In this article, we will discuss why you shouldn’t buy stocks on margin despite the low interest rates. We will review some of the risks you may face when using margin to purchase stocks.
Margin loans can be called at any time
A margin loan is not like a bank loan. Brokers can call for repayment of loans at any time and expect immediate payment, as agreed upon in the margin account agreement. Brokers do not care about your ability to repay or whether you have sufficient illiquid collateral to offer in case something happens. Brokers expect immediate payment if they ask for it, as they also have financial obligations they need to meet.
Buying stocks on margin is real debt
Margin debt balances are real debt. It’s like going to the bank and signing a mortgage, using a credit card, or taking out a student loan. Due to the ease of creating margin loans in normal circumstances, investors sometimes fail to treat these obligations with the respect they deserve.
Companies can go bankrupt
Companies go bankrupt or experience capital degradation from time to time. Many investors put irresponsibly large amounts of capital into “thriving” companies in hopes of getting rich, but sometimes they also buy call options and purchase common stocks on margin to do so.
Panic in the market
There will always be market panic and disruptions and volatility affecting the market. Many investors do not have a civilized approach to investing, so they follow investor herd behavior and incur significant losses when the stock market shows potential for decline.
No way to sell stocks or get prices amid a decline
Beginning investors often do com
Income from dividends may lead to increased taxes
Imagine buying $100,000 worth of Royal Dutch Shell stock on margin. You should receive about $6,500 annually in dividend income if the stock returns at 6.5%.
Can you use margin debt with a brokerage firm?
A good rule for margin balance in the account is not to exceed 5% of the market value of the loan, and even then, use it only to meet short-term cash flow needs; for example, depositing additional funds within a few days but wanting to make a purchase today.
A better alternative might be to obtain a negotiated line of credit with your local bank. With a line of credit, you can access funds at your discretion and repay them according to a schedule rather than depleting your account immediately.
Another option is to place your holdings of U.S. Treasury bonds into an authorized margin account while keeping stocks and other holdings in an unauthorized account. You can then leverage up to 30% of the market value of your treasury holdings. There is still a risk of loss, but considering what can happen with a margin loan, it is much lower.
Frequently Asked Questions
How much does trading on margin cost?
Margin costs, like most loans, are charged in the form of interest costs. The interest rate you will pay depends on the size of the loan and the brokerage. As the debt amount increases, the interest rate decreases. For example, TD Ameritrade charges an effective interest rate of 9.5% on debit balances below $10,000 and 7.5% on debit balances above $250,000. These rates will change as broader interest rates fluctuate.
When do you pay margin interest?
Margin interest costs are presented as an annual percentage, but they are usually charged daily. However, you do not pay these fees until you settle your margin debt. As mentioned above, you can hold margin debt for several months, or the broker can call for repayment within hours. It usually depends on the size of the debt and the performance of the trade on margin.
Do
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Sources:
TD Ameritrade. “Margin Account and Interest Rates.”
Source: https://www.thebalancemoney.com/dont-buy-stocks-margin-358101
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