Good day everyone! Happy Saturday. I have been wanting to share some knowledge on a topic I believe is important to clarify and expand on specially for my beginner investors.
From time to time someone within the Girl$ on The Money community would tell me they have been “invited” to open a margin account or to invest on margin and are wondering what to do.
A lot of the time, the question comes from someone who is very new to investing and has very limited knowledge. For that reason, I think is is VERY important to explain the facts of what margin investing really means.
After reading this post I hope you walk away educated enough to make your own personal decision on the matter or are inspired to continue learning more.
Let’s get to it.
When you open an Online Brokerage Account* and depending of how much money you fund your account with; you will notice the online broker will give you the option to open a ‘Margin Account’.
For the majority of online brokers you are only given this option if you deposit $2,000 or more of your own money (this is known as your cash account). However, the minimal requirement for margin accounts can vary depending on the broker.
In simple terms, buying on margin means that you are using borrowed money that the online broker lends you to invest. As with any loan, the option to accept a margin account and subsequently use it means there are interest rates involved (some as high as 9% per year) as well as repayment guidelines.
One of most important things to keep in mind is that you will be responsible to pay back the loan regardless of whether or not you make money on your investments. Obviously, this can get messy and is extremely risky.
In the margin world, your stocks or investments are collateral for that “loan”. If things go south and you end up losing money on your investments to the point that the online broker wants their loan back (usually when your loses are close to exceeding what you borrowed) the online broker will want to recover their loan immediately.
Some brokers will give you limited time to deposit additional cash into your cash account to cover your margin loan. However if this is not done, one of the things they can do is go ahead and sell your shares without any warning in order to cover their own personal assets.
The way most online brokers make money is by charging you a transaction fee when you buy and sell stocks. However, another way they make money is through the interest gained by offering a margin account. And so, it makes sense that they would want to protect their funds and will be watching your account like a hawk to make sure you are not in danger of defaulting on your loan.
On a personal level, I have never invested on margin and is something I consciously avoid at all costs. I remember once I added some stocks to my portfolio and didn’t realize I slightly went over the funds in my cash account. When this happened, the online broker automatically dipped into the margin account to make up for the balance.
When I realized what had happened, I immediately called my broker to let them know this was done in error and proceeded to deposit my own cash to cover the small ‘loan’. Even with almost a decade of experience in investing under my belt, I do not feel comfortable borrowing money from anyone to invest.
The market is extremely risky and volatile in the short term and we just never really know what will happen from one day to the next. You never want to be in a position where not only do your investment do poorly and you end up losing tons of money but also realize you owe money plus interest to your broker.
I personally believe there is nothing better than the peace of mind that comes from buying and selling stocks using your own money and not have to worry about anything other than waiting for your money to grow over time. However, even if some of your investments do poorly, at least you know there’s no one else’s money involved other than your own and you can be at peace with that.
*An online brokerage account is an account that allows you to invest on your own. Examples of online brokers include companies like TDAmeritrade, Ally Invest (previously Tradeking), E*Trade, ScottTrade, Fidelity, Capital One Investing, Interactive Brokers, etc.
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