Investing or Gambling

Ten years ago this month, I learned the most painful personal finance lesson of my life. In November, 1999 I had $3,000 to invest in the stock market. Everyone told me it was a great time to be in the market. I bought shares in several tech companies. Everyone was building wealth in tech, right?

By February, 2000 I had day (or week) traded my little fund to $6,000. At the pace I was on, I'd retire by 30. I upgraded my stock account to allow for trading on margin. Trading on margin means I borrowed money from my broker to fund more stock. I paid 8-percent interest, but my stock trading was earning more than 700-percent.

The day I got my $6,000 loan a friend of mine told me to buy stock in his employer. He gave me some detail about the technology that sold me on it being a solid idea. Basically, they were a typical year 2000 dot-com company; fast SPENDING tech company with no revenue and a great idea. I bought $6,000 of his company with his great tip in mind. Two weeks later the market turned sour. Because I'd bought on margin, every dollar the stock dropped caused me to lose $2 of my account value. Buying on margin essentially doubles your growth or your loss.

I received my first margin call around March 15. A margin call is a broker demand to deposit enough to bring your account value to the minimum requirement. Basically, the stock in my account might not cover what I'd borrowed from the broker without a cash infusion. The first margin call was around $1,000. I sent the check and kept day trading. Three weeks later I got my next margin call for around $3,000. I drained our savings account and had to sell a certificate of deposit (CD) we had bought for our son. I sold all of the remaining stock and closed my account the same day.

I learned a lot of lessons through my day trading expedition. The five biggest all deserve a post of their own. Here are some of the big ones. They all probably deserve a post on their own. I'll tackle that in the future.

1. Trading on margin is NEVER a good idea.
2. Trading stock and investing in a business are dramatically different things.
3. A broad-market index fund is lower risk and more likely to help you achieve your goals than picking individual stocks.
4. Diversify, diversify, diversify is to investing as location, location, location is to real estate.
5. A "hot tip" from someone with no financial expertise is best ignored.

What was your first personal finance lesson? How did it change your strategy?