“What happened to your friend who bought Tesla stock on margin,” a reader asked. He likely lost a lot of money, but I haven't asked for details. That would be rude.
On March 31, 2021, I published a post entitled, Buying Stocks On Margin Is A Bad Idea: You Could Lose Big. I wrote the post because I was alarmed by my softball friend’s excessive risk-taking.
When compared to what he was earning as an educator, his position was a huge red flag. Given he also wanted to start a family, I tried to encourage him to be more conservative during 2021's stock mania.
I learned my lesson during the 1999 – 2001 dotcom bubble collapse while working at Goldman Sachs. Fortunes are easily made and lost, which is why I encourage readers to regularly convert funny money into real assets. This way, you increase your chances of protecting your gains.
Unfortunately, my advice fell on deaf ears. In his eyes, I was a lazy softball player who didn't dive for balls, slide, and run at 100% speed. No matter how many times I explained to him I didn't want to injure myself as a dad to two young kids, he continued to chide. So he’s not really a friend, but let’s call him one anyway.
What I realize from writing this post is that losing all your money may not be the worst thing when buying stocks on margin. Let me explain.
Betting Big On Margin At The Top
Here's a portion of what I wrote in the post,
My friend makes roughly $70,000 a year as a preschool teacher.
As we got to discussing the future of Tesla one day, he revealed to me he had bought more stock on margin. Given the rise in Tesla stock, I thought he had about a $250,000 position in Tesla, which was already a lot based on his income.
When I asked him how many shares he owned now, he said, “Over 1,000!” In other words, at one point, he had over $900,000 worth of Tesla stock!
I'm not sure how he keeps getting new funds or how he was able to borrow so much. However, he did say he “only has to pay a 7% interest rate on his margin.”
No matter how hard I encourage him to de-leverage, he won't. He's adamant Tesla will continue to fly to the moon. He wants to get rich. At 38, he wants to achieve financial freedom now!
Losing Lots Of Money On Margin And Then Some
Unfortunately, since March 2021, Tesla stock is down about 70%. As a result, he may have lost a maximum of $630,000.
Since March 2021, he has gotten a new job with a raise. But even if he now makes $100,000 a year, based on my FS-SEER risk tolerance methodology, after taxes and expenses, he now has to work at least 10 more years to make up for his losses.
Having to work at least 10 more years to achieve financial freedom is kind of like Elizabeth Holmes going to jail for 10 years. OK, it's not that bad. But during the back end of his life, I'm sure he'd rather be playing softball, spending time with his daughter, and traveling than working.
Losing money is ultimately losing time. And losing time is more costly as you enter the second half of your life.
Worse Than Losing Money Investing On Margin
Besides going on margin to buy Tesla stock, he may have borrowed money from his parents to buy Tesla stock too. He helps manage his immigrant parents' rental properties. When you come from an immigrant family, money tends to get pooled together for the greater good.
It's one thing to lose all your own hard-earned money. It's another thing to lose your parents' hard-earned money. The shame can feel unbearable. As an immigrant, losing the respect of your family is the worst.
I remember getting my brother-in-law into a stock that I thought looked 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 kept going down by another 20%. Ugh. Sorry, Steve!
Losing Years Of Progress
Losing ~$630,000 is a lot for anyone. But if you lost $630,000 on margin going all-in, the $630,000 likely means your entire net worth has vanished.
In other words, at 39 years old, he may 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.
Any self-respecting person would be willing to work hard to rectify their mistakes. But to wipe away years of financial progress based on inappropriate risk exposure is a killer.
Losing The Respect Of Your Peers
When you're making money from your investments, there's a propensity to brag. And brag he did on Facebook about how much money he was making from his Tesla stock.
Just like on the softball field, there was little humility when it came to his investments. Now that Tesla stock is down so much, he no longer has the status of the “preschool teacher investing guru.”
When it comes to investing, please stay humble. If you invest long enough, you will eventually lose money. Ideally, you want to feel little emotion while you're making lots of money and losing lots of money.
If you find yourself constantly bragging over social media, 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.
Whatever the case may be, practice stealth wealth. You don’t want to lose money on margin and also lose the respect of your peers.
A reputation can take a lifetime to build and a minute to destroy. How much is your reputation worth to you? Good thing society likes redemption stories.
Unlikely To Have Lost Everything On Margin
Good news! Thanks to margin calls, it is unlikely 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 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!
FINRA Rule 4210 requires that you maintain a minimum of 25% equity in your margin account at all times. In practice, however, most brokerage firms have stricter requirements that demand you maintain at least 30% equity—and in some cases—significantly more.
Therefore, instead of losing $630,000 in Tesla, he may have only lost ~$300,000. Check out the latest margin interest rates from Fidelity. Losing money on margin plus paying a 12% margin interest rate is a bad combination!
Lose Less And Outperform
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.
Stop Buying Stocks On Margin
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.
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.
Recommendations To Build More Wealth
Invest 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 $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
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- Financial Technology (FinTech)
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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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