Risks and Rewards of Buying Stocks on Margin


What is Margin trading? Did you come across it somewhere, or is it an alienated phrase? Any of that, we’ll understand it here. Just say you invest 10,000 in stock, and your return from that stock is 20%, which is 2,000. That’s some good profit, but what if… you could borrow another 10,000 and invest them in the stock, and make more money? When an investor borrows and invests this way, it’s called Margin trading. There are rewards to margin trading but also risks. But, here we go again – risks are a by-product of every opportunity. Let’s look at the rewards and risks of buying stocks on Margin to keep you informed of what you are into.

What do you think we should talk about first, the cons or the pros? Honestly, you should know all the things that could go wrong, so you can do everything right and skip the mistakes that can possibly happen.

Risks of Margin Trading or Buying Stocks on Margin

There are certain risks associated with Margin trading – they are mentioned here for you.

  1. Amplified Losses

Margin trading can amplify an investor’s gains in a big part. Still, it can increase his loss. In fact, you can even end up losing more than what you initially invested. Traders usually think that being indebted to brokers is much simpler than dealing with banks and financial bodies. But you know the truth, this debt could just be as pressing as it is with banks.

  1. Margin Call

A margin call is when the broker asks you to add more money into the marketing account. You would have to do this until it reaches the required Margin maintenance level. When you are this borrower, your positions have generated a big loss because of the underperforming securities. The Margin account may go below a particular point. When this happens, you will need to sell some or even all of your assets in the account or add funds to meet the margins requirement.

  1. Liquidation

Based on the terms stipulated in the margin loan agreement, the broker has the right to take a measure if you fail to live up to the contract. For instance, if the investor is incapable of meeting a margin call, the broker can liquidate any remaining asset in the margin account.

Now – these are some of the drawbacks of buying or trading on the margin. You can even use a stock margin calculator to evaluate how these risks will impact you and how much of a financial stake you would be at. But, other than these, there are many more advantages to this. Let’s look at the good part.

Advantages of Margin Trading

The good part has only started, you will be looking at the positive side of margin trading, and this will lead you to think that margin trading is not a bad idea after all.

  1. The Opportunity to Diversify

If you have a portfolio that is concentrated only on one company or a current or former employer – you would be making the mistake that many do and that is putting all of your eggs in one basket. With a margin account, you would be able to use the loan proceeds to gain diversification in your portfolio without even having to sell your shares. This is a strategy that can be helpful if you have a big amount of capital gain and want to keep it away.

  1. It is an Easy Credit Source

When your account is approved for margin borrowing, you can pull out a margin loan at any given time. You wouldn’t need additional forms and applications. You will have access to cash that would be convenient in several cases, like when you are unemployed, for medical bills, or a fast way to cash for any reason. If you have a brokerage account that includes checking, you can just write a check.

  1. Flexible

As long as your debt is under your margin maintenance level, you can pay back your loan at your own flexible schedule.

  1. Tax-deductible interest

The interest that accrues on your account could offset taxable income. You can check with your tax or financial advisor for the details on this.

  1. The Interest Rates are Low

Just like a loan, you will have interest charges with a margin loan. The margin loan rates are left to the federal fund’s target rate, and your interest rate could be lesser than what you would be paying on a credit card cash advance or a bank loan. This is the case, especially on larger balances. Margin rates could also be competitive with rates on home equity loans without all of the paperwork and application fees.

We didn’t just skip to the good part but spoke about both. But here, you can clearly see that the pros outweigh the cons. This is a good thing – right? In the end, all that counts is your financial goals and how this strategy can match them.

Conclusion

You can utilize margin trading – but firstly, look at the disadvantages the strategy has and find out if you have the risk appetite for it. If you do, well and good, you can start buying stocks on Margin. But before you do, make sure you have all the details on the stock you are about to invest in.

 

 

Jeff Campbell

Jeff Campbell is a father, martial artist, budget-master, Disney-addict, musician, and recovering foodie having spent over 2 decades as a leader for Whole Foods Market. Click to learn more about me

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