Friends,
Last week, a scary headline flashed across the screen of many investors.
What is margin debt? It's when you borrow money for the sole purpose of investing it in stocks. Imagine putting $10,000 of your own money into a margin account that loans you an additional $10,000. You then buy MRGN (a fictional stock).
In some scenarios, this can be lucrative:
- If MRGN doubles, you now have $40,000 -- a 300% return from your initial investment (though you still have taxes and margin interest to pay).
But if things go badly, it can lead to financial ruin.
- If MRGN goes down 60%, you now have $8,000 in your account. But you owe ALL of that to your brokerage account, plus an additional $2,000 more. You've lost everything...plus some.
That's why the headline above -- coupled with the S&P 500's 80%+ return since January 2023 -- has some worried: if people are taking more risk, there's a greater distance to fall if things go wrong.
Alas, this is where context is everything. It's true that margin debt is at an all-time high. But that's not actually the most important thing.
The most important thing is margin debt relative to the size of the market. And when we look at that, we aren't in a danger zone...yet.
As a percentage of the Wilshire 5000, margin debt hasn't been this low...ever!
That's not to say there can't be a pullback in stocks. In fact, we've spent the last few newsletters discussing how valuations seem stretched. Instead, it means that any pullback likely won't be overly exacerbated by margin loans being called back.
The bigger takeaway: in investing a life, perspective matters. Knowing when to look at absolute numbers -- and when to look at relative ones -- makes a huge difference.
Wishing you investing success,
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Brian Feroldi, Brian Stoffel, & Brian Withers
Long-Term Mindset
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