Investing in the stock market has brought huge amounts of wealth to millions of investors. But if you think that buying stocks will automatically answer even the most dire short-term financial problems, you couldn't be more wrong -- and you're likely to make those problems even worse.

Rolling the dice
I heard a sad story from a reader yesterday. Like many people today, her finances were already stretched to the limit when she got some bad news: A contractor who had been doing much-needed repairs on her house had swindled her out of a substantial amount of money. To try to recoup her losses, she was considering investing her entire remaining savings in a single high-yielding, small-cap stock, using margin to leverage her investment. She has never invested in stocks in her life, and she's scared to death at the prospect of putting her life savings at risk, but a family member insisted that it was the best way to make money quickly.

If you're not familiar with stock investing, you might look at the market's recent gains and conclude that a strategy like this reader's is the best way to maximize your profits. But several things make a solution like this a nightmare waiting to happen. In particular:

  • Rallies like the one we've seen since March are truly exceptional. Much more frequently, stocks bounce back and forth, moderating gains and thwarting those who are looking to get big gains quick.
  • Putting all your money in a single stock increases the chances that you'll suffer a huge loss.
  • Small-cap stocks are particularly volatile, and although healthy dividend yields can make a stock attractive, double-digit yields like the stock that the reader is considering raise a bunch of concerns.
  • Investing on margin makes stock moves even more volatile and can jeopardize what might in the long run be a good investment.

Any of these concerns by itself would be enough to make any financial planner wary of a plan like the reader describes. But to see just how bad things can get, let's take a closer look at that last point: using margin.

Margin madness
The lure of margin has ensnared even the most experienced investors. Last year, overconfident corporate CEOs such as Chesapeake Energy (NYSE:CHK) CEO Aubrey McClendon and Gareth Roberts of Denbury Resources (NYSE:DNR) had to liquidate substantial amounts of their stock holdings in order to meet margin calls.

As these investors found out, the worst thing about trading on margin is that it takes you out of the driver's seat with your own investments. Without margin, no matter how bad a stock performs, you can always decide to hang on and hope for a rebound.

But when you trade on margin, you lose that control. And sometimes, it can force you out of what would have been a profitable long-term investment. For instance, say your broker forces you to meet a margin call when your investment drops to 50% of its original value. During last year's bear market, losses of 50% or more were fairly commonplace. Here are just a few top names that lost half their value in 2008:


2008 Return

2009 YTD Return

Freeport-McMoRan Copper & Gold (NYSE:FCX)



Whole Foods (NASDAQ:WFMI)



Starbucks (NASDAQ:SBUX)






American Express (NYSE:AXP)



Source: Morningstar, Yahoo! Finance. YTD return as of Dec. 7.

If you'd bought these stocks on margin, you would have had to sell out of your position at a complete loss last year. Even worse, you would have missed your chance to make back all or much of your losses during this year's rally.

Just don't do it
As tempting as it can be for an inexperienced investor, you can't afford to treat the stock market like your own personal casino. The occasional success stories you hear are far outnumbered by the tales of those who lost huge amounts of money from mistakes they came to regret.

Right now, a lot of smart investors are actually getting out of the stock market. Should you get your money out, too?

Apple, Starbucks, and Whole Foods Market are Motley Fool Stock Advisor picks. American Express and Chesapeake Energy are Motley Fool Inside Value picks. The Fool owns shares of Chesapeake Energy and Starbucks. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Dan Caplinger can assure everyone from personal experience that you can dig yourself out of a financial hole. He owns shares of Freeport-McMoRan, Chesapeake Energy, and Starbucks. The Fool's disclosure policy makes sure you know we don't have any hidden agenda.