Margin investing allows you to borrow money from a brokerage firm to purchase additional securities, using your own securities as collateral. Investing with a margin account increases your buying power. This guide will help you get acquainted with how margin investing works and the benefits and risks associated with it.
The basics of margin investing
| What is a margin account? | How is this different from a cash account? |
|---|---|
| A margin account establishes a line of credit from your broker from which you can borrow money to purchase additional securities. Eligible securities currently in your account are used as collateral for the loan, and the loan, plus accrued interest and associated fees, will need to be repaid. Your broker will require a minimum amount of equity to be maintained in your margin account (at least $2,000 in cash or eligible securities) to carry a margin debit balance or to sell a security short. Your broker can also limit how much you can borrow as a percentage of the total value of your portfolio. | When investing with a cash brokerage account, you can only use your own money to purchase securities. While using your own cash can limit both your buying power and the potential for greater returns, it's also much less risky. Understanding the benefits and risks of margin investing can help you decide which account makes sense for you. |
What is a margin account?
A margin account establishes a line of credit from your broker from which you can borrow money to purchase additional securities. Eligible securities currently in your account are used as collateral for the loan, and the loan, plus accrued interest and associated fees, will need to be repaid. Your broker will require a minimum amount of equity to be maintained in your margin account (at least $2,000 in cash or eligible securities) to carry a margin debit balance or to sell a security short. Your broker can also limit how much you can borrow as a percentage of the total value of your portfolio.
How is this different from a cash account?
When investing with a cash brokerage account, you can only use your own money to purchase securities. While using your own cash can limit both your buying power and the potential for greater returns, it's also much less risky. Understanding the benefits and risks of margin investing can help you decide which account makes sense for you.
Benefits and risks
For investors comfortable with the risks associated with margin investing, margin has the potential to increase the size of their investment and returns. Borrowing against securities may not be appropriate for everyone. Here are some things to consider:
| Benefits | Risks |
|---|---|
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Benefits
- Increased buying power
- Potential for greater returns
- Interest may be tax-deductible — consult your tax advisor
Risks
- Potential to lose much more money than you invested
- Possibility of a forced sale of your securities to cover a margin call
- Interest on margin loans can offset potential investment gains.
For more information, please refer to the US Securities Exchange Commission Investor Bulletin: Understanding Margin Accounts.
How does margin investing work?
Let's review some examples of the potential gains and losses when investing with margin versus without margin. For simplicity, we've excluded interest and fees that may be charged to your account as described in your applicable client agreements and disclosures.
You have $10,000 cash in your account. Say you want to purchase 200 shares of a stock at $100 per share ($20,000) in your margin-enabled account.
With a margin-enabled account, you're allowed to borrow up to 50% on margin, which would come to $10,000. You are responsible for the other $10,000, or 50 percent.
After the purchase, your margin-enabled account will have a Market Value of $20,000 ($10,000 Initial Investment + $10,000 Margin Debit).
Without margin, your original investment would only allow you to purchase 100 shares at $100 per share for a total Market Value of $10,000.
| Example: You purchase 200 shares of stock at $100 per share |
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What happens when the value of your investment fluctuates?
If your investment increases 20%, the Market Value of your margin-enabled account will grow to $24,000. After repayment of the margin loan of $10,000, the total remaining equity in your account is $14,000. In this scenario, with margin, you have made $2,000 more (minus interest and fees) than you would have investing without margin.
| Example: When your investment increases +20% |
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Should your investment decrease by 20%, the Market Value of your margin account will fall to $16,000 (not including interest and fees). After repayment of the margin loan of $10,000, the total remaining equity in your account is $6,000 ($10,000 Initial Investment - $4,000 Capital Depreciation). In this scenario, with margin, you have lost $2,000 more than you would have investing without margin.
| Example: When your investment decreases -20% |
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Margin calls
A minimum equity percentage (subject to change) of the total account value must be maintained at all times in your margin account, also known as margin maintenance. It's important to note that margin maintenance requirements can change based on prevailing market conditions.
When your margin account's value dips below the maintenance requirement, a margin call is triggered. A margin call requires you to either add money or marginable securities to your account, or to sell holdings to bring your account value back up to the required minimum level.
While margin calls are more likely to happen during periods of market volatility, they can occur at any time when there is a drop in account value. Monitoring your account's equity and adding funds as needed to maintain the required maintenance level will help you to avoid margin calls.
Different types of margin calls
There are three different margin call types: House calls, NYSE calls and Fed calls.
| House call: | NYSE exchange call: | Fed margin call: |
|---|---|---|
| When equity in a margin account falls below the percentage required by the broker. This call must be covered within five business days. | When equity in a margin account falls below the New York Stock Exchange (NYSE) requirement of 25% equity. This call must be covered within two business days. | When an investor purchases stocks and does not have enough equity in the account to meet the 50% equity requirement, a Fed margin call, also called Regulation T margin call, is triggered. This call must be covered within four business days. |
House call:
When equity in a margin account falls below the percentage required by the broker. This call must be covered within five business days.
NYSE exchange call:
When equity in a margin account falls below the New York Stock Exchange (NYSE) requirement of 25% equity. This call must be covered within two business days.
Fed margin call:
When an investor purchases stocks and does not have enough equity in the account to meet the 50% equity requirement, a Fed margin call, also called Regulation T margin call, is triggered. This call must be covered within four business days.
Ways you can cover a margin call:
- Deposit cash
- Deposit securities
- Liquidate securities
What if I fail to cover a margin call?
If, after a margin call has been issued, you are unable to meet the minimum requirements, forced liquidation of your assets could occur. This could happen involuntarily, meaning without your consent, and potentially at unfavorable prices, to protect against further losses and bring your account back up to good standing.