12. A Six-Foot Man Drowning in Two Feet of Water

12. A Six-Foot Man Drowning in Two Feet of Water

Every high will be a future low. But people still go broke in the market — because short-term drops are unimaginably deep, especially if you used margin. The instant margin liquidates you, you don’t get to see tomorrow’s sun. This section’s core can be put in its bluntest form: long-term, the market never stops rising — a six-foot-tall man shouldn’t drown in water that averages two feet deep — but if you used margin trading, and the market drops short-term, and the broker force-liquidates you, you are out. Out doesn’t get rebound. Out doesn’t get tomorrow’s sun.

So this section’s argument is not just “watch your position size” — it is the structural reason CLEC opposes all forms of “margin trading.” Pledging and margin are two different things — pledging uses assets as collateral with relatively lenient liquidation and low interest; margin is borrowing the broker’s money directly to buy stocks, with ruthless liquidation that triggers forced selling the moment maintenance ratio fails. This book is forever against margin. “9% annualized” — when you first hear that, it sounds bland, no surprise. 9% is better than CDs, but it isn’t a windfall either. Earning 9% each year sounds like an unremarkable thing. But this perception hides a deadly trap. 9% annualized doesn’t mean the market rises steadily 9% every year. It actually means: some years the market is up 40%, 50%, or more; some years it’s down 30%, 40%, even 80%; average all the years together and the annualized is 9%. That is precisely the core of the metaphor “a six-foot man drowning in two feet of average water.” A man 181 cm tall (about 6 feet) standing in a river that averages 60 cm deep (about 2 feet) should be safe — the water doesn’t even reach his knees. But the river’s depth is not evenly distributed. In some places it’s only one foot, so shallow you see the stones at the bottom; in some places it’s ten feet, more than enough to fully submerge. “Average two feet” is a statistic — it hides the extremes. You will not drown in the average; you will drown in the deepest pit. Investing is the same. The 9% annualized hides extreme years’ violent swings. Real annual data: 2008 S&P 500 down 37%; March 2020 alone down over 30% in a single month (though the year closed positive); 2022 NASDAQ-100 down over 30%. And on the up side: 2009 S&P up 26%; 2019 up 29%; 2023 QQQ up 54.85%. Average all these wildly swinging years and you get a mild-looking “9% annualized.” If you see only the average and conclude investing is low-risk, you are the six-foot man in the average-two-foot river, unaware of the pits beneath your feet. The crux: can your financial situation absorb the deepest pit? If all your assets are in the market with no reserve cash, one 40% drop is enough to wreck your life. If you’ve borrowed too much on top of pledging, one big drop may trigger forced liquidation and wipe you out. A 9% average doesn’t protect you from one year’s extreme decline. What protects you is position management and risk control. Let me use a hypothetical case to illustrate the risk of position-management blowing up. Suppose a 29-year-old young person takes NT$2 million borrowed from the bank plus all his savings, puts it all into 00662, then pledges 60% of it and uses the proceeds to buy more 00662. His real leverage is very high — stock-drop losses are amplified, and if the drop exceeds a certain threshold the bank force-sells his stock to cover the loan. If he happens to be entering on a rising market, the paper return looks beautiful. That doesn’t mean he is right. The risk is one sentence: “Assume you did this at a 2022-style peak; the market then dropped 40%, and you may be bankrupt.” 60% pledge means the bank’s loan is 60% of

stock market value. If stock drops 40%, your remaining stock value is no longer enough to cover loan plus interest, and the bank issues a margin call. If you can’t deposit additional cash, the bank force-sells your stock at the low — this is “blowing up.” Once blown up, you’ve lost all your stock and may even owe the bank money on top. This is like Russian roulette. A revolver has six chambers; one has a bullet. You point at your own head and pull — five times out of six you’re fine, an 83% survival rate. But the one time you hit, the game ends forever. 60% pledge is playing that game. Most of the time the market won’t drop enough to blow you up, so most of the time he is fine. But just one time — one — the market drops past his tolerance, and all of his wealth goes to zero overnight. Across decades of an investing life, hitting one extreme is not a small-probability event; it is close to certain. Let me demonstrate with concrete numbers how different pledge ratios fare under extreme moves. Suppose you hold NT$10 million of 00662, at 10% annualized. Scenario one: pledge 20%, borrow 2 million. After a 70% market drop, stock value = 3 million, loan = 2 million. Net is still positive 1 million; maintenance ratio = 3M / 2M = 150%, well above the bank’s typical 130% safety line. No margin call, no forced sell, you can safely wait for the rebound. Scenario two: pledge 40%, borrow 4 million. After a 70% drop, stock = 3 million, loan = 4 million. Net = negative 1 million — you’re underwater. Maintenance ratio = 3M / 4M = 75%, far below safety. Bank force-sells, you lose everything. Scenario three: pledge 60% (high leverage), borrow 6 million. The market only needs to drop 50% — stock = 5 million, loan = 6 million, net = negative 1 million, direct blow-up. You don’t even need a 70% drop; 50% is enough. And NASDAQ-100 dropped over 80% from 2000–2002 and over 50% in 2008. These are not hypotheticals — these are historical facts. This is where the CLEC iron-law “pledge no more than 20%” comes from. Not pulled out of thin air, but derived from extreme-scenario testing. 20% pledge means even with a 70% drop — the most extreme scenario in 200 years of U.S. stock-market history — your maintenance ratio is still above the safety line. You will not be force-liquidated, your stock will not be sold, you can hold the full position through to recovery. Back to the six-foot man and the two-foot water. The 9% annualized is the “average two feet.” It tells you long-term the water is shallow and you won’t drown. But the occasional extreme years — down 40%, 50%, even 80% — are the deep pits hidden beneath the surface. If you don’t manage your positions, control pledge ratios, keep enough emergency cash, you are the six-foot man unaware of the pits. He looks at “average two feet,” strides confidently into the river, and one step in, hits a ten-foot hole — never to surface. The core of investing is not maximizing return; it is ensuring you are not annihilated by any single extreme event while pursuing return. You must survive first to enjoy the fruits of compounding. Risk control is not timidity; it is being responsible to yourself and your family. All of CLEC’s iron laws — never sell, buy when you have money, don’t panic in a crash — sit

on top of one premise: you have done your risk preparation. Without that premise, every strategy is a castle in the air.

Key Points

One, “9% annualized” hides extreme years’ violent swings — some years up 50%, some years down 40%+; the average is 9%. A six-foot man drowns in average-two-foot water because some spots are ten feet deep. Investors are annihilated not because average returns are insufficient, but because they weren’t prepared for the extreme year. Two, with NT$10 million: pledge 20%, after 70% drop still safe (maintenance 150%); pledge 40%, after 70% drop you’re underwater; pledge 60%, only need a 50% drop to blow up. “Pledge no more than 20%” is not conservatism — it is the safety floor derived from historical extreme-scenario testing. Three, the core of investing is not maximum return but not being annihilated by any single extreme event. You must survive first to enjoy compounding. CLEC’s iron laws — never sell, buy when you have money, don’t panic — all sit on top of adequate risk preparation. Without that premise, every strategy is a castle in the air.

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Iron Law IV: Use Pledging, Avoid Margin

● Pledging: Spend Without Selling ● Margin Trading Is Poison ● Never Pay Capital Gains Tax A bank is not a place to deposit money. A bank is a place to borrow money.

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