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Insurance products are offered through our affiliated non-bank insurance agencies. Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations. A margin account is a type of brokerage account that lets you borrow money to purchase securities. Buying on margin lets experienced traders make larger investments with less of their own money. Using a margin account as part of your investing strategy, however, means taking on debt, additional costs and much more risk. Margin loans charge interest, and declines in the market value of securities bought with a margin account could require you to repay the loans at very short notice. Higher risks make margin accounts and buying on margin strategies for experienced investors only. Here’s what you need to learn to get started with a margin account. What Is Buying on Margin?Buying on margin is when you invest using someone else’s money. When you buy on margin, you are borrowing money to buy securities—in finance, this strategy is also called leveraged investing. With leverage, you contribute a small amount of your own money and you borrow a larger sum in order to buy investments. Margin loans are a form of secured lending. When you take out a loan to buy on margin, the loan is secured with the investments you purchase, much like you secure a home equity line of credit (HELOC) with the home itself. According to SEC limitations, you can only borrow up to 50% of an investment’s value, and brokerages may have their own limitations on how much you can borrow to buy on margin. Buying on margin gives you leverage to make bigger investments than you otherwise could, but it also means you’re taking on much bigger risks. You’re basically betting that an investment will increase in value. If the securities you buy fall in value—or don’t appreciate enough to cover the cost of margin loan interest—you could owe your broker more than you earn from the investment. What Is a Margin Account?A margin account allows you to borrow money to buy securities on margin. Unlike a cash brokerage account, which only allows you to spend as much money as you’ve deposited, a margin account leverages your purchasing power with debt. When you open a margin account, your brokerage extends you a line of credit you can use to buy securities. The securities are collateral for the loan, and the brokerage charges you an interest rate. Unlike other forms of debt, margin loans don’t have a set repayment schedule, but you must maintain your account value above a certain threshold. Margin accounts have a few key regulator requirements set by the Securities and Exchange Commission (SEC), FINRA and other entities. Note that your brokerage may set even higher requirements.
Margin accounts are a standard feature available for taxable accounts at most brokerages. Federal guidelines prevent most tax-advantaged retirement accounts, like individual retirement accounts (IRAs), from being available in margin accounts. Margin Interest RatesMargin interest is the annual interest rate you owe on a margin loan or a margin account. Interest rates vary from brokerage to brokerage, but some planners consider margin rates a little high. “Interest rates on margin loans quite consistently seem to be 3% or 4% higher than what you would get for a home equity line or some other reasonable type of debt,” says Brian Cody, a certified financial planner with Prudent Financial in Cedar Knolls, N.J. That’s not such a big deal if you’re using margin for short-term trades, but interest costs can add up if you use margin extensively. Each month your interest costs will eat into your returns, and investments purchased on margin need to remain in the green to prevent a margin call. What Is a Margin Call?A margin call is an alert from your brokerage that the value of your investments has fallen below the brokerage’s threshold of value for your margin loan. If you receive a margin call, you need to either deposit more money in your account or sell investments to maintain the account value that acts as collateral for your loan. If the value of your investments fall quickly or steeply enough, your brokerage may even sell them without notifying you. In many cases, a margin call forces investors to sell securities when they are worth less than their initial purchase price. Being forced to sell an investment for less than you paid for it is the core risk of investing with a margin account. “This makes it a dangerous game to play,” says Nate Wenner, a certified financial planner with Wipfli Financial Advisors in Edina, Minn. The Benefits of a Margin AccountOwning a margin account and buying on margin has benefits as well as risks.
