Buying on margin is a method of investing money in stocks without having to pay the full amount upfront. Doing so can be extremely dangerous, but buying stock on margin can also lead to huge financial rewards, as well.
-How Buying on Margin Works-
Investors can purchase stock “on margin” by paying their broker only for a percentage of the stock they buy and then borrowing the rest of the money for the purchase from the stock broker. In order to do so the investor must put up collateral to cover the loaned money. Doing this vastly magnifies any losses or gains to the value of the stock that was bought on margin.
-Duration of Margin Stock Purchases-
Stocks that are bought on margin can be held for any amount of time as long as their margin percentage remains acceptable. If, however, the value of the stock falls dramatically, the broker may require the investor to sell some of their shares or to pay off a part of their loan. If an investor is unable to cover their margin loan with their stock broker then the broker will sell off as many shares as they need to to cover the loan.
-History of Buying on Margin-
Historically speaking the process of buying stock on margin has a dubious reputation. Many credit the 1929 market collapse which led to the Great Depression as being caused by loose regulation of margin requirements by the federal government. When an investor cannot cover their margin loan, and the shares of stock aren’t valuable enough to cover the loan when sold, then the investor is forced to give up whatever collateral they offered for the margin loan. In the case of the Great Depression this meant that many people were forcibly evicted from their homes (their collateral) when the stock that they had bought on margin was devalued to an extent where they couldn’t pay back their stock brokers.
-Benefits of Buying on Margin-
There are many potential benefits to buying stock on margin. Margin buying allows smaller investors to purchase a much larger stake in any individual company than they’d be able to afford if they were required to pay all of the money for that stock up front. It allows such people to take the equity that they’ve built up in their homes, or anything else of value that they own, and to use that money as collateral. Essentially, this allows them to invest that static money into the market at will.
-Risks of Buying on Margin-
Buying stock on margin can be extremely dangerous, especially in times of financial turmoil. If you buy a large amount of stock on margin and use your home as collateral, you’re taking a very large gamble. If the stock that you’ve bought on margin suddenly plummets in value then you could end up losing your home when your stock broker calls in the margin loan. While the federal government does have safeguards to protect investors from such losses, many argue that the safeguards aren’t strict enough and that margin buying should not be allowed. Buying a lot of stock on margin definitely isn’t advisable unless you have a firm grasp of the market and fully understand what you’re getting yourself involved with.
