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Should You Ever Use Margin?
Percy writes, “Is it ever justifiable to use margin short term until you can inject necessary dollars in order to take advantage of a great buying opportunity?”
Margin is when you borrow money against the value of your brokerage account. You’re just borrowing money, and paying interest to your broker (instead of some banker). Some investors, but mostly traders, use margin in order to buy even more stocks than
they normally could afford.
In general, we counsel strongly against it at The Motley Fool. You’re going to borrow more money than you have, in order to put that into stocks, and in our experience most people (I’m going to say 89%) who do that are motivated by a gambler’s mentality. If and when that stock doesn’t work out, they’re really in trouble at that point; low on both dollars and credit, they end up having to sell out some other good positions to pay back their margin loan.
So no, we don’t generally advise using margin.
That said, it can be an effective tool when used dispassionately by people with experience and deeper pockets. For example, if in your well diversified portfolio you fully own all the stocks and cash in it and then borrow a small amount against that (say, 5% of the account’s total value), you are not substantially endangering individual positions or the account at large…. Are you doing so conservatively, and to further diversify the portfolio (as opposed to load up on one position)…? Are you extremely confident you will not be swayed by exaggerated up or down cycles in the markets?!
If so, this approach would juice your long-term returns through most market environments, and almost certainly over the course of a lifetime of investing. It’s simple math.
Dear reader, look again at Percy’s question kicking off this short essay: Which type of investment do you think Percy is contemplating? Which type of investor above is Percy?
(Do you see that phrase “short term”?)
That language to me is suspect. Percy, I don’t know you personally, but I’m guessing I’d count you among the 89%….
Percy writes, “Is it ever justifiable to use margin short term until you can inject necessary dollars in order to take advantage of a great buying opportunity?”
Margin is when you borrow money against the value of your brokerage account. You’re just borrowing money, and paying interest to your broker (instead of some banker). Some investors, but mostly traders, use margin in order to buy even more stocks than
they normally could afford.
In general, we counsel strongly against it at The Motley Fool. You’re going to borrow more money than you have, in order to put that into stocks, and in our experience most people (I’m going to say 89%) who do that are motivated by a gambler’s mentality. If and when that stock doesn’t work out, they’re really in trouble at that point; low on both dollars and credit, they end up having to sell out some other good positions to pay back their margin loan.
So no, we don’t generally advise using margin.
That said, it can be an effective tool when used dispassionately by people with experience and deeper pockets. For example, if in your well diversified portfolio you fully own all the stocks and cash in it and then borrow a small amount against that (say, 5% of the account’s total value), you are not substantially endangering individual positions or the account at large…. Are you doing so conservatively, and to further diversify the portfolio (as opposed to load up on one position)…? Are you extremely confident you will not be swayed by exaggerated up or down cycles in the markets?!
If so, this approach would juice your long-term returns through most market environments, and almost certainly over the course of a lifetime of investing. It’s simple math.
Dear reader, look again at Percy’s question kicking off this short essay: Which type of investment do you think Percy is contemplating? Which type of investor above is Percy?
(Do you see that phrase “short term”?)
That language to me is suspect. Percy, I don’t know you personally, but I’m guessing I’d count you among the 89%….
The Friend of My Friend Igor
Fool HQ once had a summer investing intern named Igor. Igor was a very talented Russian American who brought along his own investing smarts. I wish every 19-to-20-year-old was as thoughtful, as energized, and as wise beyond his years about money.
I asked him, “How’d you get started, Igor?”
“I had a mentor who got me started investing. He was a guy a year ahead of me at college… The funny thing is, he’s no longer investing!”
His friend had exhibited two distinctive tendencies with his investing, Igor conveyed: The first was he loved to find very early, so-called “development-stage companies.” These are companies that not only don’t have profits, but in some cases they don’t even have revenues. His friend’s passion about these kinds of companies had inspired him to teach others — like Igor — about investing.
The second was he loved to go almost all in when he invested. He was a so-called focused investor. He had very few companies. When he found something that he liked and he believed in, he would pile what you and I might think of as an alarmingly high percentage of his money into those few ideas.
I replied, “I’m not surprised that your mentor is no longer still in the game.”
Play that approach forward a bit — that system — and it doesn’t take too long to see what happens. Highly focused development-stage investors might get it right a few times… but when they get it wrong, they lose a lot of money. And when they’re specifically targeting early-stage, development-stage companies, it’s highly likely that a few of those aren’t going to play out so very well. Which means: They’re no longer investing.
Which is a shame! Because you have to love the passion. Young people are so advantaged in that the wealth they’re building will compound their whole lives long.
Picture a four-quadrant matrix where the vertical Y axis labeled “Company” goes from “development-stage” to “mature.” The X axis, labeled “Investor” goes from “all-in” to “diversified.”
Where is Igor’s mentor plotted?
Ah, but now we’re talking STYLE-BOXING. That deserves its own blog.