Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Margin Financing====== Margin Financing is the practice of borrowing money from your [[broker]] to purchase financial assets. Think of it as taking out a [[loan]] to invest, using the cash and [[securities]] already in your account as [[collateral]]. This allows you to control more stock than you could afford with your own cash alone, a concept known as using [[leverage]]. For example, with $10,000 of your own money, you might borrow another $10,000 from your broker to buy $20,000 worth of stock. This ability to amplify your purchasing power is a classic double-edged sword. While it can magnify your profits if your investments go up, it will just as surely magnify your losses if they go down. Because of this amplified risk, most prudent investors, especially those following a value investing philosophy, view margin financing with extreme caution. ===== How Margin Financing Works: The Nuts and Bolts ===== To use margin, you can't just use a standard cash account. You need to open and be approved for a special type of [[brokerage account]] called a [[margin account]]. ==== The Initial Setup ==== Once your margin account is active, the money or securities you deposit are considered your [[equity]]. This equity serves as the basis for your loan. In the United States, [[Regulation T]] of the [[Federal Reserve Board]] generally allows you to borrow up to 50% of the purchase price of a stock. * **Example:** You want to buy $20,000 of a company's stock. * You must provide at least 50% of the funds from your own equity, which is $10,000. * Your broker lends you the other $10,000. * You now control $20,000 worth of stock, but you have a $10,000 loan and your account equity is $10,000 ($20,000 in assets - $10,000 in loan). ==== The Cost of Borrowing ==== This loan isn't free. You will be charged [[interest]] on the money you borrow, known as the margin rate. This rate is a direct drag on your investment returns. The interest accrues daily and is typically charged to your account monthly, meaning your debt can grow even if your stocks are stagnant. This creates a constant headwind you must overcome just to break even. ===== The Dangers of Margin: The Margin Call ===== The single greatest risk of margin financing is the dreaded [[margin call]]. This is the mechanism that can turn a temporary market dip into a permanent and catastrophic loss of capital. ==== Understanding Maintenance Margin ==== Brokers require you to maintain a minimum level of equity in your account to protect themselves from a default on your loan. This is called the [[maintenance margin]], often set at around 25% to 40% of the total value of the securities in the account. If the value of your stocks falls, your equity shrinks. If your equity percentage drops below the maintenance margin level, your broker will issue a margin call. ==== An Investor's Nightmare ==== A margin call is an urgent demand from your broker to bring your equity back up to the required level. You have two options: * Deposit more cash into the account. * Sell some of your securities to pay down the loan. The problem is brutal. The broker gives you a very short deadline, sometimes just a few days. If you fail to meet the call, //the broker has the right to sell any of your securities, without your consent, to cover the loan//. This forces you to liquidate your holdings at the worst possible moment—after prices have already fallen significantly—locking in your losses and destroying your ability to wait for a market recovery. ===== A Value Investor's Perspective on Margin ===== Legendary investors like [[Warren Buffett]] and his mentor [[Benjamin Graham]] have been clear and consistent in their warnings against using leverage. Buffett has famously said that there are three ways a smart person can go broke: "liquor, ladies, and leverage." ==== Violating the Margin of Safety ==== The core principle of value investing is the [[margin of safety]]—buying a stock for significantly less than its intrinsic value to protect against errors in judgment or bad luck. Margin financing does the exact opposite. It //removes// your margin of safety. Your ability to hold a wonderful business through a temporary market panic is stripped away, replaced by a fragile dependence on your broker's whims and the market's short-term mood. A temporary paper loss, which a patient value investor can endure, becomes a real, permanent loss of capital through a forced sale. ==== A Tool Best Left Unused ==== While some highly sophisticated traders may use margin for complex strategies, for the overwhelming majority of ordinary investors, it's a path to ruin. The interest costs continuously eat away at your returns, and the risk of a margin call introduces a potential for complete wipeout that you cannot control. The ultimate logic is simple: * If a company is a truly great investment, you don't need leverage to earn a satisfactory return over time through the power of [[compounding]]. * If it's a bad investment, leverage will only accelerate your losses and make a bad situation infinitely worse.