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Leverage Risk: Why You Should Not Borrow to Buy Stocks
Key takeaways
- Leverage multiplies gains and losses by the same factor — but a loss of 100% cannot be overcome, while a gain can be unlimited.
- A margin call arrives at the worst moment: during a downturn, when it is psychologically hardest to buy.
- Interest on the loan accrues regardless of market performance — in a sideways market it quietly erodes you.
- Leveraged ETFs (2× or 3×) are suitable only for short-term trading, not long-term holding.
- Neither Buffett nor Bogle recommend leverage — and both survived dozens of crises without being wiped out.
Leverage is a tool that multiplies returns — but asymmetrically: a 100% loss cannot be recovered from, whereas gains can be unlimited, and this asymmetry is what makes leverage a lethal trap for investors.
How leverage works and where you find it
Leverage in investing appears in several forms: a margin account with a broker (you borrow from the broker to buy stocks), CFD contracts (you trade with 5× to 50× leverage), leveraged ETFs (a fund promising 2× or 3× the daily return of an index), or simply a consumer loan used for investment.
The asymmetry of risk: why leverage does not work out mathematically
Imagine an investment of CZK 100,000 with 2× leverage (own capital CZK 50,000; the remaining CZK 50,000 is borrowed).
- If the market rises 20%: value rises to CZK 120,000 → after repaying the loan, CZK 70,000 remains → a 40% return on own capital.
- If the market falls 40%: value falls to CZK 60,000 → after repaying the loan, CZK 10,000 remains → an 80% loss on own capital.
- If the market falls 50%: value CZK 50,000, all own capital wiped out. Margin call.
Leveraged ETFs: why they are unsuitable for long-term holding
Leveraged ETFs (for example 2× S&P 500) promise twice the daily return. Because of volatility decay (the loss from daily resetting), however, they persistently lose ground against the simple 2× index in a sideways or volatile market. Studies show that a 3× leveraged ETF on the S&P 500 over 10 years with high volatility can lag behind the unleveraged index.
When leverage is justifiable
A mortgage on your own home is "good" leverage — you have a real asset, a low interest rate, and a psychological anchor. Other forms of leverage on equities make no sense for retail investors. Instead of leverage, invest more of your own capital through regular DCA. The compounding effect described in the power of compound interest is a safer route to the same goal.
FAQ
Why is borrowing to buy stocks dangerous?
Leverage multiplies losses as well as gains. With 2× leverage, a 50% market decline wipes out all your own capital. The broker can also issue a margin call and sell your positions at precisely the worst moment.
What is a margin call?
A broker's demand to add capital or an immediate sale of positions if the portfolio value falls below the minimum required threshold. It typically occurs during market downturns — at the worst possible time.
Are leveraged ETFs suitable for long-term investment?
No. Leveraged ETFs are designed for short-term trading. Due to daily resetting and volatility decay in sideways or volatile markets, they persistently underperform the theoretical multiple of the index.