Hello everybody, it's Sam from Financial Samurai. And in this episode, I wanna talk about buying stocks on margin, why we shouldn't do so, and why we shouldn't confuse brains with a bull market. 2021 turned out to be a banner year for stocks, for real estate, for cryptocurrencies. And then 2022 turned out to be a bear market with the S&P 500 down about 20%, giving up all its gains.

Cryptocurrencies down 60 to 90, 900%. And then real estate finally starting to fade in the second half of 2022. So obviously losing money from anything stinks, but it's just part of the risk we take when we put our money to work in risk assets. If we invest a long enough period of time, we will lose money.

And sometimes we will lose a lot of money. The key is to learn from every single loss so you can better calibrate your risk exposure. Now the proper asset allocation is where you make money and you don't feel much emotion. And when you lose the money, you don't feel much emotion either.

This is really important to be a long-term investor, a successful long-term investor. You don't wanna get your emotions to whipsaw you, to panic sell at the bottom and then panic buy at the top because you're suffering from intense investing FOMO. I have mentioned in the past that investing FOMO is very, very hard to break.

It's I think harder than the lifestyle FOMO you see on social media, Instagram and so forth. That stuff, you can go visit Bali, you can go visit the pyramids of Egypt eventually, but investing FOMO is like, wow, that person's getting rich, I need to get rich too. And I can just click some buttons to get there without doing the proper due diligence, research and understanding of your true risk tolerance.

Now in the past, I've talked about quantifying your risk tolerance by looking at how much time you can buy with your investment gains and how much time you will lose with your investment losses. So if you always think about money in terms of time, I think it helps better calibrate how much risk you should actually take.

It makes you really focus on risk management every single quarter, every six months, every single year to make sure you have a proper asset allocation. There are really two ways to get ahead when it comes to money. One is to make more money and have greater returns than everybody else, or at least the average.

And the other way during a bear market is to lose less than everybody else. Because at the end of the day, finance is relative. So if everybody's down 50% and you're only down 10%, yeah, losing 10% will still sting, but you are relatively better by that 40% differential. So even though you might've lost money in 2022, which I did, which I think most of you have, feel better knowing that we significantly outperform those who let emotions control the way they invest.

You know, they invested too much in cryptocurrencies, too much in real estate, way too much leverage, and then they bought stocks on margin. So I've written in the past, buying stocks on margin is not a good idea because stocks, as we saw in 2022, can disappear in value overnight.

You know, you miss earnings by 3%, the stock goes down 20%, and it can just continue to go down. The values are almost not real. The only way you can realize the value, the gains of stocks is by selling. Selling on occasion, over time, and then converting that funny money into real assets or converting that money into enjoyment experiences.

There's a reason why bond companies don't accept stocks usually as collateral. And there's a reason why lenders, banks specifically, don't accept stocks for collateral either. They want hard assets, real assets, that they have higher confidence in converting into some value in case we, you default on a loan. So if large institutions are only accepting real assets as collateral, this is a lesson to be learned for all of us.

The lesson is non-real asset investments are highly volatile. They're more volatile and there's just more risk. So if you decide to buy stocks on margin, I think it's kind of like playing with a live grenade while walking through a minefield. Eventually you're gonna blow yourself up and you could blow yourself up real quick, right?

There's a saying, stocks go up like a, what? An escalator and goes down like an elevator. And so if it goes down like an elevator while you're on margin, you could lose all your money. From 2019 to early 2022, I played weekend softball all the times. Just meet up, casual games from 10.30 a.m.

on a Saturday till 2.30 p.m. It was pretty fun in general. However, the organizer would chide me and ride me all the time for not running through first base, not diving for balls, not going all out. And I told him, look buddy, I've got two young kids. I can't afford to sprain my knee, sprain my ankle, get pegged in the face.

