It's tempting but terribly dangerous, says Elon Musk of this investment strategy
Elon Musk himself uses this method. But he warns others against it. It sounds tempting, but it can be a dangerous trap. What is it?
He used it himself recently - let me put it in context:
Musk has long tried to buy Twitter. But the price remained higher than he wanted and, more importantly, than he could liquidly provide. The problem he has now is that he has run up a debt of USD 13 billion to finance the takeover of the platform. This was a margin loan, where he pledged some of his Tesla shares to $TSLA+1.3%.
The way a margin loan works is that once the value of the collateral is reduced from the amount borrowed, the borrower has to provide additional collateral to make up the difference.
The amount you can borrow depends on your financial situation and the allowable loan-to-value ratio (LVR) of your existing portfolio, i.e. your shares, managed funds or cash used as collateral. The LVR is the amount of your loan divided by the value of the shares or whatever is used as collateral.
If the value of your collateral falls in proportion to the amount of the loan, you may exceed the maximum LVR. This will trigger a 'margin call' and you will have to either reduce the amount of the loan, put in more collateral or sell some of your investment until your LVR falls below the maximum value.
Given that it took six months to complete the purchase of Twitter, it is not easy to determine when the loan was completed between May, when the Twitter acquisition negotiations were underway, and October, when the acquisition was completed. During this period, Tesla stock traded all around the $200-$300 level.
What is certain is that with the stock price closing at $120 last year, the stock lost theoretically over 60% of its value in pledge, which may have required Musk to put up another pledge to offset the drop in value.
And maybe that's why he himself is now warning against this method and tool.
Musk probably had to post additional collateral to make up the difference. The billionaire seems to infer that the margin loan was not profitable after all. Thus, he again advised all investors not to take out a margin loan to buy shares in times of market crisis, as is currently the case
"In turbulent economic times, be careful about using margin loans to buy stocks," the billionaire warned on Twitter.
It's not the first time Musk has warned against such loans. He did so back in early December. Musk advises against taking out loans at such times. In doing so, he seems to express regret for doing it himself. Many people who have made a similar mistake are said to be caught off guard.
Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.