How Margin Borrowing Can Supercharge or Destroy Your Investments
Money Rehab with Nicole Lapin- 383 views
- 6 May 2024
With margin borrowing, you can give your investments a boost— but if you're not careful, you could also lose more than you gain. Nicole explains the concept, and whether it's a money move you should make.
When I'm not hosting this podcast, I am writing books, but it is really hard for me to write when I'm at home, so I like to find remote cabins in the middle of nowhere to just hang out and write. But I hate the idea of my house just sitting empty, doing nothing but collecting dust and definitely not collecting checks. And that's why I'm an Airbnb host. It's one of my all-time favorite side hustles. Other popular side hustles are awesome, too, don't get me wrong, but they often involve big startup costs. By hosting your space, you're monetizing what you already have access to. It It doesn't get easier than that. And if you're new to the side hustle game and you're anxious about getting started, don't worry, because you're not in this alone. Airbnb makes it super easy to host. I mean, if I could do it, you could do it. And your home might be worth a lot more than you think. Find out how much at airbnb. Com/host. Did you know that some travel credit cards offer 10X points on your spending? Don't miss out on big rewards for your next trip. Nerdwallet lets you compare smart travel credit cards side by side, curated by an expert team of finance nerds.
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So if you got your eye on 10K worth of stock, but you only have five grand on hand, margin lets you borrow the rest to make the full purchase. It's like getting a bigger shovel to scoop up more of the market. It sounds a little weird to put your investments up as collateral, but it's no different than using your house as collateral for a loan or paying a security deposit on a hotel reservation. You're offering an asset as a guaranteed to a lender. In the context of margin borrowing, it means that you're borrowing money from the brokerage and using your existing stocks or other eligible securities, depending on what you're investing in, as collateral. So your brokerage becomes like the guy behind the counter at the pond shop. But instead of your jewelry, you're using your stock holdings to secure a loan. You tell the broker, Hold on to these shares for me. I promise to repay you what I borrow, but if I can't, these shares are all yours to sell to recover your money. You're essentially agreeing to let the broker use your current investments as a safety net. And by doing that, you're reassuring the brokerage that it won't be left in a lurch if things go south.
This is a new way to think about your brokerage that is totally legit. Your brokerage isn't just the home of your investments. Your brokerage can also lend you money. Just like your bank might lend you money to buy a house, your brokerage lends you money to buy securities. This service allows you to amplify your purchasing power in the stock market. Of course, this lending isn't a free-for-all. You enter into a margin agreement when you set up a margin account. This This agreement outlines what you can do, the interest rate on your borrowed funds, and the brokerage's terms for potentially selling your securities, collateral, if you can't meet a margin call. A margin call happens if the value of your collateral, the securities that you bought plus any others in your margin account, drops below a certain point, the brokerage will ask you to deposit more money or to sell some of your securities to balance out what you owe. This is the brokerage's way of ensuring that the loan remains secured. More mathiness in just a second. But First, I should mention your brokerage also isn't just going to give you money for funsies. It's a loan, which pretty much always means interest payments.
The interest rate on margin borrowing for investments can vary depending on a whole mess of factors like which brokerage firm you use, the amount you want to borrow, the market conditions. Generally, the interest rates on margin loans are calculated based on a broker's base rate plus a certain percentage that can increase as the amount of borrowed money goes up. That all translates to rates landing between below 2% to over 9%. For larger brokerages, you might see lower rates due to the ability to lend at more competitive terms. It is really important, though, for you to check specific rates offered by your brokerage as these often change based on shifts in the broader financial landscape, like changes to the Federal Reserve's interest rates, which, by the way, just kept steady this week. Heyo. So playing on margin comes with some perks. It supercharges your buying power and allows you to snatch up more shares than cash alone could grab, and that gives you a bigger shot at bigger returns. By doing all that, you're maximizing your investment opportunities. If you see a stock or a fund that you think is a great opportunity, but you're short on cash, margin has your back, and that enables you to act quickly and to snag those shares before the opportunity disappears.
