According to FINRA’s margin statistics posted at the end of the month, American investors now have $1 trillion in margin debt (roughly $800 billion is allocated towards securities and about $200 billion not yet spent). The purported justification for margin debt is that interest rates are low (particularly at a place like Interactive Brokers) and the valuation of the entire stock market is much higher so it is logical that the overall allotment to margin debt would be higher. In that regard, it is true that only about 2% of the stock market right now is reportable margin which is in line with levels over the past 25 years.
Last year, there was $479 billion in margin debt outstanding. What I find troublesome is that the number of small investors, defined as those with under $1 million in investable assets employing margin, has tripled in number over the past year with the average margin amount increasing from $53,420 to $98,383. The median value of an account for such a small investor is $289,491.
Do you realize the exposure that currently faces such an investor in the event of a “Black Monday” type event that occurred on October 19, 1987? Especially when you consider that margin is often used when cash is lacking to buy a security outright. On that day, stocks fell 22.6%. If today’s modern margin investor had a portfolio with a nominal value of $400,000 and $100,000 in margin debt, and the stock portfolio fell to $310,000. Maintenance margin is currently set at 25% of the total value of the securities in a margin account as per FINRA requirements. In such an event, an investor would instantly have to contribute $90,000 to the account or face the prospect of forced security selling at the low that would reduce the balance to $220,000. That is not even the worst case scenario as the financial crisis witnessed stock values decline by almost 40% in a matter of months.
In March 2020, the U.S. stock market had $480 billion in margin debt and a little over $150 billion of it was subject to a margin call at the beginning of the pandemic. About $100 billion was subject to involuntary selling rather than cash raises. That is selling low and missing a subsequent 80% gain. A successful investing lifetime means never putting yourself in a position to sell low. When you take on margin debt, you are contractually opening yourself to the risk that a creditor brokerage could make the decision to sell low for you.