In my last piece, we saw that using debt instead of selling equities during a bear market doesn’t appear to work. In that, I mentioned that you quickly run up against limits of leverage (i.e. no one will lend you any more money). In that simulation, we eventually got up to 84% leverage. I implied (but didn’t show) that in the real world, you would start getting margin calls and those margin calls would quickly destroy you.
This is a quick article to elaborate on that, to show how those margin calls would have worked out in practice, to make it clear how bad the previous strategy was.
Surviving the 1970s with debt & guardrails
A long time ago I did a cursory investigation about whether you could improve retirement outcomes by using debt to…
- By April 1980 your leverage has crept up past 50%. Your portfolio is $1.3 million but your debt is $680,000.
- This triggers a margin call. You need to suddenly liquidate $62,000 of your portfolio to meet that margin call.
- The next month, your withdrawal of $8,000, interest on existing debt, and general stock market gyrations result in a margin call of another $45,000.
Let’s pause: we just had over $100,000 in margin calls in 60 days. Is that going to cause a lot of stress to retiree? At this point, they are 79 years old. Maybe they are experiencing some cognitive decline. Hardly seems like the kind of thing you want to deal with when you are almost 80.
Every time there is the slightest stock market hiccup you end up triggering a significant margin call:
- $169,000 total between June 1981 and November 1981
- Another $188,000 from January 1982 to April 1982
- $233,000 over the course of 1982
You can see how all these margin calls add up. By October 1982 your portfolio is down to $971,000; you have margin debt of $421,000; your networth is just $550,000; you are withdrawing $10,294 a month; which adds up to a 22.5% annual withdrawal rate of your networth.
By riding at the edge of margin limits, you are subject to constant (often substantial) margin calls when interest accumulation and the market movements push you over the edge.
You finally run out of money entirely in November 1992, 26 years into your retirement.
It is not an improvement over just using plain vanilla 4% withdrawals.
Here’s the spreadsheet: