It wasn’t the interest payment that made me.
Key Points During a market crash, I lost thousands because of margin calls. Buy on margin only if you understand the risks and know your risk tolerance.
During the market crash that began in late 2021, many stocks slid faster than slip-n-slide, including benchmark indicators such as the NASDAQ and S&P. Many investors fled the market due to factors such as the resurgence of COVID and rising interest rates.
As in all markets, conflict creates opportunities. Leaning on Warren Buffett’s wisdom: “Be greedy when the market is fearful,” I chose a moment during the initial market slide to buy cheaper stocks on margin (at the time, my stocks were down 25% on average). I was betting that the long-term benefits would eventually eclipse the money spent on the low-interest loans.
While the spirit of the idea still resonated with me, the reality of my financial situation gripped me badly. I was forced to sell thousands of dollars in down stock to pay a portion of my borrowing margin due to an incomplete understanding of two factors: borrowing on margin and personal risk tolerance.
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What is Lending on Margin?
Margin is a type of loan. Buying stocks on margin is like borrowing money from your brokerage to buy stocks. Borrowers will have to pay interest monthly. During the market crash, I borrowed thousands of dollars from Robinhood because interest rates were rock-bottom.
Although margin loans may be a solid option for some investors, it is risky for a number of reasons. First, the benefits and harms are turbo-charged.
For example, if you buy $100 Tesla stock and the stock doubles, you only pay the original $100 to your brokerage, plus interest. On the other hand, if your stock halves, you still owe the full $100 you borrowed, plus interest. When I bought stock on margin, I knew that the money borrowed would boost my profit or loss.
Unfortunately, there’s more to buying stocks on margin — the information I failed to absorb before buying a significant portion of my portfolio on margin: margin calls.
A margin call occurs when the stock you bought on margin falls below a predetermined limit. When that limit is exceeded, your brokerage sells you enough stock to pay off your debts.
I was unaware of this. So as the market continued to decline, and my shares bought on margin lost 25% to 50% of their total value, the threat of a margin call pressured me to sell the shares I’d long for. wanted to keep
When I realized margin calls were a thing, I had two options: pay off my margin loan and eat my loss, or keep some of the debt and accept that further margin calls could force me to sell more stock. Is. I chose to keep a portion of my debt. This decision cost me dearly. Later, I realized why: I had miscalculated my risk tolerance.
What is personal risk tolerance?
Personal risk tolerance is how much you are willing to lose in pursuit of your goals. Investors with high personal risk tolerance are often willing to lose short-term assets in search of long-term funds, which allows them to better withstand high volatility and long-term downs in the stock market.
Small investors like me, who have less money to lose and more time to play, fall into this category. I told my family that I was willing to lose 100% of my investment by betting on margin, so I bought a large part of my portfolio on loan.
Knowing your risk tolerance is essential. This helps you predict when you will turn over and sell your property to save what you have left. Failing to correctly calculate your risk tolerance destroys long-term plans and puts pressure on investors, leading to poor decision making.
When my fears turned out to be true, and the stocks I bought on margin continued to fall, the pressure mounted. I made bad financial decisions, which, given I should have taken more time to think. I exceeded my risk tolerance and, in doing so, increased my losses.
Should I buy on margin?
Buying on margin is risky. Before considering investing on margin, be sure to accurately assess your risk tolerance.
The last thing you want to do is make important financial decisions when you’re in awe. Had I limited my margin investments to less than 10% of my portfolio, I would have been able to weather the storm brought on by a falling stock market much better mentally.
Finally, check with your broker for rates and verify that your funds are not at risk. Best stock brokers offer comparatively cheaper rates for the borrowers.
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