Warren Buffett offers his 'strongest argument' against a practice investors are doing in record numbers

Bill Pugliano/GettyWarren Buffett.
  • Berkshire Hathaway CEO Warren Buffett has argued against borrowing money to invest in stocks.
  • So-called margin debt rose to a record in January.
  • Margin calls, in which brokers demand a cash replenishment of their clients’ accounts, were among the reasons strategists cited for the pace of the recent stock sell-off.

Warren Buffett doesn’t recommend going into debt to buy stocks.

But that’s exactly what investors are doing in record numbers.

Margin-debt balances – loans individual investors take from their brokers in hopes of beefing up their portfolios and maximizing returns – rose to a record $US665.72 billion in January, according to data from the Financial Industry Regulatory Authority.

The regulator doesn’t share the Berkshire Hathaway CEO’s hardline position against margin debt. But last month, it issued an alert warning that “investors may underestimate the risks of trading on margin,” which involves using part or all of a portfolio as collateral. One such risk is a margin call; if an investment’s value plunges, a broker can demand a cash replenishment of the account or liquidate the portfolio without permission.

The warning proved prescient when the stock market plunged by more than 10% earlier in February. Margin calls were among the reasons strategists cited for the pace of the sell-off.

It’s these sudden, losing market moves that make Buffett skittish about borrowing to buy stocks. In his annual letter to shareholders released Saturday, Buffett illustrated the sharp drawdowns Berkshire Hathaway’s stock had experienced over the years.

Screen Shot 2018 02 26 at 3.05.58 PMBerkshire Hathaway

“This table offers the strongest argument I can muster against ever using borrowed money to own stocks,” Buffett said. “There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary.”

But for a levelheaded investor who’s not deep in debt during a market crash, there are “extraordinary opportunities,” Buffett added.

In an interview with CNBC on Monday, Buffett suggested that greed was a primary driver of margin debt.

“Borrowing money is a way of trying to get rich a little faster, but there are plenty of good ways to get rich slowly,” Buffett said. “And – you can – you can have a lot of fun while you’re getting rich as well. My partner, Charlie, says that there’s only three ways that a smart person can go broke. He says, ‘liquor, ladies, and leverage.'”

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