A reader recently asked me about a friend who had invested heavily in Tesla stock using borrowed money, or "on margin." This friend, an educator by profession, had taken a significant risk, especially considering his income and his plans to start a family. I had tried to caution him against such risky behavior, drawing from my own experiences during the dotcom bubble collapse of 1999-2001. But my advice fell on deaf ears.
This friend, who also happened to be a fellow softball player, didn’t take me seriously. He saw me as a lazy player who didn’t give his all on the field, and this perception seemed to extend to my financial advice as well. Despite my attempts to explain that I was simply trying to avoid injury, he continued to dismiss my advice.
The more I think about it, the more I realize that losing all your money might not be the worst thing about buying stocks on margin. Let me explain.
This friend of mine, who earns around $70,000 a year as a preschool teacher, had revealed to me that he had bought more Tesla stock on margin. Given the rise in Tesla stock, I estimated that he had about a $250,000 position in Tesla, which was already a significant amount considering his income. But when I asked him how many shares he owned, he said, "Over 1,000!" This meant that at one point, he had over $900,000 worth of Tesla stock!
Despite my repeated attempts to persuade him to reduce his leverage, he remained adamant that Tesla’s stock would continue to soar. He was determined to get rich and achieve financial freedom as soon as possible.
Unfortunately, since March 2021, Tesla’s stock has fallen by about 70%. This means that he could have lost up to $630,000. Even with a recent job change and a raise, he would still need to work at least 10 more years to recover from this loss, based on my FS-SEER risk tolerance methodology.
Losing money is essentially losing time, and this becomes more costly as you get older. But there’s more to it than just losing money.
In addition to buying Tesla stock on margin, he might have also borrowed money from his parents. He helps manage his immigrant parents’ rental properties, and in immigrant families, money is often pooled together for the greater good. Losing your own money is one thing, but losing your parents’ hard-earned money is another. The shame can be unbearable, especially for an immigrant. Losing your family’s respect can be the worst thing.
I remember a time when I got my brother-in-law to invest in a stock that I thought was promising. Goldman Sachs had just taken the stock public, and it was trading 10% below its IPO, so I told him to buy. But the stock continued to fall, dropping another 20%. I felt terrible.
Losing around $630,000 is a significant loss for anyone. But if you lose $630,000 on margin by going all-in, it likely means that your entire net worth has disappeared. In other words, at 39 years old, he might have lost 17 years of savings post-college. Losing 17 years of savings and investing progress feels worse than having to work 10 more years.
When you’re making money from your investments, it’s easy to brag. And brag he did on Facebook about how much money he was making from his Tesla stock. But now that Tesla’s stock has fallen so much, he no longer has the status of the "preschool teacher investing guru."
Investing should be approached with humility. If you invest long enough, you will eventually lose money. Ideally, you should feel little emotion whether you’re making or losing money. If you find yourself constantly bragging on social media, you need to find the root cause of your problem. Is it loneliness? A lack of recognition from your parents growing up? Or maybe you need to confront your grade school bully who said you were never going to amount to anything. Figure it out.
Remember, a reputation can take a lifetime to build and a minute to destroy. How much is your reputation worth to you?
Fortunately, thanks to margin calls, it’s unlikely that my acquaintance lost 70% of his $900,000 position in Tesla. A margin call is a demand from your brokerage firm to increase the amount of equity in your account. You can do this by depositing cash or marginable securities into your account or by liquidating existing positions to generate cash.
Given that he went on maximum 50% margin, he was likely forced to sell some stock once Tesla declined by 25% to maintain his 50% margin ratio. Further, Tesla’s stock price has rebounded. Let’s hope he held on!
Therefore, instead of losing $630,000 in Tesla, he might have only lost around $300,000. But losing money on margin plus paying a 12% margin interest rate is still a bad combination!
Even though the first rule of financial independence is to never lose money, it may be impossible to adhere to during bear markets. The larger your investments, the harder it will be for you to make enough money from your day job or business to keep your net worth positive.
Hence, the second-best thing you can do is to lose less money than the average person. If you lose less than the average person, then you’re actually winning. Because when it comes to personal finance, everything is relative.
At Financial Samurai, we’re all about having a risk-appropriate asset allocation so that no matter the economic environment, we’ll likely be OK. We logically invest based on how we value our time.
We are willing to feed our investing FOMO by allocating at most 10% of our capital to the riskiest assets. Even if 10% of our speculative capital declines by 100%, we’ll still have 90% of our remaining capital left.
If it’s not clear by now, please don’t use margin to invest in stocks, especially growth stocks. Not only will you be paying margin fees, but you may also lose all your money. Then there’s the loss of progress, time, and respect.
There’s a reason why bond companies and banks usually only accept real assets as collateral. Funny money can disappear overnight, as it did with the bank run on Silicon Valley Bank.
Going on margin to buy funny money assets is like playing with a live grenade while walking through a minefield.
Being 40 years old and having the same net worth as when you were 23 is depressing. The regret you will feel for confusing brains with a bull market may only grow. And if the regret grows too much, it may ruin many other aspects of a perfectly fine life.
To build more wealth, consider investing in private real estate with Fundrise, my favorite real estate platform. Fundrise enables all investors to invest in residential and industrial private real estate for just a $10 minimum. Fundrise has been around since 2012 and primarily invests in the Sunbelt region where valuations are lower and yields are higher. It currently manages over $3.5 billion in assets for over 400,000 investors.
In addition, one of the most interesting funds I’m allocating new capital toward is the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I’m extremely bullish about. The investment minimum is also only $10, as Fundrise has democratized access to venture capital as well. Most venture capital funds have a $200,000+ minimum.
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