
00:02:44.840 | So if everybody's down 50% and you're only down 10%,
00:02:49.120 | yeah, losing 10% will still sting,
00:02:51.400 | but you are relatively better by that 40% differential.
00:02:55.240 | So even though you might've lost money in 2022,
00:02:58.640 | which I did, which I think most of you have,
00:03:01.600 | feel better knowing that we significantly outperform
00:03:04.640 | those who let emotions control the way they invest.
00:03:08.920 | You know, they invested too much in cryptocurrencies,
00:03:11.900 | too much in real estate, way too much leverage,
00:03:14.520 | and then they bought stocks on margin.
00:03:17.240 | So I've written in the past,
00:03:18.560 | buying stocks on margin is not a good idea
00:03:20.900 | because stocks, as we saw in 2022,
00:03:24.440 | can disappear in value overnight.
00:03:26.660 | You know, you miss earnings by 3%,
00:03:28.240 | the stock goes down 20%,
00:03:30.320 | and it can just continue to go down.
00:03:32.240 | The values are almost not real.
00:03:35.600 | The only way you can realize the value,
00:03:37.780 | the gains of stocks is by selling.
00:03:40.400 | Selling on occasion, over time,
00:03:43.240 | and then converting that funny money into real assets
00:03:46.000 | or converting that money into enjoyment experiences.
00:03:50.600 | There's a reason why bond companies
00:03:53.160 | don't accept stocks usually as collateral.
00:03:56.080 | And there's a reason why lenders,
00:03:57.880 | banks specifically,
00:03:59.480 | don't accept stocks for collateral either.
00:04:01.560 | They want hard assets, real assets,
00:04:04.180 | that they have higher confidence in converting
00:04:07.400 | into some value in case we, you default on a loan.
00:04:12.120 | So if large institutions
00:04:15.240 | are only accepting real assets as collateral,
00:04:17.560 | this is a lesson to be learned for all of us.
00:04:20.280 | The lesson is non-real asset investments
00:04:23.760 | are highly volatile.
00:04:24.880 | They're more volatile and there's just more risk.
00:04:27.480 | So if you decide to buy stocks on margin,
00:04:31.400 | I think it's kind of like playing with a live grenade
00:04:33.520 | while walking through a minefield.
00:04:36.000 | Eventually you're gonna blow yourself up
00:04:38.020 | and you could blow yourself up real quick, right?
00:04:40.440 | There's a saying, stocks go up like a, what?
00:04:44.040 | An escalator and goes down like an elevator.
00:04:46.960 | And so if it goes down like an elevator
00:04:48.680 | while you're on margin, you could lose all your money.
00:04:52.780 | From 2019 to early 2022,
00:04:55.600 | I played weekend softball all the times.
00:04:58.580 | Just meet up, casual games from 10.30 a.m.
00:05:01.120 | on a Saturday till 2.30 p.m.
00:05:04.000 | It was pretty fun in general.
00:05:05.400 | However, the organizer would chide me
00:05:09.680 | and ride me all the time for not running through first base,
00:05:13.200 | not diving for balls, not going all out.
00:05:16.880 | And I told him, look buddy, I've got two young kids.
00:05:20.120 | I can't afford to sprain my knee, sprain my ankle,
00:05:23.760 | get pegged in the face.
00:05:25.560 | If that happened, I wouldn't be able
00:05:27.480 | to do other physical activities.
00:05:29.200 | Most importantly, playing with my children
00:05:31.200 | who are still so small and who have so much energy
00:05:34.040 | and wanna play with me all the time.
00:05:36.400 | But he didn't care.
00:05:37.680 | Every single Saturday, he would make fun of my effort.
00:05:40.960 | And then if I was on some team, he'd say,
00:05:43.600 | oh, well, good luck.
00:05:45.800 | Sam is on your team, good luck.
00:05:47.360 | But regardless of this chiding,
00:05:50.560 | it was interesting to talk to him about Tesla stock
00:05:53.800 | because he fashioned himself as an investing guru,
00:05:56.700 | even though he was a preschool teacher.
00:05:58.680 | And I gotta say, as someone who spent his career in finance,
00:06:02.360 | who got his MBA, I love listening to people
00:06:06.320 | who don't know about finance, talk about finance.
00:06:09.160 | It's actually really entertaining to me,
00:06:11.560 | talking about, they talk about the technical analysis
00:06:14.200 | because they don't understand fundamental analysis
00:06:16.480 | of a company.
