Understand the benefits and risks of margin loans.

The Risk vs Reward of Margin Trading

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It’s important to weigh the risks against the advantages of trading in a margin account, relative to a cash account. Let’s take a look at some key considerations:

In a margin account, your positions will usually be more sensitive to day-to-day market fluctuations, and if there is a really sharp decline, you could end up losing more than the total value of your account.

Additionally, you’re always required to maintain a minimum level of equity in a margin account; usually about 30% to 35% for most stocks.

If your securities should start to decline in value, and fall below this level, you’ll be required to deposit additional money into your account. If you’re either unable or unwilling to do this, your broker can close out the securities in your account to increase your equity. Unfortunately when this happens, it could be at the worst possible time and at the worst possible price. 

And the risks don't end there. If your positions lose value too quickly and your margin loan balance exceeds the proceeds from the securities your broker closed out, you could end up with no securities at all, but still owing money. 

On the up side, when you trade in a margin account, you can typically borrow 50% of the cost of any new securities.  That means you can buy up to twice as many shares as in a cash account, and this might let you take advantage of short-term market opportunities without selling any of your existing positions.

It can also make it easier to diversify your portfolio if you are overly concentrated but you don’t want to sell any of your holdings. 

When you trade in a cash account, your potential loss is limited to the amount you’ve invested, and since you own your securities outright, you get to decide when, or if, to sell them. And you won’t be forced to sell them during unfavorable market conditions due to a margin call. 

But if you only trade in a cash account, and the stock you buy goes up, your profits will usually be less than if you traded in a margin account and bought more shares. 

Always remember that this is a loan and you will incur interest charges. Whether your trades end up being profitable or not, eventually you will have to pay back the loan, plus margin interest charges. 

There is no set repayment schedule on a margin loan. Instead, when the loan is paid in full when the securities are sold. However, when you use margin to buy stock, the margin interest is often tax-deductible against your capital gains and investment income. 

Trading on margin can increase your gains if you make good investing decisions, but it can also increase your losses when you don’t.

If you feel like margin trading might be right for you, it’s easy to get started. When you open an investing account with a broker, unless it’s an IRA or some other type of retirement account, you’ll usually be offered the opportunity to apply for a margin account. 


While it’s typically never a good idea to use all of your available margin, leverage can give you the flexibility to take advantage of investing opportunities, that might not be possible in a cash account.

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Always have a plan.

Whether you are looking to increase your investment return or need a convenient line of credit, you should determine how the use of margin fits your own risk tolerance and investment goals. It’s important that you fully understand your financial situation, the rules of margin borrowing, and conditions that may affect your investments.

When you use margin loans, it's important to have a plan. You should develop a risk management strategy for your investments that is consistent with your market outlook. You should also develop contingency plans for dealing with potential margin calls and have a repayment plan ready if the market turns and margin maintenance requirements or margin interest rates rise.

  • Benefits

    • Buy more securities than you could on a cash-only basis.
    • Take advantage of timely market opportunities or make investment changes when you want.
    • Defer any capital gains taxes that might result from selling securities to meet your financing needs.
    • Repay the loan at your own pace, as long as you maintain the required level of equity in your account.
    • Enjoy a cost-effective borrowing option with competitive rates.
    • Possibly deduct the interest against your net investment income. (Please consult your tax advisor.)

     

  • Risks

    • Margin borrowing increases your level of market risk, so the value of your investments can go down as well as up.
    • You must repay your margin loan, regardless of the underlying value of the securities you purchased.
    • Schwab can change its maintenance margin requirements at any time without prior notice.
    • If the equity in your account falls below the minimum maintenance requirements (30% for most securities), you’ll have to deposit additional cash or acceptable collateral.
    • If you fail to meet your minimums, Schwab may be forced to sell some or all of your securities, with or without your prior approval.

What is a margin call?

When the equity in your margin account drops below the minimum maintenance requirement (30% for most securities), it can trigger a margin call or margin maintenance call. This means you'll have to deposit cash or securities into your account to meet the minimum equity requirement. Otherwise, Schwab may have to sell securities in your account at the current market value.

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Ways to reduce the risk of a margin maintenance call:

  • Borrow against a diversified portfolio of low-volatility securities. This reduces the risk that a single security will drop in value and trigger a margin call1.
  • Borrow less than the maximum amount allowable in your account. Consider setting your own personal maintenance level.
  • Monitor your portfolio, especially during uncertain market conditions, to anticipate a potential decline in value.

 


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