Forefront’s Monday Market Update
How to lose 20 billion dollars
Have you ever been in credit card debt or any sort of debt for that matter? The feeling of it is awful, to the point of being almost crippling. Now, this isn’t to say that credit cards don’t serve a good function, and if used properly can’t actually provide the user some added benefits, but the idea of leverage, of borrowing money, can be an emotional rollercoaster. Now imagine borrowing that money and investing it, in hopes of the investment going up, but if it goes down, you’re on the hook.
What is leverage, and margin when it comes to individual investors? Pretty simply put, investing on Margin is borrowing money, then investing it in hopes of your investment rising, you can sell it, pay the loan back and keep the difference.
Pretty straight forward, except what happens if the investment starts to go down? Well since you borrowed that money from a Brokerage firm, they might want there money back if what you invested in starts to fall. This is called a margin call, and you need to come up with that money. What happens if your investment is now worth less than what you borrowed, AND the brokerage firm wants their money back? You are on the hook for the difference!
Large Scale vs Small Scale
On a small scale, this can blow up an individual’s portfolio, and not something I ever recommend to clients. On a large scale, like we saw with Archegos Capital a family office hedge fund that managed the wealth of Bill Hwang, who also serves as the Chief Investment Officer.
Archegos was estimated to be levered up anywhere from 5 to 8 times their overall value. They lost 20 billion dollars in all, and cost Credit Suisse who was one of the firms lending them this capital 5.5Billion dollars. They weren’t speculating on bitcoin, or some crazy, fly by night company in hopes of hitting it big. The Archegos margin call was triggered by a downward move in the stock of ViacomCBS, a household name. Once the first margin call was triggered, all the other banks came knocking for their money. On a large scale, when you own billions of dollars’ worth of stock, it takes time to unwind and sell those positions, inevitably moving the market down and losing you even more money. It is a vicious cycle that Archegos found themselves in.
So how does what happened to Archegos impact you and I? Well, first and foremost many people have opted to start using margin because of the recent upswing we have had in so called “meme stocks”, and the feeling of missing the boat. Now my dry cleaner is talking to me about trading Forex on Margin. The feeling of missing the boat, while you think your neighbor is getting rich can lead individuals to make foolish mistakes, and the rise of the use of leverage over the past few months has been alarming.
Rather than think that the market can only go up, and borrowing money in hopes of capturing that upside, focus on saving more of your own dollars to invest. Increase your 401K contribution by 2% and see if you feel it each paycheck, add $250 extra dollars to a brokerage account each month. Greed is not always a bad thing, if you can use it to help maintain your discipline of saving for bigger and better things. Trying to get rich quick, or doing something because you think others are doing the same and benefiting never works when it comes to building wealth.
So how does this impact all of you?
- Don’t borrow money to try and increase investment returns
- Even the best can lose all of their money when they are reckless
Stock market calendar this week:
Thursday August 12th:
Initial and continuing Jobless Claims @ 8:30AM
Most anticipated earnings for this week: