TEMPLE, Texas — Buying On Margin was bad for the economy in the 2000's because the speculation lead to artificially inflated stock prices.
When the market eventually corrected itself, investors were forced to sell their stocks to repay their loans, causing a domino effect of falling stock prices, bankruptcies, and a general economic downturn, but the technique is still used.
So what is Buying On Margin?
Well, Buying On Margin is basically the "Wimpy" character from Popeye saying, "I will gladly pay you Tuesday for a hamburger today."
Certified Financial Advisor Neil Vannoy spoke with 6 News and said, "Buying stocks on margin is similar to the home-buying process. Borrowing money for a home allows you to buy a more expensive home than if you had to pay cash for the entire purchase price. By using margin, investors can borrow money from their brokerage firm to buy a larger amount of a stock. And if the stock appreciates, having a larger amount will lead to larger gains."
Neil also explained a simple investment return like you might see if you saved for and then bought a stock, telling us, "Assume you pay cash for a stock worth $5,000 and it increases to $5,600. This $600 gain represents a 12% return on your original $5,000 investment."
So, let's dive deeper and see how it works. Can you really use your own money, that's already invested, as a loan to make greater returns?
Neil told 6 News, "Now assume you make the same investment by using $3,000 of your money and $2,000 borrowed from your brokerage firm. By using margin, the same $600 in appreciation represents a 20% return on your initial $3,000 investment. Of course, in the real world, you'll pay interest on the borrowed money and other possible fees that will lower your return."
But be careful, because when buying on margin, or “loaned money" the market doesn't always go up. "Margin is a double-edged sword because stocks don't always increase in value. It's great when stocks go up, but it also magnifies investment losses when stocks decline. If a stock you purchase on margin declines in value you may be required to deposit additional funds in your account to cover the losses. This is known as a "Margin Call."
So, can your assets be seized or forced to pay off the losses?
Neil told 6 News, "If you get a margin call and don't deposit money in time your brokerage firm has the right to sell securities in your account to cover the debt. Keep in mind that interest will be charged on your margin balance whether or not you make money on the trade, so this makes it even more difficult to make money when buying on margin."
Due to this risk, only 10% of investors are using margin. Most investors like Neil Vannoy will tell you to get into the market, re-invest your dividends and invest for the long term to ride out market instability. But for you gamblers out there, we tackle all subjects here on Money Talks, and now you know more about buying on margin!
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