Attitude towards debt

By: ispeculatornew
Date posted: 03.30.2011 (5:00 am) | Write a Comment  (3 Comments)

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Debt is a subject that attracts an incredible amount of interest around the internet. Why? Because it’s a subject that is emotional for most of us and you can debate it in so many ways. Some like Adam Baker from the excellent ManvsDebt have mastered the subject and I personally never get tired of reading about it. Why?

Debt is part of your life no matter what

As much as we would like to avoid debt, chances are that you when you buy a car, a house or other items, you are financing part of it through debt. You might have a love-hate relationship with it or you might love the possibilities offered by debt like Mike from TheFinancialBlogger. He is one of many who strongly believes in using debt for investments among other things.

Investing on margin?

Anytime that you hear about margin investing, it usually involves borrowing money at a rate in order to make a superior return through investments. The logic is sound in principle. The S&P500 generally returns about 5-10% or so per year on average and if an investor can borrow money at a lower rate, it seems like a winning proposition doesn’t it? Of course. That is unless you suffer a crash like we had very recently. That can wipe out your entire equity very quickly.

Buffet’s opinion on debt

As discussed yesterday, I recently read the most Berkshire annual letter and Warren Buffet discussed his opinion towards debt and his dislike for it in general. He compared investing to being in a car race and while going as fast as possible is important, the critical aspect of course is to actually finish the race. Living with high levels of debt can have fatal consequences as we experienced with both companies that went bankrupt (Lehman Brothers, Bear Sterns, etc) but also with millions of ordinary people who lost everything they had because of the overuse of debt.

There is no doubt that the most recent credit crisis gave us a number of examples of the importance of liquidity. Buffet, who has always been very conservative was able to make great investments and loans to companies such as Goldman Sachs that desperately needed cash. How good was it? That is what happened on a much smaller scale to millions of regular people all around the world.

Is leverage addictive?

It’s certainly interesting to see how some investors start using leverage in a very conservative way. As that goes well, they tend to increase the leverage seeing the opportunity to do even more. That trend often continues a bit too long. So how do you stop? It’s not clear to me.

So would you borrow to invest?

While I am not as keen to borrow as some others, I still could see investing on margin as a possible way to increase my net worth at some point down the road but not for now and not in the near future either. I would have to be significantly better off than I am right now. How much more? Difficult to say. But I would want to make sure that I could sustain a 30-40% stock market crash. It can and it will happen again. If that happened again, would I be comfortable with my situation? Not right now I guess.

What about you?

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3 Comments

  1. Comment by Ravi Gupta — March 30, 2011 @ 7:51 am

    Personally I could never do it. I’ve seen it happen too many times where people go into obscene amounts of debt because they traded on margin. I follow the school of if you don’t have you don’t invest it. Only lose what you can afford to lose.

    -Ravi Gupta

  2. Comment by IS — March 30, 2011 @ 7:33 pm

    @Ravi – I certainly couldn’t argue with you, I’ve been following the same philosophy up to now:)

  3. […] was playing a game that would put me on the losing end almost every time. Last week, I wrote about margin investing and about the importance as Warren Buffet described it to “stay in the […]

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