If that happened, I wouldn't be able to do other physical activities. Most importantly, playing with my children who are still so small and who have so much energy and wanna play with me all the time. But he didn't care. Every single Saturday, he would make fun of my effort.

And then if I was on some team, he'd say, oh, well, good luck. Sam is on your team, good luck. But regardless of this chiding, it was interesting to talk to him about Tesla stock because he fashioned himself as an investing guru, even though he was a preschool teacher.

And I gotta say, as someone who spent his career in finance, who got his MBA, I love listening to people who don't know about finance, talk about finance. It's actually really entertaining to me, talking about, they talk about the technical analysis because they don't understand fundamental analysis of a company.

They talk about how things are gonna go to the moon. 2021 was a really highlight period. So I heard him talk a lot about his new Tesla car and how he bought Tesla stock in 2018, 2019, and he's making so much money. And he's the type of person who really needs to tell the world how much money he has.

And maybe it's because he's a preschool teacher and preschool teachers don't make that much money, but they make a decent amount of money. It's about 70,000, he said, here in San Francisco. And so every week I would hear him tell me how much money he made in Tesla stock.

And then one weekend he said, I bought even more stock 'cause there was like a dip. I bought more stock. And I was thinking to myself, man, how much Tesla stock do you have? How much in one position, folks? And I thought it was around $250,000 in Tesla stock, just assuming that he made money and just back of the envelope calculations.

And then he revealed to me he had over a thousand shares, which at that point meant he had over a $900,000 position in Tesla stock. And I was thinking to myself, why not? This is like never, you're like the richest preschool teacher I've ever met. How do you get that money?

And he didn't admit it, but he did say he was buying stock on margin and the margin rates are only about 5% at the time. And immediately I told him, look, dude, that is a massive position. We're in stock market mania right now. And if you lose money through margin, you could lose a lot of money.

And he just didn't have it. He just said, ah, why am I gonna listen to you? You don't even run through the bases. Okay, so fine. Well, as we know, a year and a half later, Tesla stock is down 65, 70%. Elon Musk has lost $200 billion in one year in 2022.

So that's a record. And so what happened? Well, I didn't ask him what happened because that's pretty rude. And I'm not gonna just kick a man when he's down, but I can guess what happened. And basically he probably lost up to $630,000. Now, can you imagine losing $630,000? I mean, if you had a $10 million portfolio, okay, fine, $630,000, it's just what it is, right?

It's 6.3%. But in his case, with his income, 70,000, let's say it's even 100,000. First of all, it's gonna take over 10 years for him to make up for his losses, right? This is using the FSC or methodology in terms of how many months or how many years it will take based on your average income to make up for your losses.

Now, if you are willing to spend over three years, actually in the post I said over 18 months to make up for your losses, I say you have a high risk tolerance. Now, if you got the gumption to risk 10 years of your life to make up for potential losses, then your risk tolerance is out the window.

It's massively extreme. But here's the thing. Maybe losing all your money buying stocks on margin is not the worst thing. Because I was thinking about Ford. So any self-respecting person who makes a mistake will be willing to work hard to rectify the mistake. So in his case, at least 10 years to make up for his losses of one year.

But what I didn't realize was that he probably lost his entire net worth, which means that at age 39, his net worth is equivalent to when he was 22 right out of college. Think about that, folks. Losing 17 years of savings and investments in one year. So you've got to make up for the time in the backend by working more.

And then you just wiped away all that hard work, time and savings in the front end. So psychologically, I don't know what that does to someone, losing all that progress and then having to make up for it in the future. It's obviously not good. So the next time you wanna buy something on margin or just buy any investment, think about very clearly how much you have to sacrifice in the future and how much of your progress you have to give up as well.

But guess what, folks? Losing all that time in the future and all that progress from the past might not be the worst thing, buying stocks on margin. The worst thing could be losing your reputation, your pride, your honor. In my softball acquaintances case, every week he would post on Facebook his analysis on Tesla stock and why it should be a buy and why it's going up, quarterly results and how much money he made.

