Trading on margin

[Shanemex]

I'm relatively new to investing and I am trying to understand trading on margin. It seems like the idea is pretty simple concept, where you borrow against your securities in order to buy more, which has the effect of magnifying gains and losses. I was looking at the margin rates that my broker charges, and saw that for debit balances of $500,000 or more they charge you 6%, but it is much more for balances of less than $500,000.

Now from what I've heard, the average growth in the stock market over a large number of years is around 8 or 9%. So if the market grows at 8% on average, and you can borrow at 6%, is there any mathematical reason that you wouldn't want to be borrowing as much as you could on margin? It would effectively be like getting a 10% return. Obviously there will be some bad years where you will really get hurt, but if the market has had an average yearly return of 8 or more percent over 50 years then those bad years will be averaged out, right?

Besides increased volatility, are there any other drawbacks to trading on margin? Does it have any effect on taxes, for either short or long-term capital gains/losses?

[Sniper]

As a general rule, if you can earn more on borrowed funds (after tax) than you would pay in interest, you should borrow as much as you can.

You should also know that there are products like futures and options where you can further increase your leverage.

The downside is that when things go wrong, you get hurt pretty badly, so you have to keep a careful eye on your investments.

[kimchi]

This isn't really a viable long-term strategy. There are 101 other things you need to consider.

One that springs to mind is should you see a year or two of stangnant or falling stock prices coupled with rising interest rates (financing charges) - you could be wiped out.

You said you're new to investing. Learn to be consistently profitable with ABC investing/trading and learn excellent money and trade management before you increase your risk.

[Tater10]

NASDAQ went down ~75% in 2.5 years: BUSTO on margin.
Even the S&P 500 went down 50%: Again, BUSTO on margin.

The pain is bad enough on those bad months/years with my cash only portfolio. Having to pay a hefty % on top of that is like getting kicked in the nutz.

[Shanemex]

You can't actually go broke on margin, can you? I thought margin calls were in place to prevent that from happening. So even if I didn't anticipate a huge drop and get off of margin, if not out of stocks altogether, then still the worst I could lose would be like 50%, right? I don't really understand margin requirements though, so I don't know at what level you need to reach before there is a call.

[polkaface]

[ QUOTE ]
You can't actually go broke on margin, can you? I thought margin calls were in place to prevent that from happening. So even if I didn't anticipate a huge drop and get off of margin, if not out of stocks altogether, then still the worst I could lose would be like 50%, right? I don't really understand margin requirements though, so I don't know at what level you need to reach before there is a call.

[/ QUOTE ]

Buying on margin is the only stock-based investment where you stand to lose more money than you invested. A dive of 50% or more will cause you to lose more than 100%, with interest and commissions on top of that.

Taken from investopedia.com

[Tater10]

Yes, the margin call will prevent this from happening a vast majority of the time. However, if you are margined with a stock at 30, and it opens at 12, there is no protection. Likely? No, but if you are going to be investing for a lifetime, you'll see stuff like this. If you also think about the long-term, trying to return say 10% while borrowing at 7% seems like a lot of risk to take for 3% net.

Brokers such as zecco(?) charge $0 trades, and only make money off your margin account.

[hawk59]

Your return is going to be less than you assume....The market does not go up in a straight line and having margin means you will be forced to sell when it drops, so you will have more assets losing money on the way down then you will have making money on the way up. You can work out the math under different assumptions but basically the more volatile the market is the lower your return will be when compared to what it would be if the market went up in a straight line.

[DesertCat]

[ QUOTE ]
Your return is going to be less than you assume....The market does not go up in a straight line and having margin means you will be forced to sell when it drops, so you will have more assets losing money on the way down then you will have making money on the way up. .

[/ QUOTE ]

When I first started investing, I bought a bunch of Berkshire B shares for $2,300 because Warren Buffett ran the company, so how could I lose? It had been going up for 30 years. When it went down to $2,100, I was so excited I bought more on margin. It went down to $2,000, I bought more on margin. Eventually it got down to $1,400, and I panicked that I would lose my account, so I sold every share and took a huge loss.

The next month it hit $1,900, within a year $2,400. Today it sold for $3,640. I didn't understand margin well and was probably a lot farther from a margin call at the time than I realized, but when you leverage up the pressure will be on and sometimes it can force you into a big mistake.

[ahnuld]

much has already been said, so im just going to echo the sentiment that margin trading shouldnt be where you start your investing career.