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The Pitfalls of Margin Debt

The Pitfalls of Margin Debt

Investors are utilizing record levels of margin debt to finance investment purchases. Margin debt is money borrowed from a brokerage firm in order to buy more stocks or bonds. Frequently, those who use margin debt invest in riskier securities, hoping for big gains. Borrowings are secured against the value of an investor’s portfolio. Emboldened by the sharp recovery to all-time highs after the initial panic over COVID-19, many market participants are betting that the gains continue unabated. As long as prices keep rising, investors will be able to repay their margin loans while increasing their return on capital invested. However, if portfolio values decline, which often happens unexpectedly, leveraged investors risk getting a margin call. A margin call occurs when the value of pledged collateral falls below a broker’s mandated level, requiring an investor to either deposit more cash into his or her account or sell securities to fund the shortfall. Forced selling at inopportune times can lead to permanent wealth destruction and possible bankruptcy. Below is a link to an article which includes a recent example of the perils of investing on margin (see “Star Investor Loses $20 Billion”). At First Fiduciary, we encourage our clients to avoid margin loans in any market environment. The potential upside does not outweigh the real possibility of very large losses. Instead, we prefer our disciplined strategy of looking for and buying great companies trading at attractive prices. This simple but highly effective process has allowed clients to grow and, more importantly, protect wealth over generations.

Articles We Liked:

Tree Planting
An ex-Facebook/PayPal employee makes a convincing argument that the solution to solving climate change is to plant more trees – a lot of them – and his non-profit is doing just that.

NFTs and Music
Musicians only make a fraction of a penny each time their songs are played on a streaming service like Spotify. Non-Fungible Tokens (NFTs), a new technology utilizing cryptography, could make it easier for artists to control (and profit) from their art. It may also provide a use case for cryptocurrency other than “wild speculation.”

Lost Tourist
A charming tale about a German brewer who got off his airplane in the wrong city and vacationed in Bangor, Maine, all the while thinking he was in San Francisco.

Disrupting the College Degree
Google has announced three Google Career Certificates for various technology jobs, none of which require a college degree and can be completed in six months or less. If successful, this could provide a path for people to get a high paying job without the burden of college loan debt.

Star Investor Loses $20 Billion
If there’s any lesson to take from how hedge fund star Bill Hwang managed to lose $20 billion in a few days, it’s this: Avoid leverage.

YOLO Economy
As employees begin to return to the office after a year working from home, some burnt-out workers are hitting the pause button on their careers and exploring other paths.

Learning a New Language
Ever tried to learn a new language and wondered why it’s so hard?

Bernie Madoff Obituary
The architect of the largest Ponzi scheme in history recently died, and The Economist detailed his life.

Notable Reads:

The Information: A History, a Theory, a Flood
by James Gleick
From African drums to the internet, this entertaining book details the history of human communication and information theory. Profiles of key innovators, including Samuel Morse, Charles Babbage, Claude Shannon, and Alan Turing, give great background on the people most responsible for helping humanity find signals in all the noise. Gleick also deftly walks the reader through advanced topics, including subjects like quantum computing, explaining things in easily digestible ways. – AG

The Secret of Our Success: How Culture is Driving Human Evolution, Domesticating Our Species, and Making Us Smarter
by Joseph Henrich
Through an engaging review of decades of social science research (including much of his own), Henrich makes a convincing case that it is our culture and ability to learn socially that has driven human evolution. Humanity’s “collective brain” drives genetic and biological change, rather than vice versa. The book will make you think very differently about many things. Highly recommend. – AG

Snow Crash
by Neal Stephenson
Another novel on the science-fiction pantheon, Snow Crash is the inspiration for many of the immersive video game experiences popular today, such as Fortnite. The book, written almost 30 years ago, has a contemporary feel. Stephenson accurately foresaw many of the changes in both technology and society. That said, despite its influence, the book itself doesn’t live up to the hype. Pages and pages of exposition get in the way of the minimal character development, and the convoluted plot is hard to follow. In the end, the big reveal is laughable. – AG

Restaurant Review:

Monkeypod Kitchen, Wailea Maui

On a recent visit to Maui, Hawaii, a client recommended we dine at Monkeypod Kitchen. Thankfully we did! The casual, relaxing, happy-feeling, open-air restaurant is named after the monkeypod tree, ubiquitous on the Hawaiian Islands. The beautiful tree, a single stalk with a wide canopy of leafy branches, is unlike other trees. Its leaves release nitrogen to fertilize the soil beneath it. So, rather than killing the grass and plants that live under it, the grass is truly greener under a monkeypod tree.

Chef Peter Merriman, called “the Pied Piper of Hawaii Regional Cuisine” by the Los Angeles Times, prepares a simple menu utilizing local and organic ingredients. We thoroughly enjoyed our lunch entrees of fresh fish tacos and a mahi mahi sandwich; even the bun was homemade. Our waiter happily accommodated dietary restrictions. With a view of the Pacific Ocean, fantastic food and ambiance, the monkeypod tree and aloha vibe soundly resonated. – MA

More Than a Trusted Investment Advisor

Recently, we produced detailed cash flow projections and scenarios to help determine if a client’s plans for early retirement were reasonable. Our collaborative financial planning process is an especially useful and comforting tool for clients facing life changes.

Let us know how we can help!


The data contained within this newsletter is for informational purposes only. The information contained herein should not be considered investment, tax or legal advice.

This newsletter contains links to external third party websites that are not affiliated with First Fiduciary Investment Counsel. FFIC does not control or direct the content of the information contained on these websites. Information contained on the third-party website is relevant on the date the newsletter was published but may be changed or revised by the third parties without the knowledge of and/or notice to FFIC.

Statistics and other information have been compiled from various sources. First Fiduciary Investment Counsel believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Past performance does not guarantee future results. The mention of securities or types of securities in this newsletter should not be considered as an offer to sell or a solicitation to purchase or sell any securities mentioned. Neither First Fiduciary nor the authors hold positions in any of the stocks mentioned unless otherwise stated.

First Fiduciary Investment Counsel, Inc. is a registered investment adviser with the Securities and Exchange Commission. A more detailed description of the company, its management and practices is contained in its firm brochure document, Form ADV, Part 2. A copy of this form may be received by contacting the company at: 6100 Oak Tree Blvd., Suite 185, Cleveland, OH 44131; Phone: 216.643.9100; Email: ffic@firstfiduciary.com.