00:06:17.680 | They talk about how things are gonna go to the moon.
00:06:20.360 | 2021 was a really highlight period.
00:06:23.720 | So I heard him talk a lot about his new Tesla car
00:06:27.640 | and how he bought Tesla stock in 2018, 2019,
00:06:31.840 | and he's making so much money.
00:06:33.640 | And he's the type of person who really needs
00:06:35.880 | to tell the world how much money he has.
00:06:38.480 | And maybe it's because he's a preschool teacher
00:06:40.920 | and preschool teachers don't make that much money,
00:06:43.400 | but they make a decent amount of money.
00:06:44.560 | It's about 70,000, he said, here in San Francisco.
00:06:47.520 | And so every week I would hear him tell me
00:06:50.600 | how much money he made in Tesla stock.
00:06:52.600 | And then one weekend he said,
00:06:54.600 | I bought even more stock 'cause there was like a dip.
00:06:56.640 | I bought more stock.
00:06:57.600 | And I was thinking to myself,
00:06:59.000 | man, how much Tesla stock do you have?
00:07:01.600 | How much in one position, folks?
00:07:04.660 | And I thought it was around $250,000 in Tesla stock,
00:07:07.600 | just assuming that he made money
00:07:09.640 | and just back of the envelope calculations.
00:07:12.360 | And then he revealed to me he had over a thousand shares,
00:07:15.040 | which at that point meant he had
00:07:17.120 | over a $900,000 position in Tesla stock.
00:07:21.480 | And I was thinking to myself, why not?
00:07:22.560 | This is like never,
00:07:23.720 | you're like the richest preschool teacher I've ever met.
00:07:25.920 | How do you get that money?
00:07:28.040 | And he didn't admit it,
00:07:29.760 | but he did say he was buying stock on margin
00:07:32.200 | and the margin rates are only about 5% at the time.
00:07:36.980 | And immediately I told him,
00:07:38.760 | look, dude, that is a massive position.
00:07:41.580 | We're in stock market mania right now.
00:07:44.420 | And if you lose money through margin,
00:07:46.460 | you could lose a lot of money.
00:07:47.880 | And he just didn't have it.
00:07:49.980 | He just said, ah, why am I gonna listen to you?
00:07:53.140 | You don't even run through the bases.
00:07:55.260 | Okay, so fine.
00:07:56.500 | Well, as we know, a year and a half later,
00:07:59.420 | Tesla stock is down 65, 70%.
00:08:03.080 | Elon Musk has lost $200 billion in one year in 2022.
00:08:06.480 | So that's a record.
00:08:08.120 | And so what happened?
00:08:09.000 | Well, I didn't ask him what happened
00:08:10.200 | because that's pretty rude.
00:08:11.240 | And I'm not gonna just kick a man when he's down,
00:08:14.840 | but I can guess what happened.
00:08:16.480 | And basically he probably lost up to $630,000.
00:08:21.480 | Now, can you imagine losing $630,000?
00:08:25.680 | I mean, if you had a $10 million portfolio,
00:08:27.920 | okay, fine, $630,000, it's just what it is, right?
00:08:31.600 | It's 6.3%.
00:08:34.080 | But in his case, with his income, 70,000,
00:08:37.440 | let's say it's even 100,000.
00:08:39.160 | First of all, it's gonna take over 10 years
00:08:41.880 | for him to make up for his losses, right?
00:08:44.840 | This is using the FSC or methodology
00:08:47.320 | in terms of how many months or how many years
00:08:50.420 | it will take based on your average income
00:08:53.020 | to make up for your losses.
00:08:54.840 | Now, if you are willing to spend over three years,
00:08:58.380 | actually in the post I said over 18 months
00:09:00.160 | to make up for your losses,
00:09:01.480 | I say you have a high risk tolerance.
00:09:03.520 | Now, if you got the gumption to risk 10 years of your life
00:09:08.520 | to make up for potential losses,
00:09:10.400 | then your risk tolerance is out the window.
00:09:12.840 | It's massively extreme.
00:09:14.760 | But here's the thing.
00:09:16.040 | Maybe losing all your money buying stocks on margin
00:09:20.040 | is not the worst thing.
00:09:21.800 | Because I was thinking about Ford.
00:09:23.060 | So any self-respecting person who makes a mistake
00:09:26.600 | will be willing to work hard to rectify the mistake.
