DEFINITION:
A margin account lets you borrow money from a brokerage to buy investments, using your existing portfolio as collateral. It’s like a credit card for investing—you can buy more stocks than you can afford outright, but you’ll pay interest and risk losing more than you initially invested.
WHEN AND WHY IT’S USED:
Let’s say Sarah has $5,000 in her brokerage account and wants to buy shares of a stock trading at $100 per share. With a cash account, she could buy 50 shares ($5,000 ÷ $100). However, with a margin account, she can borrow money from her broker to buy more shares.
Buying on Margin
- The broker offers Sarah a 50% margin, meaning she can borrow an additional $5,000.
- Now, Sarah can buy 100 shares instead of 50.
Potential Outcomes
- Stock Price Increases
- If the stock rises to $120 per share, her 100 shares are now worth $12,000.
- She sells all shares, repays the $5,000 loan, and is left with $7,000.
- Profit = $2,000 (excluding interest and fees), a 40% return on her initial $5,000 investment.
- Stock Price Falls
- If the stock drops to $80 per share, her 100 shares are worth $8,000.
- If she sells, she must repay the broker $5,000, leaving her with only $3,000.
- Loss = $2,000, a 40% loss on her initial $5,000.
They’re also used for liquidity. A client might need cash quickly but doesn’t want to sell investments. Margin loans provide immediate funds, though interest accrues daily.
IMPORTANCE IN ADVISOR – CLIENT COMMUNICATION:
Margin accounts require clear risk education. Clients might see borrowing as “free money” but need to understand margin calls (demands to deposit more cash if investments fall). Advisors stress that losses can exceed the initial investment.
This term also highlights the advisor’s fiduciary role. Recommending margin involves assessing a client’s risk tolerance and financial stability. For example, “Are you comfortable with a 20% portfolio drop forcing you to repay loans?”
Lastly, margin accounts can enable strategies like tax-loss harvesting without selling assets. Advisors might explain, “We can use margin to keep your portfolio intact while accessing cash for a down payment.”
CONVERSATION EXAMPLES:
Client: “I want to buy more Tesla while it’s low. Can I borrow against my current stocks?”
Advisor: “We can use margin, but if Tesla drops 30%, you’ll owe the brokerage and might have to sell at a loss.”
Advisor: “Margin lets you access $50k without selling your Apple shares, but the 7% interest rate could eat into returns.”