Buying on Margin INTRO: You would think owning volatile stocks such as Internet companies would be excitement enough. But during the past few years, a record number of investors have not only bought stocks that fluctuate widely, but they have also borrowed against their holdings to acquire even larger stakes than they could pay for in cash. This practice, called buying on margin, can be a simple way to turbocharge a portfolio, but it’s risky business. Bruce Hagan, certified financial planner with RAI Investments and Corporate Securities Group is with us to explain this strategy. Q1: First of all, explain how margin works. A1: Once an account is established with a brokerage firm, the amount that can be borrowed depends on the initial margin requirement. Brokers are free to set that amount at any level they wish, as long as it doesn’t exceed the Federal Reserve limit of 50% of a portfolio’s value. That means you can usually buy $2 of marginable securities for every $1 you contribute, with the other dollar coming from the broker. Q2: So the obvious advantage is that if you think you have a good stock idea, you can buy twice as many shares, right? A2: Yes, and there are a couple of other advantages. It can be a simple and fairly low-cost line of credit. Other than a simple margin agreement form that’s filled out when the account is opened there’s no loan application or committee approval necessary. The loan rates are generally reasonable and the interest paid is considered by IRS to be an investment expense and is therefore tax deductable. But the big appeal is the leverage factor, the ability to potentially double you profits by buying twice as much. Q3: If you can double your profits, then I assume that if the stock goes down, you also risk doubling your losses, correct? A3: Indeed it is a double-edged sword. You must be sure you can handle the risk. If you open a margin account be prepared to deal with the potential loss and don’t borrow so much that a margin call would deplete your entire account. Also, don’t use margin as a long-term strategy. The interest expense will mount and over time will negatively impact your returns. When your margined stocks go up, consider selling some to pay down your debt. Q4: I’ve heard the term "margin call". What is that? Q4: After an account is "margined", the debit balance has to be less than the firm’s maintenance requirement. In other words, you have to maintain a certain amount of equity (your money) in the account. If the value of your account falls below the maintenance requirement you will receive a margin call. That is a demand from the broker that you pay off some of your loan within just a few days. If you can’t, the brokerage firm has the right to sell your shares- at whatever price the market is bringing. Ideally, you want to have some cash somewhere in reserve to cover a call, so that you don’t get sold out at a low price. Q5: It sounds like margin can be a useful tool for some, but certainly not for everyone. A5: I couldn’t have said it better. You have to ask yourself is it wise to borrow money to speculate in the stock market. Many people would answer "No". The discussion offered above and in the movie should not be considered an endorsement by Florida State University. They are offered in the educational sense of providing thought-provoking information for our Web audience. Copyright shared with Florida News Channel (FNC), all rights reserved. Broadcast 12/10/99