The Risks of a Margin AccountUsing a margin account has a fair amount of risk because you’re leveraging your investments. These are the main risks you may encounter when you buy on margin:
“Anything you buy can go down in value, so when you buy investments on margin, you’re exposed to more risks because you have liability in terms of the cash you’re borrowing,” says Colby Davis, portfolio analyst for RHS Financial in San Francisco. “You have to make sure your investments don’t lose so much value that you lose more than what you owe.” How to Manage Margin Account RiskIf you decide to invest with a margin account, you can decrease your risk a few ways:
Do I Need a Margin Account or a Cash Account?When you open a new brokerage account, the firm will ask you if you want a cash account or a margin account. Novice investors should choose a cash account to begin learning how to trade and invest. Only open a margin account when you understand the risks and have learned how to invest. Some financial advisors encourage their clients to set up margin accounts so they have access to cash in a pinch. However, this has nothing to do with leveraged investing and more to do with cash flow. “We generally encourage [margin accounts] with our clients even if we don’t plan to do leveraged investing with them,” Davis says. “Sometimes a client needs money in a hurry, and instead of having to sell securities and wait two days, you can take the money out immediately and sell the securities the next day or the next week. You don’t have to wait as long to get the cash out.” Cody views a margin account as the equivalent of having overdraft protection on a checking account. “If you really want to buy an investment and you don’t have the cash instantly available, it’s a quick way to make sure that you have it,” he says. There are generally no additional fees for having a margin account versus a cash account. That said, taking cash on margin is still a bet that your investments will generally grow. If you’re taking a margin loan for more than just a couple of days, and the market falls and doesn’t recover, you risk a margin call. You Need a Margin Account for Short SellingShort selling is a speculative trading strategy where you aim to profit from a decline in a stock’s price. When you open a brokerage account, you need to choose a margin account to pursue short selling. Like buying on margin, short selling is a sophisticated strategy that’s not for novice investors, and the potential losses from a bad trade are much, much higher. Selling a stock short works like this: You borrow a particular stock from another holder via your brokerage account, you immediately sell the stock and pocket the profit from the sale, and then wait for the value of the stock to fall. If and when the stock’s market value declines, you buy it back and return it to the original owner. Think of short selling as a kind of mirror of conventional stock investing. Instead of buying a stock in the hopes that its value increases, you’re betting the value of a stock will decrease and you’ll be able to replace the shares you borrow for a much lower price than you sold them for. Featured Partners 1 SoFi Automated Investing 1 SoFi Automated Investing Annual advisory fee 0.25% The Risks of Short SellingShort selling involves much more risk than buying a stock long in the hopes the price increases. You ultimately must repurchase the stock that you borrowed and then sold. The more the stock gains in value, the more money you stand to lose. “The challenge with short selling is that you have unlimited loss potential,” Cody says. This is in contrast to normal investing, where losses are capped by the amount you originally paid for a stock. With short selling, there is no maximum to losses. If an investment’s price drastically increases after you short it, you still must return the number of shares you borrowed—even if the stock price is multiples more than you paid for it. Consider this scenario: A company’s stock is trading at $100 but you expect its value to fall, and you execute a short trade. If your instinct is wrong and the company doubles in value, you must buy back shares at twice the price you sold them for. In addition, federal law requires short sellers to maintain 150% of the value of the stocks they short in a margin account. This helps ensure the investors whose stocks you borrow are protected from the chance of you defaulting on a short trade. What happens when you add margin to a trade?Margin allows traders to amplify their purchasing power to leverage into larger positions than their cash positions would otherwise allow. By borrowing money from your broker to trade in larger sizes, traders can both amplify returns and potential losses.
What is a margin account in stocks?A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. Margin increases investors' purchasing power, but also exposes investors to the potential for larger losses. Learn More.
What is the effect of a margin purchase on gains and losses?A margin account increases purchasing power and allows investors to use someone else's money to increase financial leverage. Margin trading offers greater profit potential than traditional trading but also greater risks. Purchasing stocks on margin amplifies the effects of losses.
What is a margin account quizlet?Margin accounts are a common practice. It allows customers to borrow from BDs. 2 types of Margin Accounts. 1) Long - MONEY is borrowed by customer, who pays back interest until the loan is paid back. 2) Short - STOCK is borrowed and sold short, enabling the customer to profit if/when the securities' value declines.
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