The Danger of Leverage
A single fund's collapse cost major banks billions. Its lesson applies to everyday investors too.
Published April 12, 2021 · 1 min read
At the end of March, a private investment firm called Archegos Capital Management was unable to meet margin calls on enormous, borrowed positions in a handful of stocks. Its banks rushed to sell the shares, the stocks plunged, and several major banks have disclosed billions of dollars in losses. Most people had never heard of Archegos until it was gone.
What Leverage Is
Leverage means using borrowed money to invest. It magnifies results in both directions. If you invest $10,000 of your own money and $10,000 of borrowed money, a 25% gain becomes a 50% gain on your money. A 25% loss becomes a 50% loss, and you still owe the loan.
How It Goes Wrong
- Margin Calls. When the value of borrowed positions falls, lenders demand more collateral. If you cannot provide it, they sell your investments, often at the worst possible time.
- Concentration. Leverage combined with a few large positions leaves no room for error.
- Forced Selling. Once selling starts, it can push prices lower, triggering more margin calls.
Why This Matters to You
Leverage is easier to access than ever. Margin accounts, options, and leveraged ETFs are a few clicks away. Combined with recent market enthusiasm, it is tempting to borrow to invest more. But the same math that wiped out Archegos applies to individual accounts.
A Better Approach
Build wealth with money you can afford to leave invested through downturns. Diversify. Understand any product before you use it, and if you do use leverage, know exactly what happens if your investments fall 30% or more.