I mean, it was a very loud megaphone of bragging about how well he was doing. And then when the stock started declining, he would hold on and he's been quiet for over six months about his Tesla position. And that's what happens. When we're making a lot of money, we get very emotional.

And some people with outsized exposure then start bragging about how much they make. And this is very dangerous because you could end up losing money. And when that happens, you're gonna look like a fool if you've been bragging so much to the public about how much you were making.

So the key here is to stay humble when you're making a lot of money and bank those returns to buffer inevitable downside losses. You wanna be making a lot of money quietly and you wanna be losing a lot of money quietly. It works both ways. Think about how much money and how much effort companies spend on getting their reputations right.

Employee training, culture training, motto training, saying your company right, all this stuff. Because reputations take years to build and it can take minutes, minutes to destroy. And if you don't have your reputation, you have nothing. Nobody is gonna give Elizabeth Holmes and Sam Bankman Freed more money to invest.

Their reputations are done. It's gone to zero. But worse, what's worse I think is the harm that they've done to their parents. This is just worse from their point of view. The harm they've done to their parents' reputations. You know, Sam is dragging down his parents who spent decades as professors at Stanford University.

They were esteemed professors, they were respected. Now, you know, they've canceled their classes. I think people are gonna look at them with suspicion, wondering how much did they advise Sam to set up this Ponzi scheme and do illegal things. So to the extreme, we can talk about multi-generational reputation destruction and what happens to the kids of these folks.

You know, I'm talking about extremes here, but you know, the kids, the innocent kids who have nothing to do with the sins of their mothers and fathers, they might be unfairly hurt as well. So think about that. Think about that next time you wanna buy stocks and other funny money investments on margin.

In my softball acquaintances' case, look, you can't buy hundreds of thousands of dollars in one stock on a $70,000 salary. And you can't do that with margin. There's basically a limit on how much margin you can buy, which is basically 50% of the total value of your position. So how does someone making $70,000 to $100,000 buy $400,000 of stock and then borrows another $400,000, let's say?

Well, as an immigrant, he probably borrowed money from his parents 'cause this is what immigrant families do. They think about the collective. My money is your money, parents' money is my money. And as a collective, because they're immigrants with not a lot of money, they're trying to pull together their resources to get ahead for multi-generations.

So if you end up buying stocks on margin and borrowing money from your parents who came to this country with nothing and then lose hundreds of thousands of dollars of it or all of it, you are gonna be in a world of hurt mentally and you're gonna lose that honor your parents have for you, at least temporarily.

So once again, this is the danger of falling for investing FOMO. This is the danger of taking on debt to buy assets that have no guaranteed returns. You could lose money in those assets and you will end up paying a margin expense. Now, there is a silver lining to this story.

Due to margin calls, my softball acquaintance likely didn't lose $630,000 or 70% of his entire position because the online brokerage would have margin called him to force him to put up capital or sell stocks on the way down. Usually it starts at around down 25%. So instead of losing 630,000, he might've only lost 350,000.

Whatever the case may be, a $350,000 loss on a 70,000 to $100,000 income is still a lot and it's just the same story to be careful when you're buying risk assets. All right, everybody, I hope this story demonstrates the danger of buying stocks on margin. And I know, look, it's easy to think we're geniuses when times are really good and we're making money hand over fist in our stocks, real estate, or whatever asset class it is.

Just know, bad things happen all the time. I've talked about this since I started Financial Samurai in 2009 and we need to stay even keeled, humble and measured during good times and during bad times. Please, if you listen to an episode or read a post on Financial Samurai where I'm bragging and I'm not being measured, balancing the good with the bad, please let me know.

Please hit me upside the head and remind me about the importance of humility. Thanks so much everyone for listening. If you enjoyed this episode, I'd love a great five-star review. Please share this episode or this whole series with your friends because if you enjoy it, they will probably enjoy it too.

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