78 ATaleofTwoMarkets
but less on how they allocate income between investment and con-
sumption. The result is a national savings rate around zero.
But if you save more of what you make, it is easier to meet
investing goals since more assets are at work. Those who save rela-
tively smaller portions of their income are more easily tempted by
speculative impulses that make intelligent investing more difficult.
Everyone with income faces the question of income allocation.
You have to decide how much of your income to allocate to housing
costs, food and clothing, entertainment, transportation, education,
and so on. Some people also have the unfortunate chore of deciding
how to allocate income to pay for past consumption in the form of
cumulated credit card debt, automobile or personal loans, and mort-
gages on real estate.
It should be a no-brainer that the high-interest-expense items in
this category should be paid down to zero before an allocator even
thinks about investing in common stocks. If you are carrying a bal-
ance on your credit card accounts that requires you to pay something
like 10 to 18% interest annually, you are wasting your money. Pay
those debts down to zero and you will automatically earn the rate
you otherwise would be paying—guaranteed (something that is never
possible with stocks). The same holds true even for less expensive
obligations such as automobile loans (with average interest rates of
around 8 to 12%): Paying them down to zero with your extra cash
guarantees you that return. It can even be true for home mortgage
loans in some cases: Paying down 6 to 8% debt locks in that rate in
a way that no common stoc kcan ever guarantee.
Margin Trading
The growth in the number and size of margin accounts for stocks—
especially among day traders—suggests that many people foolishly
neglect these simple truths. From 1996 to 1999, margin debt rose
nearly fivefold at on-line brokerage firms and doubled among NYSE
member firms. During the decade of the 1990s, margin debt as a
percentage of total consumer debt quadrupled from 4% to 16%. Yet
many people do not understand that margin loans are not like other
consumer loans.^7
Margin traders borrow from their brokers at rates ranging around
9 to 11% in order to buy stocks with the borrowed money. They think
they can leverage those loans by using the proceeds to buy stocks
whose price rises plus dividends yield greater returns. In euphoric