Margin Benefits are Marginal at Best

Margin is one of those things that novices find puzzling about the stock market, but the concept is really quite simple. Still, with understanding the basics of using margin accounts, determining the wisdom of using margin can be quite a conundrum.

A margin account is a traditional investment account with margin privileges.

This means your broker has set up what amounts to a line of credit secured by the stocks and bonds in your account. Often this margin credit line is used to buy more stocks in the same account. But the account can also be borrowed against to buy real estate, make other kinds of investments, or simply to pay personal bills. The simple requirement is that enough assets must be kept in the account to maintain a certain value as collateral for the loan.

This is where trouble comes in. It's easy enough to maintain that collateral level when all is well, but when the economy becomes difficult and you are strapped for cash, this is also often the time when the market may drop. When the market drops temporarily, your equity value may fall, but the value of your debt doesn't change; you may encounter a "margin call" when you can least afford it.

A margin call is similar to any other loan being called in. You must pay up immediately. If you don't have the cash, your stocks and bonds are sold automatically to pay your debts. This compounds your problem: you end up selling your stocks when they are down, usually the worst possible time. Remember, the idea is to buy when prices are down and sell when they are up. So, in addition to all the other problems, margin loans can force you to make poor investment moves. In times of market crashes, a heavily margined account might be completely lost when the market drops only a fractional amount.

This leads to the idea of leverage, which is what margin accounts represent. Anytime you borrow to invest, you leverage your investment, or buying more than you can afford for a fractional down payment. Since one is buying stocks with borrowed money, or borrowing against stocks already owned, this is the result. Buying a home with a mortgage is a very similar process, but since the bank doesn't typically call your loan if home prices dip temporarily, many of the problems listed above do not arise. Still, a 95% mortgage is a highly leveraged deal, and it is very easy to lose your entire investment with even a small change in real estate prices. Even a typical 80% mortgage can wipe out the entire investment in a poor market.

Despite the many risks associated with margin or other forms of leverage, there definitely are advantages. Certainly, we've emphasized the opportunity to lose money faster, but you can also make money faster using these tools. If half of your equity comes from margin, you can gain money twice as fast. As stocks go up, your profits are compounded, because you own twice as many shares as you could normally afford. Thusly, when the market drops, you lose twice as fast.

Also, some people benefit simply by having a margin credit line available, without making use of it at all, or by only using it for short-term turnover. If used judiciously by a disciplined investor, there is virtually no risk in having access to a margin account. It is the use of the debt obligations that carry the costs. Imagine having a credit card that is never used, but the credit line is available in case of major emergencies.

In the end, leverage simply means that your gains or losses will be multiplied. Each investor must consider for him/herself the acceptable level of risk. However, we firmly believe that there are other risks, which carry better payoffs than simple use of leverage. While it is good for most investors to have access to margin, it may not be wise to use it often. In addition to interest costs, the added risks may end up causing more harm than good.

To send comments or to learn more about Scott Pearson's Investment Advisor Services, visit http://www.valueview.net

Scott Pearson is an investment advisor, writer, editor, instructor, and business leader. As President and Chief Investment Officer of Value View Financial Corp., he offers investment management services to a wide variety of clients. His own newsletter, Investor's Value View, is distributed worldwide and provides general money tips and investment advice to readers both internationally, and in the U.S.

---

Issuing Warrants to Investors

When raising capital for a business venture, warrants are a... Read More

Wit and Wisdom on Money, Wall Street and Success - Part #2

Here are ten more WISDOM packed GEMS that ooffer very... Read More

Making It Second Nature

Not long ago I was laying on my son's floor... Read More

Your Worst Enemy To Successful Investing - The Media

How do you make your investment decisions and where do... Read More

Basic Options Terms

Options are good investing and speculative instruments. But options terminology... Read More

Why You Need To Buy and Sell Gold Coins (Part 5)

Grading coinsThe condition of a coin is commonly summarized by... Read More

A Gadfly On A Dinosaurs Butt, Or The Hood-winking Of The American Investor

Have you ever noticed how some words in the English... Read More

The Convertible Craze Brightens The Future Of Equities

Convertibles are stealing the show with their safe investment image... Read More

Retirement or Financial Freedom?

In the past most people never retired. They died. The... Read More

Keep Stock Market Investment Profits

Have you had one of those huge investment winners ?... Read More

Investing & Online Stock & Share Trading- The Stock & Share Markets are Booming But Be Warned

I had the pleasure of being invited on a friend's... Read More

A Safe Port For Mutual Funds But Not You!

Soft dollars, a form of legal kickback, is a sly... Read More

Is Starting A Business For Me? What To Consider Before Starting A Business

Do you have the right temperament?Starting a small business is... Read More

Porters Five Forces Analysis

If you've ever listened to Warren Buffett talk about investing,... Read More

Discipline in Investing and Trading

Discipline can be simply defined as your ability to follow... Read More

Begging Your Trust in Africa

The syntax is tortured, the grammar mutilated, but the message... Read More

Guru Focused: Robert Olstein?s Short Sells

While it is rather rare that value gurus sell stocks... Read More

Critical Options Investing Tip When Trading Naked Calls and Puts

An option is a derivative trading product that is best... Read More

Investing 101: Risk Terminology - BETA

About thirty years ago, statisticians armed with all of their... Read More

5 Day Trading Tips for Success

1. How to Treat Gap Openings A gap up or... Read More

Can Your Annuity Do This?

Okay, so I can tell you I have sat in... Read More

How To Find An Investment Advisor

Do you think you need an Investment Advisor? Hold on... Read More

Remembering TEOTWAWKI and Learning from It

Its only been about 5 years since we had major... Read More

Oil and Gasoline Price Uncertainties

The Light Crude Continuous Contract hit an all-time high at... Read More

Looking For a Safe Investment? Try a Certificate of Deposit

If you are looking for a safe investment and you... Read More

Everybody Wants to Know How to Invest

Those unfamiliar with the process of making and managing investments... Read More

5 Things To Know About The Stock Market

50% Of U.S. Households Invest In The Stock Market Individuals... Read More

How Do I Start Investing Online and What Are Some Basic Tips?

If you are new to investing online, don't put your... Read More

Asset Location ? Increase Investing Returns & Reduce Your Taxes

Location ? Once the holy grail only for real estate... Read More

The Cost of Green Eggs and Ham

Young readers know that March 4th is the birthday of... Read More

To Retire Rich, Save and Invest Early

If you want to retire rich, start saving investing early.... Read More

Sell Discipline for Investors: Importance and Execution

Investors usually don't have an aversion to buying an asset.... Read More

Trend Following

Trend following also called momentum trading is the simplest and... Read More