A risky strategy that warrants extreme caution and is not for long-term investments
Posted by CopyTeam
This year, investors are making record-high margin investments against their accumulated assets. According to FINRA, margin debt had reached $847 billion by the end of April.1 Much of this activity is fueled by low interest rates and rising stock prices, making leverage investing more appealing. However, investing on margin poses significant risks.
You can purchase securities “on margin” by basically taking a loan from your brokerage company, using your investment portfolio as collateral. This method allows you to buy more shares without having to lay out more cash. Remember, though, that you must pay interest on the amount borrowed. If the stock you purchase rises, you will have the money to pay the loan back. But if the stock moves in the other direction, you could lose more than the money you’ve borrowed. One way to pay the loan back is through other available cash; that way you don’t have to realize gains to clear your portfolio of the debt.
The question of whether to invest on margin is something you should discuss with your financial professional. When the market is robust, it can make sense for certain investors. However, it is not a strategy to be used if you’re desperate to cash in on quick gains because you need the money. To learn more about investing on margin, feel free to consult us for a review of your financial situation.
Note that you must apply to borrow on margin much the way you apply for a home equity loan. The broker will evaluate your annual income, net worth – both liquid and invested – and even your credit history. Your finances are carefully scrutinized to determine if you have the resources to manage a margin account.2
Furthermore, qualified portfolios must meet specific margin requirements. For example, the Regulation T margin requirement for new purchases is 50% of the total purchase amount. Imagine, for example, that you would like to purchase $10,000 of Company A stock on margin. You would be required to deposit $5,000 or have at least $5,000 in equity in your account.3
Also, be aware that FINRA Rule 4210 requires that an investor keep at least 25% equity in his margin account at all times. Some brokerages may insist on an even higher percentage.4
Be aware that the risks of investing on margin are substantial, as you could lose more money than you deposited in your reserves. If the stock you bought on margin drops in price, your broker may enforce a “margin call,” which means you would have to deposit more in the margin account, or the broker can sell that stock. Not only does the investor have no say in which securities are sold, but the broker isn’t even required to inform him of the sale. Also note that the loan isn’t fixed; your interest rate may increase making the cost of the loan even more expensive.5
Always make sure you fully understand policies and procedures for a margin call. You really need to know the rules. Even better, check with an expert.
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1 Carla Mozée. Business Insider. June 4, 2021. “Leverage ‘can rip your arms off,’ former TD Ameritrade boss says in warning to meme-stock retail traders.” https://markets.businessinsider.com/news/stocks/meme-stock-leverage-warning-ex-td-ameritrade-boss-amc-reddit-2021-6-1030495097. Accessed June 24, 2021.
2 Fidelity. 2021. “Margin Loans.” https://www.fidelity.com/trading/margin-loans/overview. Accessed June 24, 2021.
3 Will Kenton. Investopedia. Nov. 4, 2020. “Regulation T (Reg T).” https://www.investopedia.com/terms/r/regulationt.asp. Accessed June 24, 2021.
4 Jason Fernando. Investopedia. Feb. 11, 2021. “House Maintenance Requirement.” https://www.investopedia.com/terms/h/housemaintenancerequirement.asp. Accessed June 24, 2021.
5 Fidelity. 2021. “Important Information about Margin Lending.” https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/Using_Margin.pdf. Accessed June 24, 2021.
Content prepared by Kara Stefan Communications.
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