Monday, June 14, 1999

A Lesson On Margin


This long bull market has given all of us dreams of becoming rich. Opening a margin account and potentially doubling our returns is very tempting to many of us. With the intention of aggressively capitalizing on technology and Internet stocks, I moved my money from mutual funds to an online brokerage, opening a margin account.

A margin account requires close monitoring. Being fully leveraged, I monitored my account daily. When my portfolio performed well, my online broker permitted me to buy more stocks with my unrealized gains. I did so. Typically, this meant that I would buy stocks at a high price. Being Foolish, the actual price did not matter.

Then came the mild correction in technology and Internet stocks in April. I spent the work days checking the sticker prices and my portfolio to make sure that I would not have to meet margin calls. I decided to sell some of my stocks at a loss.

I told myself, I am not going to buy on margin anymore. Yet, when the prices rebounded, I bought more stocks, again on margin. This time I thought that I had made smart decisions. The stocks couldn't really fall very much, could they? In early May, less than a fortnight after my "smart" decisions, I saw my portfolio falling and approaching the limit when margin calls could be made. So I decided to sell some of the stocks that I had recently bought. Once again, I suffered some losses because I was forced to sell when the price was low. Buy high and sell low surely never made anyone rich!

Today, I've decided to form a strategy to reduce my margin allocation to 20% of my total portfolio by December 31, 1999. I plan to do the following: (1) Not buy any more stocks until the margin portion is 20% or less; (2) Save and send as much money as I can to my online brokerage account (today I plan to mail a check for a small amount); and (3) Towards the end of December of this year, I will see whether I have met my target. If not, I will sell some stocks to meet the target.

I have already identified which stocks to sell. Sell I will, for a gain or a loss, I don't care. What will I gain by these decisions? I will no longer have to keep monitoring my account daily. I can spend time in other, more meaningful pursuits. I can sleep peacefully at night, not caring whether the stock market drops by 50% tomorrow.

Those of us investing heavily on margin see only one side of the coin. We see that our profits can be doubled. The flip side is that our losses are doubled, too. Plus, we pay interest on the borrowed money. The good part of this experience for me is that I lost only about 10% of my money. Yet, if I had been more conservative, bought less on margin, I would have had more money in my portfolio. Let us not be greedy. Let us always use reason and logic to guide us in our investment decisions.

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