In a bull market, a lot of people get enticed to use leverage to enhance their portfolio returns. Leverage comes in many forms, loans using existing stock as collateral, top-ups on home loans and using them to buy stocks, punting on stock futures etc.
“Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbours get envious.
But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as well learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.” - Warren Buffett, Berkshire Annual Report, 2010
In this context, let me recount the story of Rick Guerin - Buffett's contemporary and acknowledged by him as "Superinvestor of Grahamville". Guerin lost significantly and dropped out of the investment landscape after the steep crash of 1974 when he received margin calls because he was highly levered. He had to liquidate some of his best investments including Berkshire Hathaway stock. Today, everyone knows of Buffett and Munger but hardly anyone has heard of Guerin. (In fact, to be honest I was also not aware of Guerin's history before reading about it in one of Mohnish Pabrai's interviews).
As Buffett said in the quote above some people can become rich but in an alternate history (Taleb's definition) of events can become a pauper. So, keep away from leverage.
