During the Market Crash, I Invested on Margin. It Cost Me Thousands

It wasn't the interest payments that did me in.

During the market crash beginning in late 2021, many stocks, including benchmark indicators like the NASDAQ and S&P, slid faster than a Slip-N-Slide. Factors like the resurgence of COVID and rising interest rates led to many investors fleeing the market. 

As in all market drops, from conflict arises opportunity. Leaning on the wisdom of Warren Buffett: "Be greedy when the market is fearful," I chose a moment during the initial market slide to purchase cheaper stocks on margin (at that point, my stocks were down 25% on average). I was betting long-term gains would eventually eclipse the money I spent on low-interest loans. 

While the spirit of the thought still resonates with me, the reality of my financial situation caught up to me in a bad way. I was forced to sell thousands of dollars in down stocks to pay off a portion of my borrowed margin due to an imperfect understanding of two factors: borrowing on margin and personal risk tolerance.

What is borrowing on margin?

Margin is a type of loan. Purchasing stocks on margin is borrowing money from your brokerage to buy stocks. Borrowers must pay monthly interest. During the market crash, I borrowed thousands of dollars from Robinhood because the interest rates were rock-bottom. 

Although margin loans can be a solid option for some investors, it's risky for several reasons. First of all, gains and losses are turbo-charged. 

For example, if you purchase $100 of Tesla stock and the stock doubles, you only owe that original $100 to your brokerage, plus interest. On the other hand, if your stock gets cut in half, you still owe the complete $100 borrowed, plus interest. When I purchased stock on margin, I knew the borrowed money would boost my gains…or losses.

Unfortunately, there is more that goes into buying stocks on margin -- information I failed to absorb before purchasing a significant portion of my portfolio on margin: margin calls.

Margin calls happen when the stocks you purchase on margin fall beneath a predetermined threshold. Upon exceeding that threshold, your brokerage makes you sell off enough stock to pay off your loans.

I was unaware of this. So when the market continued to fall, and my stocks bought on margin lost 25% to 50% of their total value, the threat of a margin call pressured me into selling stocks I wanted to hold onto long-term.

When I realized margin calls were a thing, I had two choices: pay off my margin loans and eat my losses, or keep some loans and accept that further margin calls may force me to sell more stocks. I chose to keep a portion of my loans. This decision cost me. Later, I realized why: I had grossly 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 quite a bit of short-term assets in the quest for long-term wealth, which lets them better withstand high volatility and prolonged downturns in the stock market.

Younger investors like myself, with less money to lose and more time to play with, tend to fall into this category. I told my family I was willing to lose 100% of my investments by betting on margin, so I purchased a large chunk of my portfolio on loan. 

Knowing your risk tolerance is essential. It helps you predict when you will fold and sell your assets to protect what you have left. Failing to calculate your risk tolerance accurately destroys long-term plans and causes investors stress, leading to poor decision-making.

When my fears proved true, and the stocks I'd bought on margin continued to fall, the pressure mounted. I made poor financial decisions that, in hindsight, I should have spent more time thinking through. I'd exceeded my risk tolerance and, in doing so, compounded my losses.

Should I buy on margin?

Buying on margin is risky. Before considering investing on margin, make sure to accurately gauge your risk tolerance.

The last thing you want to do is make important financial decisions when fearful. Had I limited my margin investments to less than 10% of my portfolio, I might have been better able to mentally weather the storm brought on by the falling stock market. 

Finally, check your broker for rates and verify your funds aren't at risk. The best stock brokers offer comparatively affordable rates for borrowers.