Generally, using margin to buy stocks isn’t a great strategy. If the stock price tanks, you could lose your initial investment and struggle to cover the margin call, all while paying margin interest.
Lately, though, more people are tempted to use margin due to a prolonged bull market and lower interest rates. The allure of quick wealth, often amplified by online hype, is hard to resist. Unfortunately, when the market turns, those without solid investment strategies often face significant losses. Since starting my investment journey in 1995, I’ve witnessed many people lose substantial sums repeatedly. It’s heartbreaking and could be avoided with more disciplined investment choices.
Let’s explore why buying stocks on margin isn’t wise. We’ll cover some basics, examples of margin buying, and the infamous margin call.
Here are six reasons why I advise against buying stocks on margin:
1. It turns you into an active investor. Margin buying means you’re speculating, which usually doesn’t fare well against passive, long-term investments.
2. It amplifies losses. Active investors often underperform. Using margin increases both potential gains and losses, magnifying the impact of underperformance.
3. It’s costly. Margins come with borrowing costs that can vary significantly, despite overall low interest rates.
4. It increases emotional stress. With greater financial swings, margin buying can strain your personal life, especially during market dips.
5. Forced sales. If your investments drop in value, you might have to sell at the worst possible time to meet margin requirements.
6. Loss of time. Beyond financial loss, the time spent recovering from financial setbacks is precious, especially as you age.
Despite these warnings, the allure of margin buying has never been higher. Here’s an example: A friend earning $70,000 annually got me into Tesla in 2018. Since then, Tesla’s success tempted him to increase his investment using margin. At one point, he controlled $900,000 in Tesla stock. Despite a steep interest rate, he remained optimistic about further gains. Unfortunately, after a major market downturn, he faced significant losses, impacting his financial and personal life deeply.
Margin allows investors to borrow up to 50% of the purchase price of marginable investments. While this can double buying power, it also increases exposure to market downturns. For example, if you own $100,000 in stock and buy another $100,000 on margin, a 40% market drop could drastically reduce your equity, triggering a margin call. If you can’t cover the call, the brokerage might liquidate enough assets to meet its required maintenance margin, potentially causing significant financial damage.
Margin should be used cautiously, if at all. The potential for higher returns is enticing but comes with increased risks and costs. High margin interest rates and the possibility of forced sales during market downturns make it a risky strategy. Instead, consider more stable investments like real estate, which tends to be less volatile and can offer substantial returns through capital appreciation and rental income.
