Questions on Margin and Cash

Hey Saul, I noticed you mentioned the use of margins (or closing them out) in this months summary. I was wondering, if you don’t mind, could you please expand on how you use margins in your account? When and why would you open a margin? What decisions making process goes into that? Thanks for all you do, Saul …I’m learning so much. LakeFisher

Hi LakeFisher, You sound as if you may be new to this exciting game of investing :grinning:, so I have to start off by explaining that using substantial margins is incredibly dangerous. What buying on margins means is that you are borrowing money against the stocks in your account. I’ve been a customer of my broker for many years so I guess that they trust me, and I just looked at one of my taxable accounts which is authorized for margin, and I see that I am authorized in that account to borrow a little MORE than the entire value of the stocks in the account. That would be a crazy thing for me to do. Think about it. If the stocks in the account went up 50%, with the help of margin I’d be up 100%. Great huh?, But if the stocks went down 50% I’d be totally wiped out! I’d lose everything I have. It would be like playing double or nothing. But actually, I’d be getting margin calls long before that, and would have to be selling my stocks at the bottom.

Here’s another issue. If you have just 20% margin, or 40% margin, and your stocks went up 50% you’ll make 60% or 70% instead of 50%, and so instead of having 150% of what you started with, you’ll have 160% of what you started with with the 20% margin or 170% of what you started with with the 40% margin. Nice, but no big deal. Not an earthshaking difference.

But stocks go down too. What if you lost 70% or 60% of what you started with instead of 50%.

Well if you lose 50%, you have 50 left, and it takes a 100% gain to get you back where you started from.
But, if you lose 60%, you have 40 left, and it takes a 150% gain to get you back where you started from.
And, if you lose 70%, you have 30 left, and even a 200% gain, tripling, won’t get you back where you started. Those ARE earthshaking differences!

As you can see, the consequences on the down side are much more devastating than the benefits on the up side, which we talked about above, are rewarding. Granted, stocks go up more than they go down, but still, just a month or two ago the market averages were down almost 40% at their bottom.

I recently had about a 2% net margin because I wanted to buy a little more of certain stocks than I had the cash for, and I didn’t have anything I wanted to sell. That 2% was just a trivial adjustment, and margin is simply NOT a part of my investing strategy. I don’t think I’ve ever been over 3.5% margin in thirty years of investing. And as you can tell, I’m not a conservative investor. But I like to think that I am a prudent one.

Saul - was there ever a time in your investing career when you actively managed to a meaningfully higher % of cash across all of your accounts (5%, 10%, 20%) for some significant period of time? If so, when or what stoked that decision and what changed to inspire you to manage to roughly 2% as the norm for you today? Eric

Hi Eric, I don’t remember ever actively managing to having higher percentages of cash in my account. I set aside money to live off but that is different than my investing money. I don’t try to time the market, and I’ve always been fully invested plus or minus a couple of percent.

I hope that that helps,