00:09:29.840 | So in his case, at least 10 years
00:09:31.920 | to make up for his losses of one year.
00:09:34.860 | But what I didn't realize was that
00:09:37.600 | he probably lost his entire net worth,
00:09:40.440 | which means that at age 39,
00:09:43.120 | his net worth is equivalent to when he was 22
00:09:47.160 | right out of college.
00:09:48.600 | Think about that, folks.
00:09:50.040 | Losing 17 years of savings and investments in one year.
00:09:55.040 | So you've got to make up for the time in the backend
00:10:00.460 | by working more.
00:10:01.840 | And then you just wiped away all that hard work,
00:10:04.380 | time and savings in the front end.
00:10:07.200 | So psychologically, I don't know what that does to someone,
00:10:12.200 | losing all that progress
00:10:14.880 | and then having to make up for it in the future.
00:10:17.520 | It's obviously not good.
00:10:19.160 | So the next time you wanna buy something on margin
00:10:22.100 | or just buy any investment,
00:10:24.120 | think about very clearly
00:10:26.300 | how much you have to sacrifice in the future
00:10:28.860 | and how much of your progress you have to give up as well.
00:10:32.420 | But guess what, folks?
00:10:33.860 | Losing all that time in the future
00:10:36.980 | and all that progress from the past
00:10:38.820 | might not be the worst thing, buying stocks on margin.
00:10:42.860 | The worst thing could be losing your reputation,
00:10:46.300 | your pride, your honor.
00:10:48.180 | In my softball acquaintances case,
00:10:51.440 | every week he would post on Facebook
00:10:53.840 | his analysis on Tesla stock and why it should be a buy
00:10:56.920 | and why it's going up, quarterly results
00:10:59.520 | and how much money he made.
00:11:00.800 | I mean, it was a very loud megaphone of bragging
00:11:04.220 | about how well he was doing.
00:11:06.440 | And then when the stock started declining,
00:11:08.560 | he would hold on and he's been quiet for over six months
00:11:12.360 | about his Tesla position.
00:11:14.000 | And that's what happens.
00:11:15.040 | When we're making a lot of money, we get very emotional.
00:11:18.040 | And some people with outsized exposure
00:11:21.720 | then start bragging about how much they make.
00:11:24.400 | And this is very dangerous
00:11:26.240 | because you could end up losing money.
00:11:28.560 | And when that happens, you're gonna look like a fool
00:11:30.720 | if you've been bragging so much to the public
00:11:32.600 | about how much you were making.
00:11:34.060 | So the key here is to stay humble
00:11:36.040 | when you're making a lot of money
00:11:38.400 | and bank those returns
00:11:41.060 | to buffer inevitable downside losses.
00:11:45.080 | You wanna be making a lot of money quietly
00:11:48.640 | and you wanna be losing a lot of money quietly.
00:11:52.680 | It works both ways.
00:11:54.080 | Think about how much money
00:11:56.680 | and how much effort companies spend
00:11:59.800 | on getting their reputations right.
00:12:02.720 | Employee training, culture training, motto training,
00:12:05.640 | saying your company right, all this stuff.
00:12:08.680 | Because reputations take years to build
00:12:12.280 | and it can take minutes, minutes to destroy.
00:12:16.200 | And if you don't have your reputation, you have nothing.
00:12:19.400 | Nobody is gonna give Elizabeth Holmes
00:12:21.680 | and Sam Bankman Freed more money to invest.
00:12:24.460 | Their reputations are done.
00:12:26.520 | It's gone to zero.
00:12:28.060 | But worse, what's worse I think
00:12:31.280 | is the harm that they've done to their parents.
00:12:34.540 | This is just worse from their point of view.
00:12:37.060 | The harm they've done to their parents' reputations.
00:12:40.040 | You know, Sam is dragging down his parents
00:12:42.200 | who spent decades as professors at Stanford University.
00:12:46.120 | They were esteemed professors, they were respected.
00:12:48.840 | Now, you know, they've canceled their classes.
00:12:51.760 | I think people are gonna look at them with suspicion,
00:12:54.080 | wondering how much did they advise Sam
00:12:58.040 | to set up this Ponzi scheme and do illegal things.
00:13:00.880 | So to the extreme,
00:13:01.980 | we can talk about multi-generational reputation destruction
00:13:06.780 | and what happens to the kids of these folks.
