I saw a sexy advertisement from a brokerage firm bragging about
its rock bottom borrowing rates.
"While the Fed is lending money at almost zero interest
rates, why not take advantage of it? Our company will lend $1
million at 1.3% for every $200,000 in a portfolio margin
Margin or "margin loans" allow you to buy additional securities
by borrowing money from your broker and using the value of your
brokerage account as collateral.
Here's an example:
Let's say you buy a stock for $50 and the price of the stock
rises to $75. If you bought the stock in a cash account and paid
for it in full, you'll earn a 50 percent return on your investment.
But if you bought the stock on margin - paying $25 in cash and
borrowing $25 from your broker - you'll earn a 100 percent return
on the money you invested. Of course, you'll still owe your firm
$25 plus interest.
The broker's advertisement continued:
"See our high dividend scanner for the many hundreds of stocks
that yield over five percent."
The problems of this strategy should be obvious. Even if you're
borrowing money at 1.3% and getting a much higher dividend yield
(NYSEARCA:PGF) from your stock investments, a lot can happen.
What if your stock decreases in value? For example, let's say
the stock you bought for $50 falls to $25. If you paid for the
stock with your own money, you'll lose 50 percent of your
investment. But if you bought on margin, you'll lose 100 percent
and that's not all. You still must come up with the margin interest
you owe to your bookie, I mean broker.
There are a few more caveats.
Not all securities can be purchased on margin. That means you
probably can't buy the 19% yielding penny stock your "genius"
neighbor just unearthed.
Also, in volatile markets (NYSEARCA:VXX), investors who put up
an initial margin payment for a stock (NYSEARCA:IVV) may, from time
to time, be required to provide additional money if the price of
the stock falls. What if you don't pony up the additional cash? The
brokerage firm has the right to sell securities that you bought on
margin without notifying you. And if your broker sells your stock
after the price has plummeted, then you've lost out on the chance
to recoup your losses if the market bounces back. Before opening a
margin account, keep these facts in mind:
You can lose more money than you have invested;
You may have to deposit additional cash or securities in
your account on short notice to cover market losses;
You may be forced to sell some or all of your securities
when falling stock prices reduce the value of your
Your brokerage firm may sell some or all of your securities
without notifying you to pay off the loan it made to
Contrary to how they may be sold, margin accounts can be very
risky. Even though they may appeal to sophisticated investors or
those with lots of money, there are much safer ways to achieve
higher income without putting your capital in front of a firing
squad. So far this year, our
Income Mix ETF Portfolio
, has generated over $7,700 or 7.70% in annual income, using a
portfolio of low cost ETFs. It doesn't chase yield and it doesn't
Remember: Trading on margin is only for people with a high
tolerance for risk. Even if you're borrowing money at 1.3% dividend
yields can be cut, stock prices can fall and borrowing rates can
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