A concerning trend is on the rise – using leverage to invest.
A recent survey found that 40% of individual investors take on debt to invest. Half of them borrow $5K or more.
The problem is that leverage is that magical thing that works until it doesn't! 🧵
A recent survey found that 40% of individual investors take on debt to invest. Half of them borrow $5K or more.
The problem is that leverage is that magical thing that works until it doesn't! 🧵
The idea of leverage is simple. Compounding takes time to work - but you can accelerate the process by using debt.
If you have high conviction in a directional bet, you can use equity as collateral to borrow more money.
If you use 2x leverage, you could 2x the returns!
If you have high conviction in a directional bet, you can use equity as collateral to borrow more money.
If you use 2x leverage, you could 2x the returns!
But what happens when the price drops?
You lose twice the amount. The stock needs to drop only 50% for you to be wiped out. (FYI: $TSLA was down 63% last year!)
If you don't use leverage, you can lose at most 100%. But with leverage, it can cost you everything and then some.
You lose twice the amount. The stock needs to drop only 50% for you to be wiped out. (FYI: $TSLA was down 63% last year!)
If you don't use leverage, you can lose at most 100%. But with leverage, it can cost you everything and then some.
Leverage isn't free money - We haven't even considered interest rates yet.
43% of people took a personal loan or used their credit cards - with APRs of up to 23%, you would need a 23% return just to break even.
Imagine losing money even after making 20% return!
43% of people took a personal loan or used their credit cards - with APRs of up to 23%, you would need a 23% return just to break even.
Imagine losing money even after making 20% return!
So is there a way to use leverage correctly?
Yes - Ian Ayres and Barry Nalebuff (both professors at Yale) argued in a 2008 paper that it’s responsible for young investors to use leverage.
Yes - Ian Ayres and Barry Nalebuff (both professors at Yale) argued in a 2008 paper that it’s responsible for young investors to use leverage.
The argument made is that when we are young we need to maintain a lot of exposure to stocks but we would be cash poor.
The solution is to use margin to invest in equity and gradually decrease the percentage of leverage as you become older.
The solution is to use margin to invest in equity and gradually decrease the percentage of leverage as you become older.
Ideally, you would get a better risk-adjusted return if you had a well-diversified portfolio and then leveraged that instead of increasing concentration of your portfolio by investing in individual stocks.
The other option is to invest in Leveraged ETFs e.g the $TQQQ which invests in the Nasdaq with 3x leverage.
It has 58% CAGR compared to $QQQ's 22% CAGR over the last 10 years.
The downside is that a 33% drop in value will drive your portfolio to zero.
It has 58% CAGR compared to $QQQ's 22% CAGR over the last 10 years.
The downside is that a 33% drop in value will drive your portfolio to zero.
"In theory, theory and practice are the same. In practice, they are not." - Albert Einstein
While using leverage makes a lot of sense theoretically, even seasoned investors have been wiped out using leverage.
Ask Bill Hwang if you don’t believe us!
While using leverage makes a lot of sense theoretically, even seasoned investors have been wiped out using leverage.
Ask Bill Hwang if you don’t believe us!
Leverage is a great tool to multiply gains on a sure bet.
But like Buffett said, "If you're smart, you don't need leverage. If you're dumb, it'll ruin you."
A deeper look into why you should stay away from leverage👇marketsentiment.substack.com
But like Buffett said, "If you're smart, you don't need leverage. If you're dumb, it'll ruin you."
A deeper look into why you should stay away from leverage👇marketsentiment.substack.com
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