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What Is a Margin Account?

A margin account is a type of brokerage account that allows investors to borrow money  in order to purchase securities. The broker lends an investor cash for them to invest in stocks or purchase financial products. With a margin account, the dealer uses the cash account as collateral for the investor to purchase securities. 

Buying on the margin is beneficial to traders because it allows them to participate in larger investments. Investors can do this without having to use as much of their own money. Taking on a margin account also means taking on more debt and any added financial risks. It is important to know this prior to getting started with a margin account.

How Do Margin Accounts Work?

When using a margin account investors can possibly face larger financial losses. They are able to inherit additional purchasing power. With a margin account, you can borrow and purchase securities on the margin.

You’re able to leverage your purchasing power with debt rather than being limited to your own money. Brokers lend lines of credit that are used to purchase securities. They then charge an interest rate that is tied to the loan.

What Is Buying On Margin?

Buying on the margin is when you choose to borrow another person’s money in order to purchase securities. When you buy on the margin you’re borrowing a large amount of money. You only have to use a small sum of your own income to make investments

When you take out a loan to buy on the margin the money is secured along with all of your investments. When you buy on the margin you are hoping the value of your investment will continue to increase. You’re taking on additional risk because you are expecting the securities to increase in value and cover the margin interest rate costs.

Margin Interest Rates

Margin interest rates will vary depending on your broker. The margin interest rate is the annual rate you will owe on your margin account. Margin interest rates will also depend on the dollar amount of your loan. Also, the percentage rates are usually much lower than personal loan rates. Interest rates can start to add up if you consistently purchase securities on the margin, so be careful. 

Margin Account Rules

With a Margin account, you must meet the minimum margin requirement. The Financial Industry Regulatory Authority (FINRA), Securities and Exchange Commission (SEC), and other government institutions have set key regulator requirements for margin accounts that must be adhered to.

Your regulator requirements may even be higher depending on the broker you are borrowing from. Under the minimum margin requirement, FINRA requires that you must deposit in your margin account the lesser of $2,000 in cash or the complete purchase price of any stock that you plan to buy on the margin.

Also, when you buy on the margin you will have an initial margin requirement which means you will be limited to only being able to borrow 50% of the cost of securities that you intend to purchase. This is beneficial because it allows you to double your purchasing power. The maintenance margin rule requires that you must maintain a certain balance in your margin account after you purchase securities. 

Margin Account Example

With the initial margin requirement, you will be limited to only being able to borrow 50% of the cost of securities that you intend to purchase. So if you have $2,500 in your margin account you will be able to double your purchasing power and buy up to $5,000 in stocks on the margin. 

Benefits Associated With Margin Accounts

With Margin account, you are exposed to many benefits. Let’s review the various ways these types of accounts can benefit you.

  • Margin Loans Provide You With Access To Cash: You can use margin loans to make purchases that aren’t related to your margin investment account. So by owning margin loans, you will have access to additional spending power. 
  • Leverage: When you buy on the margin you can leverage the value of your investments. Owning a margin account helps you make larger investments and make additional purchases. Having additional spending power and leverage can help you increase your potential returns. This will allow you to have a wider variety of investment options to choose from.
  • Profit From Shared Price Declines: After you borrow and sell shares, then buy them at a later time you can gain a profit. This is based on the difference between the sale price minus the buyback amount. This financial strategy allows you to profit from a declining stock by purchasing them and selling them back at a lower price in the future.
  • Flexible Loan Repayment Schedules: Margin debt can be repaid at any time as long as you maintain the collateral limits that come along with your original loan. You will have to pay back the margin loan along with the interest payments. However, you will at least have a flexible loan repayment schedule to work with. 

Risks Associated With Margin Accounts

While margin accounts have their upsides, it is important to note the potential risks associated with them as well.

  • Margin Calls: Using a margin account comes along with many risks such as the potential to encounter a margin call. If the securities that you purchase continue to decrease in value you may be forced to sell them. You must do this in order to keep your account within the margin threshold.
  • Losses: When you invest using the margin you have to be careful because your potential losses can build up very quickly. If the market fails that could cause your cash account to possibly fall down to zero. Your margin account loan investments also can potentially fall to zero. This would result in you owing the balance along with the added interest rate amount.

How Do You Manage Margin Account Risk?

Managing margin account risk is essential if you plan to make any investments. You can keep a cash cushion within your margin account which will act as a buffer and will help you maintain the value of your account.

Also, you need to remember to pay close attention to the interest rates you are accruing before you make any investments. It’s important to continue to pay off your interest rate charges on your account because they can quickly grow.

Are Margin Accounts a Good Idea?

Margin accounts can be a good idea for some individuals if you understand all the rules, regulations, and risks associated with your investment. For example, you should avoid ever investing money that you know you can’t afford to lose.

You need to be aware of all the costs associated with any money that you borrow and how they may impact your future return. Margin accounts can serve as a great way to make money. They may also be dangerous because of the leverage and margin call risks you may face.

What’s Next: Consulting a Financial Advisor

Are you unsure about the next move you should make? Do you feel like you are ready to invest in Margin accounts. Or do you feel like you would prefer to be assisted by an experienced financial advisor? Margin accounts are risky and every investment you make should be carefully considered so that you understand all of the potential outcomes. 

A financial advisor can help you understand how to manage margin accounts, interest rates, and increase the value of your investments. You should consider utilizing a financial advisor to help keep you organized and prepared to make wise investments. Financial planning requires a lot of time and dedication. It is important to keep a regular account of all your expenses associated with owning a margin account.