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Leverage compounds losses. Here’s what my failed leverage experiment taught me.
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Mistakes happen. That’s what I told myself as I stared miserably at the red line skewering my Robinhood account. My lovely, once-a-year vacation had been irrevocably damaged by my decision to invest with leverage. In days, I lost thousands of dollars to Mr. Market.
Months after repaying the loan in full (and then some), I’ve come to a shocking realization: I lost thousands of dollars to leveraged investment, and I’m not totally mad about it.
The experience taught me three valuable lessons, and it did so for relatively cheap. Here’s why I’m glad to have lost a hefty chunk of my portfolio when I did.
Lesson No. 1: Leverage hesitation
I did the thing, but don’t get me wrong — I passed a half-dozen warning signs along the way. My stock advisor. Skeptical family members. Concerned friends. Folks looked at me sideways when I confessed to leveraging investments. This is when you buy stocks with borrowed money to potentially boost returns.
I believed them. But it wasn’t until my portfolio plummeted, margin calls happened, and the heartburn set in that I really understood what it meant to lose borrowed money.
On leverage, rising stocks soar — and falling stocks plummet. You can lose a lot more than what you initially invested. When it happened to me, I learned that folks have good reasons to avoid investing on leverage, especially when you’re investing large sums.
Lesson No. 2: Margin calls
I leveraged my investments through a margin account, which lets investors borrow from a broker to purchase stock. Back then, I had no idea that margin calls were a thing.
Margin calls happen when you lose too much borrowed money. Your broker makes the call, and you must sell invested stocks to repay your debt. This happens when your stocks are at rock bottom, the worst possible time to sell.
Because I didn’t understand the risks, I over-invested and lost thousands. Now, I know better.
Lesson No. 3: Don’t catch the falling knife
The stock market crashed. Excited by the prospect of low prices and fearful the market would zoom to previous highs, I invested mid-crash. The result? The market continued its slow, rolling tumble, taking my investments down, down, down.
Lesson learned: Don’t attempt to time the market short term. I’m no trader. Ideally, I leave my money in the market for five years or longer — preferably until retirement. Though valuations matter, getting emotionally invested in stock market volatility was a mistake.
In the pursuit of short-term gains, I lost quite a bit. You can bet that next time, I’ll think twice.
But the stakes were low
I’m not mad about any of this — not anymore. I’m just happy that I learned these lessons at a discount when the stakes were low. Had I been heavily invested in the market, I could have taken out way more leverage, possibly damaging years’ worth of savings in a single move.
Generally, beginner investors should steer clear of investing with leverage. But to those who can’t resist the siren call, I understand. Some things you’ve got to experience firsthand. Ideally, margin investors start small, with a tiny percentage of their total portfolio.
Young investors with long investment horizons have the freedom to take risks. Don’t feel pressured to try margin, but if you must dabble, it’s best to learn when the stakes are low.
Is leverage terrible?
No. Leverage is a financial tool, neither good nor bad. But it’s an advanced one. Like options trading, it can quickly demolish your hard-earned savings if you play your cards wrong. And with Fed rates climbing to recent highs, monthly interest payments are nothing to scoff at.
Folks new to investing may consider beginner-friendly stock brokers to start. There’s plenty of money to make in the un-leveraged market. Long-term investors can maximize their chance of earning returns by following expert stock investing advice.
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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Cole Tretheway has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
