Margin Can Make you Rich…or Really Really Poor

Written by The Dividend Guy on April 30, 2008

Darth Vader

What if you could double your returns on a 5% increase in stock price with no extra work? Sounds good right? That is the sales pitch you often hear from some stock brokers when they try to convince the average investor to buy stocks using margin - or borrowed money to purchase investments. When things go well, margin has the wonderful impact of multiplying your gains sometimes to the tune of doubling your returns. However, what brokerage houses don’t tell you is that when things go bad they also can double your losses and take you to the dark side.

Take a look at this chart that was published in an April edition of the Investor’s Business Digest (Insert aff link). In this chart, the first column highlights various returns an investor could see on a stock holding. The second column shows what your return would be if you do not use margin and use only the money you have to buy the stock. The third column shows what your return is if you use margin to buy that stock.

Effects of MarginClick to Enlarge

Everything looks awesome when the shares price rises. However, have a look at what happens when the stock you hold starts to turn to the dark side. If your stock tanks by -15% and you are loaded up on margin, then your actual return on the stock will be -30%. Essentially you have lost that 30% in stock value but you also have to pay back that money you borrowed to buy the stock with. When one of my holdings drops by 30% I feel dumb enough as it is (thanks Citigroup) - I don’t need to feel like a full-on dumba$$ by doubling that loss because essentially I made a bet on the stock price going up.

As long term dividend investors, margin is probably something that I would suggest we stay away from. Perhaps it has a place, but I honestly can’t think of one. Let me know if you have used margin and how it worked out for you using the comments section.


Recommended: ING DIRECT makes $aving money simple! Open your account online today and start earning 3.00% variable APY. No Fees and No Minimums!

del.icio.us| Digg| Furl| Reddit| Google| StumbleUpon| Technorati| Help|

2 Comments so far

  1. Dividend Growth Investor Carnivals, Festivals and Blogs - April 29, 2008 April 30, 2008 8:43 am

    Dividend Guy,

    If you use a smaller margin percentage like 25%, you will be wiped out not at a 50% loss, but at 80%. If you own a diversified portfolio of ETF’s and can afford to pay as little in margin interest as possible, then you might be able to come out ahead in the very long term, assuming of course that stocks continue going higher..

  2. Stefan April 30, 2008 4:23 pm

    Buying on margin is good even for buy-and-hold investors during a market correction, when many stocks are “on sale” and it’s a good opportunity to use the margin as a short-term “buffer” until you get more cash.

POST A COMMENT

If you would like to make a comment, please fill out the form below.

Name - (Required)

Email - (Required but not published)

Website - (Optional)

ENTER YOUR COMMENTS BELOW






Student Loan

www.financialwebring.com