Buying on margin an option?

When I started to get in touch with finance and stock markets I was also in touch with different finance products. I tried to buy stocks, sell them on higher stock price with profit. I tried to trade forex and options. I was frustrated because I lost some of my capital. I didn’t have the knowledge to trade on profitable basis. If you are trading forex you’ll also be in touch with trading on margin and other functions – I would call it “freaky” stuff for no professional traders. Its freaky because you are trading with more capital as you’ll have invested. Currently I’m using the dividend growth strategy as I’m sure its the right one to become financially independent. All the money I’ll save will be added to my portfolio to invest in great companies which are paying dividend and will grow them from year to year.

 

Most of brokers are given the option to open a cash or margin account.  A margin account often have other requirements and terms & conditions. On Investopedia you can see the difference between cash and margin account – the main difference is that on a cash account you need the money on account to enter a new position. Once you are selling a position often the amount is available few days later. Also you are only to buy long positions. If you want to buy a short position – be aware to use it only as trader with high experience – or trade options then you’ll need a margin account.

When could a margin account help you in investing?

The broker is allowing you to buy more shares as your actual amount. If you have a cash of $10,000 then you would be able to buy for additional $10,000 (assuming 100% margin) – in total $20,000. The additional margin is up to the broker, some of them are allowing 100%, 50% or other. In case you are using the margin, you have to pay interest as borrow capital. The interest rate is much different from broker to broker, but let’s see what my broker is offering for the moment.

My current broker offers following:

Margin: 50%
Interest: USD Libor + 1,25 %

The USD Libor is 0,30 % currently what means the total interest rate is 1,55 %. I could buy stocks with 3% yield and paying 1,55% which means I would have a profit of 1,45%. More invested capital means also more cash flow. It seems to be very interesting as the credit from brokers are much lower as usual credit card rates. For an account of $100,000 and a possible margin of $50,000 it would be $725.00 more profit and cash for your account.

No margin without risk

It seems to be a fair deal without risk. But is it true? If you buy stocks on margin, you have costs of interest. The yield must be higher than the interest to have a profit. You also need to keep an eye on USD Libor. If the USD Libor is going up than it could be a risk for your account. If you are using the margin completely and your positions are going down, the broker will issue a margin call. That means you have to sell your positions or add more cash on your account. In case you are not able to add more cash to your account, you need to sell stocks or broker will do it automatically.

At a time of low interest rates it seems to be very attractive to boost the profit.

Would I use margin to buy stocks?

Currently I don’t use a margin to buy stocks as I’m afraid that I don’t have it under control. If I need dept capital to buy stocks it also means that I haven’t the money to be invested. But I could imagine to buy on margin in case I have the money on other account and not transferred already to the broker account.

What do you think? Do you use margin for investing? 

 

Comments

  1. says

    I never used margin for any of my investing. I fully understand the potential rewards of leveraging your investments but for my taste the risk is just too much to take especially when building a steady dividend paying growth portfolio.

  2. says

    I have ever used a margin for investing. I see where there is value buy using them, but the value comes with risk. I will say though that the last few puts I sold had 1 day expirations. If I had a margin account my profit would have gone from hundreds to thousands.

  3. says

    Patrick,

    Buying on margin is not for me – too much risk and uncertainty. Furthermore, I’d have to monitor my stocks all the time, which doesn’t sound appealing at all.

    I’d rather wait until I have enough capital to invest and then pull the trigger than to rely on outside forces to build my long-term portfolio.

    Best wishes,
    NMW

  4. says

    Thanks for the interesting post!

    I believe that the current negative interest environment isn´t the most favorable to start using margin. LIBOR´s only way from here can be up. Over time the interest will kill you. Additionally stocks tend to return much less in rising interest rate environments. There is even the chance of a significant correction of stock markets when central banks decide tighten. Theory suggests that cost of capital for corporations goes up sending the value of stocks down. If that is the case and you are too highly levered a margin call is imminent.

    The times where I would think about using margin is in cycles where central banks are easing (post crisis). Macro factors would then work in favor of you. Lower interest rates would lead to cheaper credit for you and better chances for higher stock prices, b/c of increases in the liquidity and cost of capital benefits. The perfect storm if you will.

    PS: what brokerage are you using? Mine, Onvista, is charging about 4% for a Wertpapierkredit!

    Best wishes

Leave a Reply