Bill Ackman's Biggest Warnings: Leverage, Margin Calls, and Zero-Day Options

0:00Nicole Lapin:So if you haven't heard by now, I recently sat down with Bill Ackman, the one, the only. And you know what? I don't have a vision board for money and rehab per se. But if I did, his face would be right there in the middle. I have wanted him on the show for years and he finally came on. If his name is new to you, by the way, here's the cliff notes. He runs Pershing Square. He's one of the most watched hedge fund managers alive. And in some years he has posted returns north of 50 percent. He also saw the 2008 financial crisis coming years before Wall Street did. and there was a big ROI for being right.

0:33Nicole Lapin:It is a really juicy goods story. So I'm not going to tell you the full thing, but I'll give you the short version. Back in 2002, Bill zeroed in on a company called MBIA. If you've never heard of it, that's kind of the point. MBIA was a bond issuer, one of those really boring behind-the-scenes companies. The problem with MBIA was that it slapped its AAA rating on other people's debt to make it look safer. Bill looked under the hood and decided that AAA rating was basically fantasy. So he did two things. First, he shorted the stock, and then he bought credit default swaps. Think of credit default swaps like insurance that pays out if the company blows up.

1:13Nicole Lapin:Then he published a teardown called Is MBIA AAA, laying out exactly why he thought the whole thing was a house of cards. It got really juicy in financial circles. At the time, though, no one took it seriously. MBIA's stock actually went up the day his report dropped, and then the SEC opened an investigation on him, not the company. All right, fast forward to 2008, and Bill was right. MBIA cratered, and Bill finished closing out the trade in 2009 for about$1.4 billion on a bet that cost him around$64 million, I will say, to put up. All of this to say, Bill has the kind of track record on Wall Street that make people lean in when he talks.

2:01Nicole Lapin:When he came on the show, he was super generous with his time. He gave me an hour, and I'm linking the entire episode in the show notes if you haven't seen it yet. But today, I'm going to tell you the things that he said that I am honestly still thinking about and why it matters for you. Here's where I think we should start. P.E. stands for Price to Earnings Ratio. It's the price of a company divided by the profit the company earns per share. So a PE of 20 means you're paying$20 for every$1 of annual earnings. I've done a few episodes all about this, so I'll link those in the show notes as well.

2:34Nicole Lapin:But Bill makes a different point. He says flip the PE ratio upside down instead. What percentage are you earning here? To use the same example,$1 of earnings is 5 % of your$20 investment. That's your earnings yield. Basically, the interest rate the business is paying you right now on your money. That's where the comparison to a bond comes in. And no, investments are not bonds. They are not guaranteed in the same way that bonds should be. But the comparison really underpins the Ackman philosophy. He wants businesses where that 5 % yield gets bigger every single year, run by companies so dominant that nobody can knock them off.

3:11Nicole Lapin:And he has a name for them. Durable compounders. These are the boring but unkillable businesses, the Amazons, the Metas, the Microsofts, that don't need a hot new product cycle to keep printing money. And compound is the key word here because compounding is the closest thing to magic that finance has. This is why the most powerful thing that an investor owns isn't capital. It's time. And Bill said it himself. And he also gave some cautionary tales, which really stuck with me because honestly, I was a bit surprised. So leverage is rich person speak for debt, and it cuts both ways. It can multiply your wins and multiply your losses.

3:50Bill specifically warning about borrowing against stocks that you already own. And this really surprised me because it goes against the buy, borrow, die strategy that has been associated with billionaires like Jeff Bezos. The goal of buy, borrow, die is exactly that. You basically grow your wealth while sidestepping taxes for forever. First, you buy appreciating assets like stocks or real estate, and you hold because you only owe capital gains taxes once you sell that asset. So as long as you don't sell, that growth is never taxed. Then when you need cash, instead of selling your asset that triggers the tax bill, you borrow against those assets.

4:29Debt obviously is an income, so it's not taxed. The goal is for the interest rate of your debt to be lower than what your assets are earning, meaning your portfolio keeps compounding while you spend that borrowed money to live. Then finally, the last part of the strategy is a little bit morbid. You die. We all die, but this is where the loophole really happens. Thanks to the step up in basis rule, your heirs inherit those assets at their current market value, wiping out all of the never taxed gains. The loan then gets settled from the estate and the appreciation that funded your lifestyle escapes income tax entirely.

5:02It is a sophisticated move and it definitely can work, but it doesn't always because of margin calls. So here's the thing. When you borrow against your portfolio, those stocks are your collateral for the loan. If the market drops and your collateral shrinks below what the lender requires, they call you up and they demand either more cash or more stock immediately. If you can't cover it, they sell your positions out from under you for you. This can happen when your stocks are at the bottom, aka the worst possible moment to sell. And this has even happened to billionaires. This is true, and it's brutal.

5:42In 2023, a short seller report hit Carl Icahn's company, and because he'd pledged a huge chunk of his shares against personal loans, his net worth cratered roughly 41 % in a single day, around$10 billion gone. That's the margin trap. But to be clear, the lesson isn't leverage is for suckers, It's that leverage removes your ability to wait out a storm, which brings us to Bill's least favorite trend these days. I want to shout this from the rooftops. One day options or zero day options are contracts that bet where a stock or an index is going to land by the end of the trading day. They expire in hours and they have exploded in popularity.

6:28These things now make up close to half of all daily options activity tied to the S &P 500. Here is the big problem. An option is a bet on direction and timing. You are not investing here

6:40Nicole Lapin:is basically a coin flip unless you have confidential information, which is also not investing. That is insider trading and that is illegal. Bill is a billionaire who has studied companies for years and has a huge team to do it. And even he can't call a single day. So when somebody shows up on your feed and says they can, that's your cue to close the app. For today's tip, you can take straight to the bank. If you want the borrowing against your portfolio magic that the rich do use safely, keep your loan to value ratio tiny. Bill's own line was that five cents of debt against a dollar of assets might be fine, but 30 or 40 cents is how you get wiped out.

7:19So flip the script and build your own margin of safety before you ever borrow a dime. Keep three to six months of living expenses in cash in a high yield savings account completely out of your brokerage account. That cash cushion is what lets you say no to a margin call and yes to buying when everybody else is panic selling, which as Bill will tell you is exactly when real money gets made. The wealthy don't win because they borrow. They win because they never have to sell at the bottom. Build the cushion that guarantees you never have to either.