And you get ultimate flexibility with margin. You don't need to wait for the funds to clear like you would depositing cash from a bank, and you don't need to sell assets to wait for that transaction to post. You can get up and running pretty quickly with margin. And now that we've covered that base, let's talk about the risks because they are significant. Just like margin can amplify gains, it can also magnify losses, too. A dip in stock prices might just be, oh, whatever in regular scenarios, goes. We know that, right? The stock market goes up, the stock market goes down. That's its thing. But a dip in stock prices when you're borrowing money, that's not a, oh, whatever. That's more of a, oh, you know what? And then there's the dreaded margin call I alluded to earlier. This is definitely the worst case scenario of margin borrowing. If your investments dip below a certain value, your brokerage will call your debt asking you to add more cash or securities into your account pronto. If you can't meet a margin call, they might just sell your stocks to cover it, potentially causing you to cash out at the worst time.
And brokerages typically have a hard and fast rule around how low your investments need to dip before they can issue a margin call. Typically, they require 30 % for what's a maintenance requirement. But this concept is a little easier to follow with the number trail, so let's use your 10K investment again as an example. Say your brokerage requires that 30 % maintenance requirement. You put in 5K plus another 5K from your brokerage as a margin loan. So your brokerage has 50 % equity in that investment, right? Half of your investment is theirs until you pay it back. If whatever you invested in drops and your 10K is now worth only 6K, the investor equity has also also dropped to 1K, or the 6K value minus the 5K loan, or just 17 % of your total investment. But your brokerage has that hard invest rule that they need to have at least 30 % equity in your investment. So this drop would trigger a margin call. And when that happens, your brokerage is going to need you to give them 30 % of that new 6K value, which is 1,800 bucks. You do have some time to come up with this money, but it's not a lot of time.
It's around 2 to 5 days. And in order to come up with that money, you could either deposit 1,800 bucks into the account, or you could sell other investments in order to put money into the account, or you could deposit more marginable securities, which is a little bit more complicated. But the big picture here is you're going to have to come up with the cash at a time when your investments are down. And if you needed to borrow on margin anyway, you probably don't have a lot of liquid cash. So this whole story adds up to being a pretty ugly picture at this point. To play it safe on the margin tightrope, you need to know your limits. Just because you can borrow a lot doesn't mean you should. Assess your own financial landscape and decide how much risk you can comfortably handle. And while I prefer less risky strategies where you don't need to keep your eyes glued on your brokerage account, with margin borrowing, you do need to keep a close eye on your investments and your account balance, setting alerts for significant market moves can help you react quickly and wisely. For today's tip, you can take straight to the bank.
If you do want to try a margin loan, to get the best terms possible, you should compare margin rates at different loan amounts because the rates can be tiered based on the margin balance. But always, always remember that while borrowing on margin can amplify those gains, they can also magnify those losses. Do you ever get FOMO, fear of missing out? Well, do you ever get FOMO-Tupita, fear of missing out on the perfect higher? If so, I have the antidote. It's LinkedIn jobs. Linkedin jobs helps you hire professionals you can't find anywhere else, even those who aren't actively searching for a new job but might be open to the perfect role. In any given month, over 70 % of LinkedIn users don't visit other leading job sites, and that adds up to a serious squad of awesome candidates. Linkedin has over a billion professionals on the platform, and these candidates are super qualified, so much so that 86 % of small businesses get a qualified candidate within just 24 hours. I work with LinkedIn jobs for all of my dream team needs, so they're hooking up Money Rehabbers at linkedin. Com/mnen. Go there and you can post your job for free.
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And your home might be worth more than you think. Find out how much at airbnb. Com/host. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoy. Our researcher is Emily Holmes. Do you need some Money Rehab? And let's be honest, we all do. So email us your moneyquestions, moneyrehab@moneynewsnetwork. Com, to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.