Margin balances have reached a new record high as a widening class of affluent Americans borrowed against their portfolio investments to buy more stock.
Margin debt has reached the highest point in two years as investors borrowed a record $722.1 billion against their investment portfolios through November, topping the previous high of $668.9 billion from May 2018, according to the Financial Industry Regulatory Authority (FINRA). This amount is a 28% increase since the same time last year and is up nearly 10% from $659.3 billion in Oct. 2020. The surge in risk-taking indicates that investors were euphoric as COVID-19 vaccines neared.
These investors are chasing bigger gains and exposing themselves to potentially devastating losses through riskier plays, including concentrated positions, trading options, and leveraged exchange-traded funds (ETFs). The milestone is not a good sign for the stock market since margin debt records often precede market volatility, as seen in 2000 and 2008.
The S&P 500 has jumped nearly 67% since its lowest point on March 23 and dozens of stocks have rocketed even higher. Tesla is up 685% year-to-date after joining the S&P 500, while Zoom Video Communications has gained 429% so far this year as remote work became the norm due to the coronavirus pandemic. Meanwhile, COVID-19 vaccine maker Moderna is up 516% for the year.
Investors who use margin debt pledge their securities in exchange for loans from brokers to buy more securities or sell short a stock. Regulation T says investors can only take on margin debt of 50% of their account balance, though the typical margin requirement is 25%.
However, investors can get into trouble if their collateral falls below a certain threshold and triggers a margin call — one of our most popular terms in 2020, which spiked in March as the stock market was cascading. Once there is a margin call, investors must decide whether to put up more money or sell the securities underlying the loans.
Some investors use their margin balances to trade options. In 2020, a record number of options contracts have traded with an average 29 million options trading hands each day this year, a 48% increase from 2019, according to Options Clearing Corp. Traders can obtain options to hedge their portfolios from stock declines or make bets that major indexes or individual companies will gain or lose value.
While these strategies provide opportunity for major gains, they also provide opportunity for major losses. Those who overextend themselves can be burned. Many investors lost money this year when oil prices turned negative and shares of Eastman Kodak took a sharp fall after news that its chair received stock options one day before the announcement of a government loan to help the company make drugs.