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Oct 28

Do It Yourself Asset Management 5

6. Avoid buying “on margin” and leveraging:

A big factor in the stock market crash of 1929 was buying “on margin.” This is a term meaning that a stock is bought on credit, where the buyer might put up 10% of the price and was actually taking out a loan for the other 90%.

After the crash, the US Government passed new laws to limit this practice, but it still happens.

Today there is another term, “Leveraging” which means that people use the equity in stocks they own (but may have bought on margin) as collateral for acquiring more stocks.

This is an extremely dangerous practice, especially for the small investor. If they do this, they are no longer risking “money they don’t need” but EVERYTHING they have.

A true story: In Florida there was a “small” investor whose portfolio had reached a value of one million dollars.

He was an active trader and the brokerage firm he was working through gave him his own office and computer setup.

But he was leveraged to the hilt, and didn’t really own much of anything.

When “Black Monday” hit, the brokerage firm gave him a “margin call” of about $20,000. This meant he had to come up with $20k to cover the full prices of stocks he had bought on margin. They must have known almost to the dollar how much cash he could get.

Once he tapped himself out to pay the margin call, they glommed onto the cash and immediately hit him with another margin call which he couldn’t even begin to pay.

So he realized that he was going to lose his entire portfolio, and there was nothing he could do about it.

He brought a gun into the brokerage firm’s offices and shot as many of them as he could before he shot and killed himself.

It was discovered later that he had been a criminal and was part of the witness protection program. This illustrates the dangers of buying “on margin” and “leveraging.”

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