00:13:09.280 | You know, I'm talking about extremes here,
00:13:10.760 | but you know, the kids, the innocent kids
00:13:13.440 | who have nothing to do with the sins
00:13:15.400 | of their mothers and fathers,
00:13:17.120 | they might be unfairly hurt as well.
00:13:20.300 | So think about that.
00:13:21.360 | Think about that next time you wanna buy stocks
00:13:23.600 | and other funny money investments on margin.
00:13:27.600 | In my softball acquaintances' case,
00:13:30.120 | look, you can't buy hundreds of thousands of dollars
00:13:33.320 | in one stock on a $70,000 salary.
00:13:36.640 | And you can't do that with margin.
00:13:39.160 | There's basically a limit on how much margin you can buy,
00:13:41.600 | which is basically 50% of the total value of your position.
00:13:46.440 | So how does someone making $70,000 to $100,000
00:13:50.200 | buy $400,000 of stock
00:13:53.680 | and then borrows another $400,000, let's say?
00:13:56.640 | Well, as an immigrant,
00:13:59.000 | he probably borrowed money from his parents
00:14:01.440 | 'cause this is what immigrant families do.
00:14:03.960 | They think about the collective.
00:14:06.600 | My money is your money, parents' money is my money.
00:14:09.880 | And as a collective,
00:14:11.200 | because they're immigrants with not a lot of money,
00:14:14.160 | they're trying to pull together their resources
00:14:15.980 | to get ahead for multi-generations.
00:14:18.480 | So if you end up buying stocks on margin
00:14:20.800 | and borrowing money from your parents
00:14:23.080 | who came to this country with nothing
00:14:24.600 | and then lose hundreds of thousands of dollars of it
00:14:27.400 | or all of it,
00:14:28.920 | you are gonna be in a world of hurt mentally
00:14:32.360 | and you're gonna lose that honor your parents have for you,
00:14:36.800 | at least temporarily.
00:14:38.200 | So once again,
00:14:39.320 | this is the danger of falling for investing FOMO.
00:14:43.880 | This is the danger of taking on debt
00:14:45.960 | to buy assets that have no guaranteed returns.
00:14:49.720 | You could lose money in those assets
00:14:52.040 | and you will end up paying a margin expense.
00:14:56.520 | Now, there is a silver lining to this story.
00:15:00.000 | Due to margin calls,
00:15:01.960 | my softball acquaintance likely didn't lose $630,000
00:15:05.840 | or 70% of his entire position
00:15:08.080 | because the online brokerage would have margin called him
00:15:11.920 | to force him to put up capital
00:15:13.320 | or sell stocks on the way down.
00:15:15.600 | Usually it starts at around down 25%.
00:15:18.280 | So instead of losing 630,000,
00:15:20.120 | he might've only lost 350,000.
00:15:23.640 | Whatever the case may be,
00:15:25.000 | a $350,000 loss on a 70,000 to $100,000 income
00:15:29.280 | is still a lot
00:15:31.320 | and it's just the same story to be careful
00:15:33.680 | when you're buying risk assets.
00:15:36.320 | All right, everybody,
00:15:37.160 | I hope this story demonstrates the danger
00:15:39.520 | of buying stocks on margin.
00:15:41.520 | And I know, look, it's easy to think we're geniuses
00:15:45.000 | when times are really good
00:15:46.120 | and we're making money hand over fist in our stocks,
00:15:49.240 | real estate, or whatever asset class it is.
00:15:52.400 | Just know, bad things happen all the time.
00:15:56.360 | I've talked about this since I started
00:15:57.840 | Financial Samurai in 2009
00:15:59.960 | and we need to stay even keeled,
00:16:02.480 | humble and measured during good times and during bad times.
00:16:07.200 | Please, if you listen to an episode
00:16:09.880 | or read a post on Financial Samurai
00:16:12.160 | where I'm bragging and I'm not being measured,
00:16:15.120 | balancing the good with the bad, please let me know.
00:16:18.240 | Please hit me upside the head
00:16:20.040 | and remind me about the importance of humility.
00:16:23.560 | Thanks so much everyone for listening.
00:16:25.000 | If you enjoyed this episode,
00:16:26.120 | I'd love a great five-star review.
00:16:29.080 | Please share this episode
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00:16:31.800 | because if you enjoy it, they will probably enjoy it too.
00:16:35.200 | And if you'd like to support my work,
00:16:37.160 | check out Buy This, Not That.
00:16:39.460 | You can go to financialsamurai.com/buythisnotthat
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00:16:49.920 | Take care, everyone.